July 14, 2007

Knowing when - and how - to grow - by Sanjay Anandaram

“I don’t think if we’ll be able to attract him to our company as he has to take a pay-cut” is what I heard the founder and CEO of a startup say last week. He was referring to a candidate’s resume that had been sent across by a friend. The profile was terrific and seemed like the startup could certainly benefit enormously from having the candidate on board. The CEO though was troubled by the apprehension that the candidate would be unaffordable. Being cost conscious and frugal was a practiced way with this CEO and his founding team. So what is the CEO to do when he now needs experienced and specialized talent to help the organization grow?

In the period from the late 90s to the early 2000s, excess seemed to be the name of the game at startups. Fancy offices resembling space age fashion show venues, sky high salaries, perks like on-site cappuccino machines were quite common place as investors poured money into next generation internet businesses. Then the bottom fell out and everyone started talking of the virtues of being frugal and cost conscious. It is extremely hard to find a company that collapsed because it cut too much cost too fast! But a lot of investors and entrepreneurs emerging from the bust took cost consciousness and frugality to another extreme – resulting in the creation of anorexic companies. Let me explain.

Every business needs a certain threshold level of investment to first establish itself (these could including building technology, acquiring facilities & infrastructure, acquiring customer, a certain market presence and so on) and then another injection of investment to grow and scale. The initial threshold level required by a company is a function of the market, competition and the quality of the initial team. To establish the initial value proposition in the market, the company has to be careful with its money and smart about how to deploy it. It must be frugal and leverage its relationships and resources to the maximum extent possible. As the company establishes its value proposition, the technology and infrastructure need revamping to handle growth, additions have to be made to the management team, marketing spends increase and so on.

It is at this stage that the mind-set of the CEO has to adjust to the changed circumstances of his/her company. “Do I continue with the frugal approach and work my resources to the bone or do I spend money on aspects of my business that affect growth?” “Do I spend money and make that business trip to meet customers and business partners or do I stay with email?” “Do I spend money on hiring the best or do I make do with the less than satisfactory senior management?” “Do I spend money on a marketing campaign or do I hope for “viral” messaging to take place?” Investors do not invest in a company so that you can return their money unspent after 2 years. Investors invest because they want to extract value out of the company they’ve invested in. Value is created through value generating activities. Value generating activities include first and foremost, profitable sales and an increasing number of such sales. Whatever is necessary to achieve this end result must be invested in.

For example, investing in creating a top notch sales team but being smart in their incentives is certainly a good idea. Being generous with stock options coupled with operational freedom and involvement in company decision making can help attract a class of executives. In some cases, top class talent can be lured by the vision of creating (without interference) the next great company; The CEO’s passion, ability and vision to get the best for his company is put to test in such cases. The famous example of John Sculley of Pepsi being lured to the unknown Apple by Steve Jobs is worth noting here. Sometimes, it becomes imperative to pay the individual higher than market rates. In such cases, there are trade-offs to be considered. What would be the incremental gain to the company by having such individuals on board? What would be the downside of not having heavy hitting talent on your side? What is gained by way of sales, market presence, ability to hire others, time and so on?

If the incremental gains are more than incremental costs, then the decision must be taken in favour of investing. Mistakes will happen but the decision making process must not change. There are far more examples of companies, especially in India, that have under-invested themselves to oblivion than there are of companies that have splurged.

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.