For Annual Planning, Investing Beats Budgeting

Just like dental work or pulling weeds, annual planning is something we know is painful yet necessary. Obviously, budgeting helps companies predict their cash needs. Less obviously, budgets, and even just the act of building them, are critically important for aligning internal teams on strategy, prioritizing initiatives, attracting capital, and setting the right targets to measure and manage against.

Having spent the better part of a decade working in corporate financial planning, I can tell you that the traditional budget process is a relic optimized for a world we no longer live in.

A typical budget cycle involves department heads, corporate executives, and financial analysts. As a starting point, an analyst will trend a department’s revenues and expenses forward based on their own assumptions of momentum and seasonality. They may assume that certain expenses will grow as the company grows (e.g., increasing hiring for customer support as sales increase), and that others will remain mostly fixed (e.g., rent for the corporate headquarters staying roughly the same, even as the company grows a bit). Department heads and finance then play a game of tug-of-war over headcount increases, premium software subscriptions, revenue targets, and travel budgets before settling on something that is often a modest increase over their current sales and spending. After all, nobody gets in trouble for approving a six percent year-over-year budget increase.

Traditional management structures and their procedural components emerged and excelled at a stage in our industrial evolution where market disruptions were gradual and the nature of work was more consistent and routine. Consequently, they struggle in today’s age of rapid innovation and extreme interconnectedness. For modern corporations, who are under incredible pressure to innovate and whose activities span many different functional, industry, and geographic domains, traditional frameworks and processes inhibit their ability to stay nimble and solve complex problems ^[1].

Planning, and measuring against that plan, should stay, but the way we go about it needs an update.

Budgeting Like An Investor

Zero-based budgeting, beyond budgeting, better budgeting, and activity-based budgeting are just a handful of the more recent and popular methodologies that strive to move past the traditional process in favor of something more dynamic. While they have their differences, the core concept underlying each is that planning should resemble an investing process.

Venture investing is different than traditional budgeting in that funding rounds start from first principles, where investors evaluate teams, plans, markets, and risks to comprehensively understand an opportunity. When done properly, goals are defined such that they are clear and measurable, but not overly prescriptive and rigid. While an annual forecast is typically put in front of a board of directors, venture backed startups aren't tightly managed to each individual expense line. Instead, they are primarily evaluated on their ability to hit their targets on key performance indicators (KPIs) such as user growth, monthly active users, customer churn, top-line sales, gross margin, and cost per acquisition, while keeping their overall spending to appropriate levels to optimize return on investment (ROI). This way, startups know what their mandate is from their investors and they have considerable autonomy and flexibility to adjust their strategy as they evolve and conditions shift. On the other side, investors stay focused on only the most important measures of success and avoid micromanaging their portfolio.

Investment-based Budgeting In Action

Founded in 2014, ConsenSys is a multinational blockchain company building enterprise applications, developer tools, and more. In addition to developing innovative Ethereum tech, Joseph Lubin, the company’s founder, wants to develop innovative self-organizing managerial practices that embody blockchain’s decentralized principles. Accordingly, the company refers to itself as a “mesh” of interconnected, yet meaningfully autonomous teams and individuals.

In 2019, we piloted “Mesh Fund” to arm ConsenSys with a modern budgeting process tailored to its unique org structure. Members of finance and other executives acted as partners in this internal fund, and top-level teams petitioned to get access to capital, internal authority, rights to use the ConsenSys brand, and access to internal services. Those top-level teams could then reallocate their resources into subordinate units through a similar, recursive process. Here how the whole thing worked:

1

Petitioners prepared a presentation that covered their team’s: purpose and mission; realistic operating goals; execution plan; financial plan; key risks; team composition and governance structure (who’s on the team and how they make decisions); and resource requests.

2

A panel of subject matter experts that covered a diverse range of functional areas was assembled to advise the petitioner in their preparation and to evaluate their final pitch.

3

In a video conference (open to the entire company) the petitioning team presented for an hour then answered questions for another hour. Panel members asked two to three questions each, followed by more questions from anyone else in attendance (asked via Sli.do, in the order of most upvoted). The video from the meeting was recorded and shared with those who couldn't make it.

4

Feedback (required from panel members, but optional for others) was collected and synthesized into a summary that was shared with the CEO and the petitioners. Typically this feedback focused on the pros and cons related to the market opportunity, business model, strategy, team qualifications, and risks to ConsenSys, as well as suggestions on follow up work and recommendations for next steps. The CEO considered the feedback before making a decision on how to proceed.

5

Mesh Fund worked with the CEO and petitioners to draft a suitable mandate agreement that covered:

Scope: Outlining the high-level purpose of what the petitioning team exists to accomplish;

Financial commitments: Including revenue requirements, maximum burn amounts, and spending limits (e.g., max $40k/month for travel);

Operating commitments: Specifying various operating obligations specific to each petitioner (e.g., performance requirements related to churn, customer satisfaction, and employee utilization);

Cultural commitments: Clarifying how the petitioner must act within the company (e.g., participate in various company events, treat others with respect and kindness, operate with integrity, and provide exceptional customer service);

Reporting commitments: Laying out what regular reporting the petitioner must submit weekly, monthly, and quarterly (e.g., customer satisfaction, user growth, and site uptime metrics);

Internal authority & domain: Detailing what unique powers and rights the petitioner has internally (e.g., exclusive rights to contact external customers in the entertainment industry);

Support: Confirming service levels of support from various internal teams (e.g., SLAs detailing brand design, content creation, and online advertising support from the marketing team); and

Oversight: Detailing how the team is to be held accountable (more on this in #7).

To add flexibility and mitigate risk, any of these conditions were allowed to be adjusted at any time by the CEO. Mandate agreements weren't meant to be a binding legal agreement, even though they may have felt that way. Rather, they were intended to be a clear memorandum of understanding.

6

Once both parties agreed to the conditions, the mandate agreement was signed and uploaded for anyone inside the company to see on a shared drive. The petitioning team would then be considered a Mesh Fund portfolio team.

7

The portfolio team would then be managed and evaluated per the oversight conditions set forth in the agreement. Similar to the way a venture fund checks-in with portfolio companies, this typically meant that a Mesh Fund analyst was designated to consolidate all reporting materials, compile a scorecard that detailed how the team did in complying with all of their various commitments, and conduct a review with the team and other stakeholders to dig deeper into the subjective measures of performance. The outputs were shared with corporate executives and senior personnel inside of Mesh Fund who could decide whether or not some type of intervention was necessary (e.g., adjustments to commitments, personnel changes, comp increases, and strategy tweaks).

So How’d It Go?

In all of the important ways, the pilot was a success. First, by focusing intensely on the fundamental purpose of a team and the relevant KPIs, and establishing only the necessary, essential boundaries in a clear document, we made expectations for teams exceptionally clear. This allowed teams to be nimble and autonomous, while still remaining highly aligned and accountable. It also made the management of these teams simpler and more effective by keeping oversight focused on measuring the most relevant indicators of performance.

Second, by thinking of the resource allocation as an investment made to achieve some defined purpose, ConsenSys evaluated budgets from first principles. This prevented us from using a prior year’s annual financial performance as the justification for the perpetuation of any activities.

Third, by assembling a diverse panel of subject matter experts and inviting the entire company to view the presentation, ConsenSys received higher quality questions and feedback, and more meaningfully embodied one of its core values, “radical transparency”. Even after the mandate agreement had been signed, ConsenSys employees benefited from their thorough understanding of what various teams existed to do, how they do them, and why.

Nothing is perfect however, and we noticed that this was a slower, heavier process early on. While we'd surely get faster and smoother with practice, trade offs related to speed, transparency, and managerial control will need to be weighed and balanced.

Mesh Fund isn’t meant to be copied by every company. Instead, I encourage you to take inspiration from the design and iterate on a process that feels right for your organization. If you do, I'd love to hear about it and drop it in the comments below.

¹Lee, Michael Y., and Amy C. Edmondson. “Self-Managing Organizations: Exploring the Limits of Less-Hierarchical Organizing.” Research in Organizational Behavior 37 (2017): 35–58.

This guest blog is written by Rob Solomon. Rob is the founder of Cone, which builds solutions that enable decentralized organizations. His background is in corporate finance, operations, and organizational design for decentralized companies.