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1、Forecasting&Scenario PlanningPAT GRADY&RAVI GUPTA MAY 2022The objective of this presentation is not to give a comprehensive overview of forecasting and scenario planning.This is tailored specifically to how forecasting and scenario planning come into play when the world around you is changing rapidl

2、y,as it is at the moment.Weve been living in an environment of abundance.In an environment of abundance a rational actor chooses to invest the incremental dollar.The challenge is that the world has changed.The thing that worked yesterday may not work tomorrow,which creates a problem.Today well talk

3、about what it means to build a great business,why the world changing poses a problem,and what we can collectively do about it to set ourselves on a good path.What is a great business?Most people have an intuitive sense for what constitutes a great product or what constitutes a great culture,but not

4、for what constitutes a great business.This could be because the environment were coming out of defines a great business differently than the environment were heading into.One idea that withstands the test of time is that a great business generates durably high returns on invested capital.“Durably hi

5、gh returns on invested capital”boils down into three wordsfree cash flow.SEQUOIA CONFIDENTIALIn three wordsFree Cash FlowFree cash flow is what defines a great business.What it means:Free cash flow for you as an operator means freedom.Free cash flow for your employees or your customers means trust:t

6、hey know that the company is going to be around tomorrow.Free cash flow for an investor is the definition of value.If youve ever looked at a DCF model(a discounted cash flow model),its what underlies all valuation.SEQUOIA CONFIDENTIALHow does Revenue convert into Free Cash Flow?1.Gross Margin2.Opera

7、ting Margin3.Working Capital4.Capital IntensityAt the top of this slide is revenue and at the bottom is free cash flow.In the middle are the four key operating decisions,or operating levers,that determine how effectively your business can convert revenue into free cash flow.These are things that nee

8、d to be baked into your product,your pricing,your packaging,and your distribution model.These things werent necessarily top of mind over the last years as we were operating in an environment of abundance.They should be top of mind as we head into an environment of scarcity.SEQUOIA CONFIDENTIALAtomic

9、 Units of InvestingIN WHAT ASSET ARE YOU INVESTING?Company unitOperating unitCustomer unitWe do not expect early-stage companies to produce free cash flow today.We do,however,want to encourage you to have a clear line of sight to producing free cash flow over time.One way to do that is to think abou

10、t the atomic units of investment for your business.The difference between an investment and an expense is that an expense yields no future benefit and investment yields a future benefit.At the early stages,the atomic unit may be the customer unit.Hopefully thats a very clear investment,where the amo

11、unt of money you put in to acquire and serve the customer is less than the amount of money you get back from the customer.If thats true at the unit level,you can start to roll that up into the operating unit.Maybe the operating unit level is the city,maybe its a product line,maybe its a segment,but

12、hopefully over time,the customer rolls up to the operating unit.The operating unit rolls up to the company and produces free cash flow at the company level over time.SEQUOIA CONFIDENTIALWhat does it mean to build a Great Business?StoryMetricsFinancialsValuationGreat BusinessThe financial reward for

13、building a Great BusinessThis is another framing for what it means to build a great business:The story needs to translate into a set of metrics that eventually produces a set of financials that generate free cash flow.Thats the input.The output is the valuation,which is just the reward for having bu

14、ilt a great business.The causality runs from left to right.A Path to Free Cash FlowTHE MUST-HAVE:To recap this first section:The thing that is critically important in an environment of scarcity,which we believe were heading into,is having a clear path to generating free cash flow that begins at the

15、atomic unit,and rolls up to the company level.This starts with a story that produces metrics,that produces free cash flow at some point in time.What is the problem?The environment of recent years has not rewarded a lot of thought around the path to free cash flow.The environment that were heading in

16、to is going to demand it.That creates a problem.What is the problem,more specifically?SEQUOIA CONFIDENTIALThe Tide is going OutThe tide is going out.This is the total VC money invested market-wide,year by year,for the last 25 years.If you go back to 2000 and 2001:the dollars invested in 2000 were cu

17、t in half in 2001,and then they were cut again in 2002.There was about an order of magnitude drop over a two-year period.2022 is pacing to look a lot like 2001;2023 might shape up to look a lot like 2002.So we believe we are heading into a different environment.SEQUOIA CONFIDENTIALRisk On versus Ris

18、k OffTide is In:Risk On!Innocent until proven guiltyInvest in dreamsReward growthSpend on S&MEat Sugar(VC$)Grow Fat(use$to solve problems)Tide is Out:Risk OffGuilty until proven innocentInvest in reality Reward profitabilityInvest in R&DEat Protein(Customer$)Build Muscle(use brain cells to solve pro

19、blems)When the tide is in,risk is on.When the tide is out,risk is off.When risk is on,it means that people are innocent until proven guilty and investors are willing to buy a dream.When risk is off,it means that people are guilty until proven innocent and investors want to invest in reality.When ris

20、k is on,it means that growth is rewarded and the incremental dollar spent on sales and marketing is a good investment.When risk is off,it means that people reward profitability and its a good time to invest in product and in R&D.When risk is on,you can eat sugar(venture capital money)and grow fat,wh

21、ich means using money to solve problems.When risk is off,you need to eat protein(customer money)and build muscle,which means using critical thinking to solve problems.These are two very different sorts of environments that reward very different sorts of behavior.SEQUOIA CONFIDENTIALThe Market has Ch

22、angedStoryMetricsFinancialsValuationRISK ON!RISK ON!RISK OFFRISK OFFWhen risk is on,people are willing to believe in a story or in a dream.When risk is off,people want to see financials.This is true not just of investors,but customers:they want to know that you have a durable business.Its also true

23、of employees:they want to believe that you have a sustainable business.They may want to see a liquid stock.When risk is off the connection between the story and the metrics and the financials needs to be much tighter than when risk is on.Story alone may get you most of the way there.SEQUOIA CONFIDEN

24、TIALYesterdays market rewarded excess;tomorrows will not Without a clear path to Free Cash Flow,there is no more moneyClear path:story metrics financialsClear path:customer unit operating unit company unit The ProblemThe market that were coming out of rewarded spending the incremental dollar;the mar

25、ket that were heading into probably will not.Without a clear path to free cash flow,theres probably no money available from investors,maybe not from customers,maybe not from anybody else.The clear path is translating the story into metrics into financials.Start with the atomic unit(which is probably

26、 a customer)and then roll it up into successively bigger units until you get to the company,so that its understood how the business produces free cash flow at scale.SEQUOIA CONFIDENTIALPascals WagerEven if were wrong about the market,it always makes sense to build a great business.Tide is OutTide is

27、 InBuild a Great BusinessGrow at all costsMARKET ENVIRONMENTYOUR BEHAVIORYou do not need to believe that were right about where the market is going to believe that the best plan of attack is to focus on free cash flow,and that the path to free cash flow is to build a great business.Regardless of the

28、 market environment,it is a good idea to build a great business.If we are right that the tide is out,then,then you definitely want to focus on the path to free cash flow.What is the solution?So:what is the solution?Optimize for long-term market leadershipsubject to the constraints of realityOBJECTIV

29、E:The objective in forecasting is to optimize for long-term market leadership,subject to the constraints of reality.Optimizing for long term market leadership means building a great business,which means producing free cash flowbecause thats what allows you to sustain your operations and invest in in

30、novation for the future.In this section well discuss the constraints of reality and specifically how reality is changing.SEQUOIA CONFIDENTIALReality has ChangedSpendingTalentFundingThere are three legs to the stool:spending,talent,and funding.SEQUOIA CONFIDENTIALSpending RealityEnterpriseRevenue Gro

31、wthOpexCapexConsumerInterest Rates:mortgage paymentsInflation:gas pricesPropensity to consumeBusinesses are facing either drops in revenue or declines in revenue growth.That puts pressure on their business,which means theyre revisiting operating assumptions and OPEX.In many cases theyre pausing capi

32、tal investments and reducing CAPEX.On the consumer side,propensity to consume is going down.Rising interest rates mean that the house somebody wanted to buy a year ago now costs them three times as much.Not because the price of the house went up by 3x,but because their monthly mortgage payment just

33、went up by 3x.Inflation means that somebody who had to spend$80 to fill up their tank last year is spending$200 to fill up this year.Thats$120 worth of stuff that they cant buy anymore.SEQUOIA CONFIDENTIALSpending RealityEnterpriseRevenue GrowthOpexCapexConsumerInterest Rates:mortgage paymentsInflat

34、ion:gas pricesPropensity to consumeTheir Spend is Your RevenueTheir spend is your revenue.This is why revenue forecasting assumptions that were good and valid last year may not hold next year.SEQUOIA CONFIDENTIALFunding RealityAVAILABILITYPRICENASDAQ Composite IndexTEV/NTM RevThis is the funding rea

35、lity.On the left is the availability of capital.On the right is the average trading multiple for the NASDAQ composite index over the last 30-ish years.You can see a spike around the internet bubble,and a spike around the COVID bubble.We suspect that over the next couple of years,both the availabilit

36、y and the price of money will be very different than theyve been for the last couple of years.That may not yet be true today so today may be an excellent time to raise one last round before we head into what might be a prolonged contraction.SEQUOIA CONFIDENTIALReality has ChangedYour Plan has Change

37、dREALITYPLANSpendingRevenueTalentCostFundingProfitReality has changed,which means that your plan has changed.Their spending is your revenue.Talent is your cost,funding is your need for profitability.SEQUOIA CONFIDENTIALPlanning During Uncertain Times OUT OF YOUR CONTROLIN YOUR CONTROLINPUTREVCOSTOUT

38、PUTPROFITHere is a way to think about planning in uncertain times:Start with an input thats out of your control,like revenue.Figure out some revenue scenarios and then move to the cost part of the equation,which is in your control.Then move to the profit part of the equation,which is the output.The

39、objective function is to be able to fund your future.SEQUOIA CONFIDENTIALSpending Reality Revenue PlanABILITY TO PAYDESIRE TO PAYHighLowHighLowThis is one conceptual framework for thinking about spending.There are two dimensions to consider:1)desire to pay(how much do the customers love your product

40、 or want your product?)and 2)ability to pay(can the customers afford your product?).In an environment of abundance,all the yellow converts into revenue.In an environment of scarcity,all of that yellow goes away.SEQUOIA CONFIDENTIALSpending Reality Revenue PlanENTERPRISECONSUMERDesire to PayUnique&Co

41、mpellingGross MarginMagic NumberAcquisition&Engagement/RetentionOrganic as a%M12 User Retention80%+60-80%60%$2.00+$1.00-2.00$1.0090%+50-90%50%40%+20-40%20%Here are some quantitative benchmarks:Green is good in any environment.Yellow is good in an environment of abundance,but maybe not so good in an

42、environment of scarcity.Red is not so good in any environment.Wed be happy to go deeper with founders on the benchmarks that may be more relevant to your specific business.SEQUOIA CONFIDENTIALSpending Reality Revenue PlanENTERPRISECONSUMERAbility to PayAbility to paythese pyramids mean different thi

43、ngs:On the enterprise side,the top represents the small number of very high value customers,and the bottom represents the large number of very low value customers.Big companies that generate cash tend to be reliable customers.Small companies that do not generate cash tend to be unreliable when the t

44、ide goes out.On the consumer side,think about this as Maslows Hierarchy:if youre at the base of Maslows Hierarchy addressing a fundamental need,then your customers will have relatively high ability to pay as you head into a recessionary environment.If youre at the tip of Maslows Hierarchy,doing some

45、thing thats more of a luxury product or a nice-to-have,then your customers ability to pay may go away in an environment of scarcity.SEQUOIA CONFIDENTIALSpending Reality Revenue PlanGOODBADEnterprise Examples$60 Billion$200 MillionHere are a couple of examples on the enterprise side.If you go back to

46、 the Internet bubble.Microsoft performed exceptionally well during 2000-2001.Their growth rate and free cash flow margin ticked down a bit,but they just kept chugging along.They were selling a must-have product largely to big customers.At the other end of the spectrum,there was a there was an organi

47、zation called Internet Capital Group,which was essentially a conglomerate of B2B marketplace businesses that would raise money from venture capitalists and then spend that money on each others products.When that money dried up,their ability to spend on each others products dried up,and all of the re

48、venue dried up.An organization that peaked at$60 billion of market cap during the bubble and dropped to$200 million about 18 months later.This is a stark example of a company that was selling must-have products to good customers versus a company that was selling nice-to-have products to bad customer

49、s.SEQUOIA CONFIDENTIALSpending Reality Revenue PlanConsumer Examplesh/t Bryce Kam,SCGEOn the consumer side,heres a look at what happened during the global financial crisis in 2008-2009.Walmart and Amazon were selling consumer staples.They performed reasonably well during that period.Expedia and Will

50、iams Sonoma,by way of comparison,shrunk in 2009.Travel and fancy home goods are luxuries,and people tend to cut those first in a recessionary environment.SEQUOIA CONFIDENTIALSpending Reality Revenue Plan3 Sets of Questions to Ask Yourself1.Desire to PayHow strong is our product/market fit?Where is i

51、t evident in our numbers?2.Ability to PayWho are my customers?Are they going to survive?Is my spot in their budget going to survive?3.Benchmarks What examples from 2000/2001 or 2008/2009 are relevant to me?What current public companies should I be watching?There are three sets of questions that you

52、might want to ask yourself when youre thinking about how spending changes convert into revenue:The first is around desire to pay.The second is around ability to pay.The third,trying to quantify the first two,is to look at benchmarks from companies similar to yours and see how they performed during t

53、he Internet bubble,during the global financial crisis,or how theyre performing today.We would encourage you to look in these places for benchmarks to help convert the qualitative aspects of this into numbers.SEQUOIA CONFIDENTIALPlanning During Uncertain Times OUT OF YOUR CONTROLIN YOUR CONTROLINPUTR

54、EVCOSTOUTPUTPROFITOnce you have some revenue scenarios,you can start to map them into your cost structure.SEQUOIA CONFIDENTIALTalent Reality Cost PlanBUILD MUSCLER&DCUT FATCOGS S&MG&AOverall,we would encourage you to think about building muscle and cutting fat.This is counterintuitive because a lot

55、of people would think,“Sales and marketing pays for itself,therefore,Ill invest in sales and marketing.”We encourage you not to do that.The reason is,long term,the best product tends to win,and that is more true in an environment of scarcity than in an environment of abundance.We would encourage you

56、 to keep investing in the product side of your business,and if you need to cut something try to cut it out of COGSsales and marketing,and G&A.SEQUOIA CONFIDENTIALTalent Reality Cost Plan1 Exercise to DoHIGHRough DiamondFuture StarConsistent StarMEDIUMInconsistent PlayerKey PlayerCurrent StarLOWTalen

57、t RiskSolid ProfessionalHigh ProfessionalLOWMEDIUMHIGHPERFORMANCEPOTENTIALHeres one exercise you can do with your team.If youre if youre a small team,you can do this yourself.If youre a large team,you could do this with their respective organizations.Its called a nine box.It plots people across two

58、axes of performance and potential.In an environment of abundance,you can afford to make the incremental investments in people who land in these yellow boxes.In an environment of scarcity,you may choose not to make that investment,and focus all of your time and energy on the people who are in the gre

59、en boxes.SEQUOIA CONFIDENTIALPlanning During Uncertain Times OUT OF YOUR CONTROLIN YOUR CONTROLINPUTREVCOSTOUTPUTPROFITOnce we have revenue and cost we we get to profit.SEQUOIA CONFIDENTIALFunding Reality Profit PlanFund Our Future“Go FOF Yourself”OBJECTIVE:36 MONTHSFULLY FUNDEDThe objective on prof

60、itand this is meant in a lighthearted wayis to go FOF yourself,which means to“fund our future.”A good outcome would be fully funded.For an earlier stage company that may not be plausible,so wed encourage you to think about at least 36 months of runway.Why 36 months?Theres no magic to that number,but

61、 during the Internet bubble,it took about three years before it felt like we were back to a reasonably normal funding environment.SEQUOIA CONFIDENTIALREVENUE SCENARIO ADown 0%REVENUE SCENARIO BDown 25%REVENUE SCENARIO CDown 50%COST PLAN ADown 0%3+YRSRUNWAY3 YRSRUNWAY3 YRSRUNWAYCOST PLAN BDown 25%FUL

62、LYFUNDED!3+YRS RUNWAY3 YRSRUNWAYCOST PLAN CDown 50%FULLY FUNDED!FULLY FUNDED!3+YRSRUNWAYOUT OF YOUR CONTROLIN YOUR CONTROLFunding Reality Profit PlanScenario Planning MatrixThis 9 box brings everything together.It saysStart with the things that are out of your control and create a few discrete scena

63、rios around what you predict your revenue may be.We dont know if down 0%,25%50%are the right numbers for you.Come up with your numbers using the exercise we did earlier around desire to pay and ability to pay.Look at benchmarks.Once you have a few revenue scenarios,think about what is in your contro

64、l,which is your cost plan.Again,we dont know if down 0%,25%,50%are the right numbers for you.You can do the nine box exercise around building muscle and cutting fat,and come up with your own discrete scenarios.The resulting output is your runway.If you end up with a few scenarios where youre fully f

65、unded,its ideal.Shoot for fully funded or 3+years of runway.Start with a scenario that has fairly conservative assumptions,where youre in the green or at least in the yellow on the things that are in your control.Monitor your progress weekly or monthly,and if and when you see your company outperform

66、ing that scenario,unlock some increments.Have defined trigger points to unlock more spend.Be tough on what metrics need to happen to unlock dollars.SEQUOIA CONFIDENTIALSummaryGreat Businesses generate Free Cash Flow.If you want to build a great business,you need a clear line of sight to generating F

67、CF.Yesterdays market didnt reward FCF.Tomorrows will demand it.Even if were wrong about that,you have little to lose and much to gain if you act accordingly.Your plan is no longer valid because the world has changed.Come up with revenue scenarios and then match your costs to those scenarios to achie

68、ve financial freedom.Go FOF yourself!Remember,this is your moment.You do have the ability to go“fund your future.”We believe the world is going to change.The revenue forecast for the vast majority of companies is going to come down,and you cant just go and buy growth right now.Ultimately you need a free cash flow story.Yesterdays market was the blip.That was the anomalytoday is the durable reality.Thank you.