Introducing “BOB”: the Bessemer Optimal Budget
Best Practice Budgeting
By Jeff Epstein & Byron Deeter
Bessemer Venture Partners
“How aggressive should we be when we set our budget?”
This is one of the most common questions CEOs and CFOs of our portfolio companies ask us as they plan
their budgets for the New Year.
They want to grow their companies as fast as possible and invest in exciting new programs. However, if they
aim too high, missed budgets can damage credibility and lead to dangerous cash shortfalls.
On the other hand, if companies aim too low, they may grow too slowly, leave the door open for competitors
and risk lower valuations on their next round of financing.
What’s the best way to balance these competing goals?
-----------------Drawing from practical experience with hundreds of early stage companies through the years, our team at
Bessemer Venture Partners has developed a practical set of budgeting best practices to address this
challenge for companies with over $5 million in annual revenue.
We call it BOB – The Bessemer Optimal Budget.
---------------BOB’s core principle is recognizing probabilities in budgeting and forecasting.
For example, a company can set:



An aggressive budget it expects to achieve only 30% of the time, or
An “expected case” budget it expects to achieve 50% of the time, or
A conservative budget it expects to achieve 70% of the time.
It can then measure the actual results. For instance:


If a company achieves its budget in 5 out of 10 quarters, it’s achieving a 50% BOB.
If 5 out of 10 Bessemer portfolio companies achieve their budgets this year, they’re achieving a 50%
BOB.
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Going a level deeper, BOB has four components, as described below:
Best Practice Probability of Achievement
1.
2.
3.
4.
Sales Plan & Marketing Plan
Revenue Budget & Revenue Forecasts
Cash Budget & Cash Forecasts
Wall Street Guidance – first year
30%
50%
70%
90%
BOB – Core Components and Setting Targets using Probabilities
One: BOB Sales Plan and Marketing Plan
Recommended target: 30% probability of achievement
Revenue consists of New Revenue and Recurring and Upsell Revenue.
Fast growth is the lifeblood of venture-backed companies. Fast growth requires New Revenue from new
customers, new marketing channels, new distribution partners, new products. All of these are risky.
Yet companies must invest in these risky new plans. At Bessemer, we want our companies to dream big and
to invest sensibly to achieve their dreams, in spite of the risks. Many of our companies reach their
impressive goals, and with luck and hard work, some reach goals they never thought possible.
Other companies hit roadblocks along the way: customers delay buying, marketing experiments fail, new
products are delayed.
We encourage our companies to aim high. Even if they don’t succeed, they often achieve more than they
would have achieved with more modest plans.
As a result, the BOB Sales Plan for New Revenue, recognizing the inherent risk, has a 30% probability of
achievement.
Likewise, for companies where revenue is generated by Marketing, not Sales, the BOB Marketing Plan for
New Revenue has a 30% probability of achievement. Companies where both Sales and Marketing generate
revenue will have both a Sales Plan and a Marketing Plan.
Sales VPs will often assign individual quotas to their salespeople which add up to 10% more than their Sales
Plans. This leaves room for some level of potential underperformance and attrition at the salesperson level.
CMOs will often do the same, assigning goals to each marketing program which add up to 10% more than
the Marketing Plan.
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Two: BOB Revenue Budget:
Recommended target: 50% probability of achievement
Andy Grove, in High Output Management, points out that in professional sports, which is highly competitive,
optimized and measured, 50% of the players win every game, and 50% lose.
We believe a Revenue Budget with a 50% probability of success, as in sports, is a best practice.
To achieve this, best practice companies start with the Sales Plan and/or Marketing Plan, then build in a
cushion for unforeseen delays and surprises. Then they add Recurring and Upsell Revenue from existing
customers, which is more predictable than New Revenue.
Overall, best practice companies set their Revenue Budget at the “Expected Case” – in other words, they
achieve their Revenue Budget 50% of the time.
Three: BOB Cash Budget
Recommended target: 70% probability of achievement
The CEO’s job is to dream big and achieve those dreams.
The CFO’s job is never to run out of cash.
It’s usually easier to achieve budgeted expenses than budgeted revenues, but even here, surprises can
develop. Important customers may require extra R&D investment and customer support, unexpected
employee turnover may lead to extra recruiting, training and temporary employee costs, technology
transitions may result in higher costs of operations.
Offsetting this, venture backed companies often can’t recruit all the high quality employees as fast as they’d
planned, so employee costs may be somewhat under-budget.
A 50% probability of achieving the Revenue Budget combined with possible expense surprises creates too
much risk for venture-backed CEOs and CFOs, who want to insure that their cash burn, measured in dollars,
and their cash runway, measured in months, at least meets their plan.
Best practice CFOs have a solution for this: the Reserve. The Reserve is budgeted as an expense line, in
reserve for unforeseen expenses or revenue shortfalls. The amount of this reserve should be sufficient for
the company to achieve its BOB Cash Budget 70% of the time.
This gives the CFO, CEO, Board, and shareholders confidence that the company has the cash resources it
needs to survive and prosper.
Together, the Revenue Budget, Expense Budget and Cash Budget comprise The Budget. This is the plan
approved by the Board; the company reports monthly and quarterly results compared to this Budget.
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Four: Going Public – Wall Street Guidance
Recommended target: 90% probability of achievement
As companies prepare to go public, they add another key metric: Wall Street Guidance. Guidance is
typically more conservative than the Budget. According to JP Morgan’s analysis of 203 recent technology
IPOs, companies achieved their first and second quarter post-IPO revenue “Street estimates” (which are
based on Guidance) over 90% of the time.
When Credit Suisse reviewed 534 technology companies which went public since 2005, they found that
companies achieved their revenue “Street estimates” 73% of the time.
In other words, public companies guide to a 90% achievement level in their first year post IPO, then guide to
about a 70% achievement level in later years.
BOB – Best Practices and Caveats:
Best Practice: Build Updated Quarterly Forecasts
The Budget, once approved, never changes, but the world does change.
Best practice companies build updated forecasts quarterly to account for these changes since their budgets
were approved. Many companies issue forecasts monthly when conditions are changing quickly. Large
companies such as Oracle issue updated forecasts weekly as part of their rigorous management practices.
Best practice forecasting uses the same 30%/50%/70% probabilities as BOB, updated with new information.
For instance, after Q1, the full year Cash Forecast will include Q1 actuals, plus an updated Q2 – Q4 forecast
based on all newly available information and judgments, with an updated Reserve to reach a 70% probability
of achievement.
Best Practice: Link Bonuses to Plans
Best practice sales executives’ bonuses are based on achieving their Sales Plans. Sales Plans will not be
achieved every year.
Nevertheless, top quality sales leaders will achieve their plans often enough, and when they do, are likely to
be the highest paid executives in the company.
Bonus formulas are ramped, so sales leaders are paid well whenever they grow New Revenue quickly, even
if they fall short of their Sales Plans.
In much the same way, marketing executives’ bonuses are based on achieving their Marketing Plans.
Best practice bonuses for other executives and employees are tied to the BOB. Often, bonuses are paid
50% based on achieving the BOB Revenue Budget and 50% based on achieving the BOB Cash Budget.
Many companies pay bonuses for achieving specified operating goals, including year-end MRR (Monthly
Recurring Revenue), customer renewal and upsell rates and customer satisfaction rates.
Often the Cash Budget part of the bonus is adjusted to account for extra investments specifically approved
by the Board of Directors during the course of the year.
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Many companies pay “above target” bonuses for executives and sales leaders when they achieve “above
target” results.
Best Practice: Avoid Q4 Optimism Bias
At Bessemer, we’ve seen quite a number of budgets with reasonable revenue budgets for Q1 and Q2, with a
little extra revenue thrown in at Q3 and a big jump in Q4.
After all, companies often budget to ramp up hiring and marketing investments early in the year, hoping
they will pay off by Q4.
Companies which achieve their Revenue Budgets in Q1 through Q3 and miss in Q4 may even feel they’re
planning effectively, by achieving budget in 3 out of 4, or 75%, of the quarters.
Leaders and Boards of Directors who believe this are deceiving themselves. The most important revenue of
the year is the revenue run-rate at year-end, which establishes the base for recurring revenue the following
year.
Best practice companies achieve their Q4 Sales Plans, Marketing Plans, Revenue Budgets, Expense Budgets
and Cash Budgets at least as often as their Q1-Q3 plans.
Best Practice: Use BOB for Bookings
Many companies sign binding agreements with customers in one period which lead to material revenue in
later periods. In this case, “Bookings” becomes the key metric instead of “New Revenue”.
The BOB for Bookings replaces the BOB for New Revenue, and has a 30% probability of achievement.
Likewise, individual sales quotas for Bookings total 10% more than the BOB for Bookings.
Best Practice: CEO and Board Discussion about Budget Probabilities
BOB is one of the best ways to balance growth with predictability, but it’s not the only way. Bessemer
recommends that CFOs explore several budget scenarios with their CEOs and specifically discuss
probabilities of various outcomes.
At first, this may be uncomfortable, because CEOs are paid to be optimistic while CFOs are paid to be
pessimistic: CEOs are likely to believe an outcome has a 70% probability, while CFOs will have a lower,
more conservative, view.
It’s especially important to have the probability discussion with your Board. You may even want to survey
the Board before the discussion, to determine their probability expectations for meeting revenue and cash
budgets.
Don’t be surprised if you learn your Board members have widely varying probability expectations. If so, it’s
even more important to discuss this with your Board and to reach agreement on the optimal budget
probability for your company.
Conclusion:
Companies with BOB: The Bessemer Optimal Budget can have their cake and eat it too.
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They grow as fast as possible, investing heavily in exciting new programs.
At the same time, they under-promise and over-deliver their Cash Budget.
Exhibit 1: Sample Budget and Probabilities
Million $
Notes
1
Assigned Sales Quotas & Marketing Plans
New Revenue or Bookings
10% more than # 2
2
Sales & Marketing Plan
New Revenue or Bookings
Probability of Achievement BOB Budget
$
5.5
30%
$
5.0
50%
50%
50%
$
$
$
4.0
6.0
10.0
50%
$
$
$
12.0
1.0
13.0
70%
$
(3.0)
Budget:
3
4
5
Revenue
New Revenue
Recurring & Upsell Revenue
Total
6
7
Expenses
Expenses
Reserve
Total Expenses
8
Operating Income (Loss)
Row 5 - Row 6 - Row 8
Row 6 + Row 7
Feedback:
We’re interested in your feedback. If you implement BOB at your company, let us know how it’s working
out, what benefits you’ve found and what obstacles you’re facing. If you have a story you’d like to share, a
budgeting or forecasting Best Practice, or any comments, suggestions or questions, feel free to email Jeff
Epstein at [email protected].
Credits:
Thank you to JP Morgan and Credit Suisse for their review and analysis of public company performance
compared to Wall Street guidance.
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