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Episode 19

The Rule of X: The Art of Setting Ambitious and Attainable Targets

Episode details

This week on the Expert Voices podcast, Randy Wootton, CEO of Maxio, speaks with Jeff Epstein, Operating Partner at Bessemer Venture Partners and a distinguished figure in the business and finance sectors. Randy and Jeff discuss the rationale behind budgeting, emphasizing its role in predicting financial futures, resource allocation, motivation, and maintaining fiscal discipline with investor funds. Jeff talks about the recent introduction of the Rule of X by Bessemer Venture Partners, examining the balance between growth and profitability. Jeff also shares pragmatic wisdom from his time at Oracle about setting realistic yet ambitious targets and flourishing within set constraints.


Randy Wootton
Randy Wootton
CEO, Maxio
Jeff Epstein
Jeff Epstein
Operating Partner, Bessemer Venture Partners

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Video transcript

Randy Wootton (00:04):

Hi, this is Randy Wootton, CEO of Maxio and your host of SaaS Expert Voices, the podcast that brings the SaaS experts to you to help us understand where we are today and what's happening tomorrow. Today I'm really honored to have Jeff Epstein join us, who's been in the business world for 40-something years and has had this incredible career spanning lots of different roles, primarily as a finance guy, multiple times CFO, we'll talk a little bit about that in a second. But for the last 13 years, has been at Bessemer Ventures Partners, one of the really best VCs out there who publishes an enormous amount of thought leadership in terms of SaaS and thinking about SaaS. They've invested in some of the best companies and actually, the inventors of the Rule of 40 and now the Rule of X.


And so Jeff, I've really enjoyed following you over the years and I appreciate you being here on our podcast.

Jeff Epstein (00:56):

Randy, it's a pleasure to be here. Thank you very much.

Randy Wootton (00:59):

Great. And so just with your background, I think I counted, it was four times CFO, and Oracle for three years. Is that correct?

Jeff Epstein (01:07):

That's right.

Randy Wootton (01:08):

Do you have a favorite story from Oracle? Everybody thinks of Oracle as just one of those just companies that have redefined technology and being the CFO must have just been an incredible opportunity to see the trends playing out. Is there one story you think of about Oracle that you'll keep for the rest of your life?

Jeff Epstein (01:29):

There are a lot of stories. One of my favorites is when I was in a meeting with Larry Ellison and Thomas Kurian, who at the time ran software engineering at Oracle and now he's running Google Cloud, and Larry was talking about a new project that we wanted to be done and it was going to cost about $50 million a year. And so they agreed that they were going to do it and Larry said, "Okay, let's go." And Thomas said, "Okay, but I need $50 million more budget." And Larry said, "Thomas, you have a $3.5 billion budget. Find the $50 million."

Randy Wootton (02:03):

I wish I had that problem.

Jeff Epstein (02:06):

I thought that was a pretty good leadership lesson about you got to get things done within the constraints that you have.

Randy Wootton (02:12):

Well, that's actually a perfect segue for today's conversation, Jeff. I think we're going to talk about two things. One is setting a budget and we will put a link to the article that you wrote on this in the show notes, but I just want to talk through it. I thought some of your insights were great and both having been at large companies but really over the last 13 years and having been on multiple boards of early stage companies, helping to give guidance to CEOs and CFOs in terms of how to set up a budget, that ultimate agreement with the board in terms of the results you're going to deliver. So that'll be one topic.


And then the other one, which I hope to get into given the time, is just the evolution of the role of CFO and what you saw during your time and then again over the last years that you've been on boards, how that has changed. And so I'm really looking forward to it, but starting with a budget, maybe just back up a little bit. It sounds like a goofy question, but why do companies build budgets? It's like this prediction of the future. You don't really know what's going to happen, but there's an obligation to do it every year. It's a scramble exercise for the entire team, but what's the broad remit of why you think it's a good exercise and what are people trying to accomplish?

Jeff Epstein (03:23):

That's a key question to ask. Why have a budget at all? Because when you develop the budget you want to make sure you're achieving the goals of having the budget. The first thing is to predict the future. So you'd like to know what the future is going to hold to the extent you can. Are you going to run out of cash or you need to raise more capital? How many people will you need to hire? So part of the budget is simply a relatively accurate prediction. Secondly, it's a resource allocation function. So we're going to hire 100 people, how many engineers? How many salespeople? How many people in marketing? If you don't have a budget, everyone wants everything and you need to make trade-offs. And so the budget is a forcing function so the leadership team can get together and say, "We can't do everything. We have to have certain resources here in certain areas." You're not going to get everything you want.


And then the other is motivate people. It's a way of keeping score. It's like in a basketball game, "Are we winning the game?" So if you have a budget and every once in a while you achieve it, you can accomplish it and people feel good about it if things are going well. And that's often tied to compensation. So often an annual bonus is tied to the budget, which is motivating if it works, and perhaps demotivating if you don't make the budget.

Randy Wootton (04:41):

Yeah, I look forward to picking each of those apart a little bit more detail. I think the other one in your article, which I feel especially in this time where lots of companies are declining or they're not meeting the growth targets, is the budget is in some ways an expense envelope with specific expectations around EBITDA i.e cash to be able to pay off your loans if you have interest, which is the new reality for many of us. But also, I think there's this... And you had written about this, I'm just emphasizing this idea that you are often in a VC/PE-backed world, you're using other people's money and that cash, you have to be able to show is being deployed, to your point, effectively in terms of investment. But also, at what point do you pull the plug?


And I think having alignment with the board out of the gate each year and saying, "This is the profile that we're going to operate within," allows everyone to understand, "Are we still tracking towards our overall objectives of shareholder value creation?"

Jeff Epstein (05:41):

Exactly. And one way to think about that is the trade-off of growth versus profitability. If we spend more money, we'll either have lower profits or actually have a loss or cash flow negative, but we hope to grow faster. If we are more conservative, spend less money, we're going to grow more slowly. And the question is, what's the optimal level for our company at this point in time?

Randy Wootton (06:03):

So let's talk a little bit about that. I do want to come back to budgets don't exist in and of by themselves, but they have to be aligned to strategy. But you open the door, you guys are the inventors of the Rule of 40. You've now come out with this new idea of the Rule of X that really puts a premium on growth versus EBITDA margin. Everybody wants to know, "What is the percent trade-off that I want to have between growth and EBITDA?" Do you have any rules of thumb that you've used as an investor and sitting on many boards to just help our audience think about that more than just you got to hit the Rule of 40 or now the Rule of x?

Jeff Epstein (06:37):

Yes, I do. The Rule of X is something that Bessemer has just written about this last year. The Rule of 40 actually comes from Vista Equity, which was-

Randy Wootton (06:46):

Oh, sorry. I thought you guys were the initial... Okay, great. Thank you.

Jeff Epstein (06:48):

And Bessemer has written a lot about applying it. So just to review, the Rule of 40 says you take your revenue growth rate plus your either profit margin or a free cash flow margin and you add the two together, and if it's 40 or above, the company is doing well. If it's below 40, you're not doing very well. And what that implies is that a company like Oracle, which has a 40% profit margin and a 0% organic growth rate, so it's a Rule of 40, is equal in value to a company that is growing 40% a year but that's breaking even in terms of multiples, multiple of revenue or multiple of typically the way they would think about it. It's actually not quite true. It's a good rule of thumb, but it turns out that revenue growth is more important than profitability at almost every point in the cycle.


So if you think about what life was like two or three years ago when the stock market was very high for technology companies and you looked at the public company valuations and you tried to create a best fit line looking at all public technology companies relative to their growth and their profitability, the best fit line was about a five to one ratio, meaning five revenue percentage points... Well, one revenue percentage point equals five margin points.

Randy Wootton (08:08):


Jeff Epstein (08:09):

So a revenue point is five times more important than a margin point, which that was the growth at all costs type of environment. At the bottom of the market, it was probably back to one to one, and now it's back to normal, which is two or two and a half to one, which has been a trend line for decades in terms of growth and profitability. And that makes a lot of sense because if you think about... Let's say there's two companies and one isn't growing at all and one is growing very fast. In 10 years, the one that's growing fast is being much larger. And assuming they can get to a reasonable profit margin at that point, the present value of that is going to be very high. But if you have a company that it takes 20 or 30 years to get to profitability, no one can wait that long. So you have to get to profitability in some reasonable length of time, which is typically 10 years from the time of a company's founding in the technology business often they're getting profitability.

Randy Wootton (09:03):

That's great guidelines. There's a gentleman that has written an article, Todd Gardner, about the porpoise move, and the porpoise move is getting profitable every once in a while just so you can show that you have control over the business and then be deliberate about the investments you're going to make and you go negative EBITDA for a while. And I think there is something about the discipline that it forces to get breakeven and then be again, aligned with your board as you build your budget and say, "These are the areas that we're going to invest in." And so you're going to go negative for some period of time, always conscious of the cash that you have and your ability to either raise cash through investors or additional funds from a PE sponsor.


And maybe that's a good segue back into the idea of budgets. One of the things I think about, this is my third gig as CEO, but is always trying to manage a board, not just about quarterly performance, but there's four conversations you have a year. One is the strategy conversation, another is around the budget. The third is a people review, and the fourth is what I call the product review. And so you start with your strategy, you frame it, and then you have that informs your budget, and then that's the allocation of resources which show up either in people or product.


But for you, in your experience, I imagine I've sat on some boards and sometimes people use the budget as a strategy conversation and they come and say, "Hey, here's our strategy and our budget and investments." How do you think about the distinction that you draw between the conversation you want as a board member around strategy versus the conversation you want about having it manifest in the budget?

Jeff Epstein (10:32):

Well, I completely agree with the order that you put those in with strategy comes first, where strategy fundamentally is making tradeoffs. So, "What is the single most important thing we need to accomplish this year? Let's make sure we do that. And then if we have extra resources or extra time, what's number two and number three?" And then the budget is a way of putting numbers to the strategy and saying, "We have a certain limited resources. How are we going to allocate those resources in order to accomplish the strategy?"

Randy Wootton (10:58):

Great. And then just one other element, which I think you alluded to in your article, which I think is so powerful, is this idea of a budget is a one-year fiscal budget, but it's part of a broader three to five-year plan. And so how have you seen people frame budget within that context or coming out of this strategy? My last strategy conversation with our board was, "Hey, here's how we need to shape the business over the next three years. If we want to have this type of transaction or this type of profile of the company, these are the growth assumptions. This is what's going to come from organic versus inorganic. This is what we need on these dimensions." How have you thought about current fiscal year budget within that broader three to five-year plan and ticking and tying it so it all makes sense?

Jeff Epstein (11:42):

When I was a CFO, if I would be meeting with my Head of Sales and Marketing and my Head of Product and Engineering and we're trying to figure out what the budget for the year is, what inexperienced CFOs do is they just say, "Well, what do you want? What do you need to accomplish your goals?" And then everyone comes in and says, "Well, I need to hire 300 people and I need to do this." And then you add it all up and costs are way too high. And then you have to negotiate people down. And it's a bad way to think about it.


The better way to think about it is to say, "Here's where we are this year. Where do we want to be in five years as a company? What revenue do we want to have? What kind of revenue growth at that point? What kind of profit margin at that point?" And in a software company, it's relatively easy because the costs are fundamentally people costs.

Randy Wootton (12:22):


Jeff Epstein (12:23):

You can say, "In five years, if we're going to be $1 billion in revenue and have 20% profit margins, we're going to have $800 million of costs. How many people can we have at that 0.5 years from now? And then roughly, how many of those people are going to be in product and engineering versus sales and marketing versus G&A?" And all the leadership team can generally agree that that's where we want to be in five years. That's about where we need to be. And then you say, "Well, where are we today?" And then you can draw a line between today and five years from now and say, "Well, look, if your department has 100 people today and you're going to have 200 people in five years, you're not going to have 200 people next year and then not grow at all for four years."

Randy Wootton (13:03):


Jeff Epstein (13:04):

That's not the way the world works. So if you have 100 today and you'll have 200 in five years, you'll probably have maybe 125 this... Next year, you'll hire 25 people net, maybe 30, but it's constrained and it's constrained by... What that process does is it helps the department head think as a shareholder of the entire enterprise and it says, "I want to maximize the whole company, not just my department." And then they can see where their department fits in the whole.

Randy Wootton (13:34):

That's great. And we'll pick up a little bit on how to set exact bonuses as a team, qualitative and qualitative in a second. One thing that struck me was this idea of headcount planning in this world of AI augmentation where functions are being reinvented in terms of, "Hey, I need this many salespeople." It used to be a BDR to AE ratio or impact to software engineer is now able to get 70% of their code done with AI. And so how many sprint points can a software engineer now in theory be responsible for with an AI-augmented type capacity? Have you seen that play out at all in terms of this round of budgets where people are betting on AI efficiency improvements as they think about their scaling across headcount, or is it still too early?

Jeff Epstein (14:23):

That's what everyone would like to have. I haven't seen it yet. I've heard anecdotally that many software engineers can be twice as productive, but I haven't seen a company say, "We're going to have half the number of engineers." The other area besides engineering that there seems to be a lot of promise is customer support. So if you have a large organization, you have 300 people in customer support, can a lot of that work be done through self-service and AI? We did it years ago at Oracle for instance. There was a time back, it's now almost 30 years ago, where we had a large number of people in our customer support function and when the internet was first pretty young, we moved to self-service.


So rather than have someone have to call someone to open up a ticket to solve their problem, we just had a website and we said, "Tell us your problem." And we then directed them automatically to, "Here's the answer." It wasn't AI, it was simply a rules-based type of thing. "If you want to reset your password, here's how to reset your password."

Randy Wootton (15:21):


Jeff Epstein (15:21):

And then we didn't have to take the call. So we actually did have more than a 50% reduction in the number of customer support people back 30 years ago when we implemented that over the course of a year or two. So I think that'll happen again, but I just haven't seen it yet.

Randy Wootton (15:34):

Right. As an operator, I don't want to admit any of that right now until I am 100% certain in terms of what those ratios are and the impact. So I would imagine it's probably a couple of years until we can really document that and then be comfortable with saying, "Hey, I need half the engineers to accomplish the same amount of work."

Jeff Epstein (15:52):

There are a couple of companies that I work with which are helping that to happen. So one is called AppZen, which is AI for expense accounts and AI expenses, and they have a lot of data now that when people implement... Think about in the finance department, if someone has an invoice, someone in the finance department has to prove the invoice and say, "Is this legitimate? Is it not? Match it with what the original order was." And there's a whole team of people at Oracle, we had hundreds of people like that who were in the accounts payable department.


And so what AppZen does is it automates that with AI, and when a company implements AppZen initially, within a few weeks, they're twice as productive. So they can literally reduce their head count. If they had 20 people in their accounts payable department, they can literally go to 10 people within a few weeks, and within six months they typically get down to have an 80% improvement. So that's one company which is demonstrating that at many of their customers.

Randy Wootton (16:56):

That's great. I think being able to have those proof points and case studies, et cetera. One of the things we talk about Maxio is it allows you to have a smaller finance team because you don't need all the billing folks as well. So for our size company, think of us like a Series C. We have seven, I think people in finance broadly. My CFO has worked at multiple firms before, including PE companies, said he would need 11 or 12 people. And so I think that works really well when you're pitching to multiple times CEOs or CFOs. It's harder to make the case for someone to say, "No, trust us, here's our ROI and TCO calculator and it's going to work."

Jeff Epstein (17:33):


Randy Wootton (17:33):

And I know within the year, I just want to bank those things as savings that are going to help me hit my EBITDA target versus sign up for them at the budget, whole process and see how I can get away with that. But that leads to a conversation around how do you set targets? And in your article, you talk about it's a game of probabilities and would love to just talk through that. And then specifically the Andy Grove 50/50 rule, which scares the heck out of me, but can you talk a little bit about this idea of probabilities and then we can talk about do you need three different budgets? Do you have one budget? And you talk about puts and takes. How do you think about the game of probabilities?

Jeff Epstein (18:11):

Well, I'll tell you the story of how this first came up. I was at a board meeting many years ago and the company missed its budget. And one of the board members started criticizing the CEO and saying, "Budgets, you really have to hit your budget all the time. That's your job as CEO is to make your numbers."

Randy Wootton (18:29):

Oh, I know that.

Jeff Epstein (18:30):

And then another board member said, "No, no, no. If you remember when we set that budget a year ago, we wanted to be aspirational. We knew it was going to be tough to make." And I've always thought that if you set an aspirational budget, you don't quite make it yourself, you probably still do better than if you weren't as aspirational. And then the two board members started having an argument and I'm sitting here saying, "Well, I wasn't on the board a year ago, but maybe we should have had that conversation at the beginning, not at the end."

Randy Wootton (18:53):

Yeah, totally.

Jeff Epstein (18:53):

So we all align. And then I took a look at Bessemer's portfolio and Bessemer has 200 portfolio companies now, so we can actually quantify it. We can say, "Of our 200 companies, they all have a budget, at the end of the year, how many companies achieve their budget? Is it 100%? 50%? Is it some other number?" And of course, it changes year to year. And when the market is getting worse, more companies miss their budget.


So for instance, in 2023, most of our companies miss their initial revenue budget. And sometimes it's the other way around when things are getting better. But on average, the question is how do you want to manage the company? And you can think of three examples. One is a very optimistic person, one is a very conservative person, somewhat in the middle. So the optimistic profile is Elon Musk. He says, "We're going to go to Mars next year. We're going to have one million Teslas produced this year." And he's done it very publicly and many of his public announcements, Tesla has failed to achieve. Nevertheless, Tesla's an incredible company, has produced incredible results. And clearly, he believes that if you aim high, that's how you drive the best performance.


Take another very wealthy, famous, successful person, Warren Buffett. His philosophy is always, "Under promise and over deliver." You want to have reasonable expectations and then achieve them. His partner, Charlie Munger, who sadly just passed away, said, "The secret to a happy life is actually low expectations."

Randy Wootton (20:30):

Right, right. On multiple fronts, in relationships, in your work life-

Jeff Epstein (20:35):


Randy Wootton (20:36):

In your physical training.

Jeff Epstein (20:37):

There you go. So that would be the very conservative way. And then you mentioned Andy Grove. He wrote a very interesting book called High Output Management, and he says, "If you're the executive and you've got a team of people," it's like imagine being the coach in a sports team and you can't necessarily change the players in the short term. You've got the team you've got. Why does one team win and another team loses? It's because the coach has formed that team and gotten the best out of their players, gotten them to perform at their very highest levels. And how do you do that? And Andy Grove's belief is you do that with a 50/50 probability, meaning 50% of the time you fail, which is actually a pretty aggressive way when you think about it.

Randy Wootton (21:20):

Especially if you have compensation tied to it, which we'll get to in a second. But right? You got people saying, "Hey, 50% of my bonus is tied to these targets and I only have a 50% chance of hitting them." Unless the upside is hockey stick, that could be demotivating, but please, keep going. So 50/50 rule, what else [inaudible 00:21:40]?

Jeff Epstein (21:39):

Well, his philosophy was if you think about professional athletes, these are the most talented people in the world. They're being paid enormous amounts of money, they're working really hard to try to make the playoffs and win the championship, and yet 50% of all professional athletes lose every game, right? It's just the way [inaudible 00:21:57] in the NBA.

Randy Wootton (21:57):

Right. Interesting. Yep.

Jeff Epstein (22:02):

I like that. I think that makes sense from a motivational point of view that 50/50 is... If you think about your own college teachers or high school teachers who were the best teachers, they probably were also the toughest graders. They had the highest standards and they expected you to meet those standards.

Randy Wootton (22:18):

So I don't disagree. And your article, I actually think is called The Goldilocks Approach to Setting Your Budget. And what I talked to my team about is how do you create something that's aggressive but achievable? And the nuance, which I really liked about your article was you say, "Hey, there are four targets in a budget that you're ultimately working towards. It's your revenue, your profit. If you're a public company, Wall Street Guidance and then sales quota."


I think people obviously understand revenue and profit, Wall Street Guidance and then sales. It might be worth chatting a little bit, but then very specifically in terms of the confidence interval that you recommend people have around those targets because they're different. It's not 50% for each of them. How have you thought about that and what have you seen play out?

Jeff Epstein (23:00):

Well, first is to set the framework. I don't recommend these numbers for every company in every year. I think each company should decide what probabilities it wants to achieve for that company in that year and talk about it, CEO and the CFO should talk about it to the board. So I'll give you some general rules of thumb, but then every company should adapt it to their own specific situation because every situation's different. And let's start with revenue. I personally like the Andy Grove approach, which is 50% of the time you should make your revenue budget, 50% you should miss, and it should be as accurate as... Your best estimate of what you think the world would look like. And that seems to be somewhere between Elon Musk and Warren Buffett approach, and I like that approach.


Then take the sales quota. If you have a revenue budget and you're going to make it 50% of the time, and then you say, "Well, I have 50 salespeople and each salesperson has a quota. If I make their sales quota the same as the revenue budget, the chances are I won't make the revenue budget," because on average, some people will quit or you'll be fired. Somebody's not going to do that great. Some people will do fine, but it's almost never the case that everyone hits their sales quota and that achieves the revenue. So you need some sort of cushion and to do that, it means you actually have to have a lower probability. If your revenue budget is 100, your sales quota might add up to 110 or 120.

Randy Wootton (24:29):


Jeff Epstein (24:29):

Which means it's a lower probability.

Randy Wootton (24:31):

Right. Yeah, I think that's a great point. I always think about street quota. What do you provide an uplift to the Head of Sales? What's the uplift on top of that to Director of Sales? And then what is the quota on the street for the AEs? One rule of thumb I've used just so you can keep AEs, is that 80% of the team is achieving at least 80% of their quota.

Jeff Epstein (24:51):


Randy Wootton (24:52):

And that if you don't have that dynamic playing out because there isn't enough pipeline of opportunities, people don't have a hope of hitting their number, you're going to lose some seasoned AEs. So managing that over assignment and then expectation of attainment I think is one of the most important components of building the budget is your revenue model. Right? And then how does that play out?

Jeff Epstein (25:15):

Now, that's for a company which is a sales-oriented company. Other companies are more marketing-oriented than sales, but it's the same concept that you would have all these marketing programs, you've got search engine optimization, we've got search marketing, we've got social media marketing, got maybe some broadcast, and you put in all those marketing plans and you want to add your marketing expectations to add up to more than your revenue budget to give some cushion.

Randy Wootton (25:40):

100%. I think the way we think about that, and I'm only going to B2B SaaS guy, is what is the pipeline that has to build to match the capacity, the sales capacity? So street quota, what is that? So for using an example, like 10 million bucks, marketing sales have to be totally aligned in terms of how many dollars need to be invested in paid search versus events, et cetera, to create the pipeline, the days to close and the percent win rates that gets you to an 80/80 hit. So I think that's a great rule of thumb. With profit, you actually suggest that being higher. Talk a little bit about that both theoretically and then structurally within the P&L, how you can make that work?

Jeff Epstein (26:25):

Well, profit is usually a good indicator of cash flow as well, and one of the CFO's number one jobs is to never run out of money.

Randy Wootton (26:33):


Jeff Epstein (26:34):

So it's pretty important to be conservative when you're thinking about cash flow forecasting and therefore profit forecasting. And so if your revenue budget is a 50% probability of achievement and your costs are relatively predictable as they are in many companies where it's headcount related, then if you just did nothing else, then your profit would have a 50% level of achievement as well, and your cash flow would've a 50% level, which to me is inadequate. I'd want a much higher percentage probability of achieving my cash outcome. And therefore, we put in a contingency.


So in the expense line, you have all your normal expenses. And then I would put in another row in my expense budget which says contingency, which is things that are going to go bad, but I don't know what they are yet because usually there are surprises that are more negative surprises than positive surprises.

Randy Wootton (27:22):


Jeff Epstein (27:22):

It could be that maybe the revenue isn't going to be achieved, it could be that one of my cost elements goes out of whack. It could be that I have a surprise, I have a litigation or something that comes up. So if you put in that contingency, you'll be able to achieve your profit most of the time, and you can set that... Often people set that to 70% or 80% probability. So seven or eight years out of 10, they'll make their profit target.

Randy Wootton (27:49):

That is really interesting. I've never had that contingency line item. I'm going to talk to my CFO about it. One way that I think people optimize for EBITDA, especially in a software company where 70% of your costs are employees, is you have control over when you hire to the ramp for the year, you have control over backfilling, you have control over moving to lower cost labor markets. And then unfortunately, I think what we've seen, I think there's been a million tech layoffs in the last two years, '22 and '23, is you're seeing, I think a lot of people that are saying, "Hey, we maybe weren't hitting our revenue goals. We still have to deliver the EBITDA” or AKA profit. And that unfortunately leads to some belt tightening on that front.


Maybe this is a good opportunity to shift to exec bonuses because one of the things, just at Maxio, so we have an executive team... Well, actually, we have our VPs, directors and the executive team are all on the corporate bonus and it's all quantitative. It's tied to EBITDA, ARR growth and revenue. And for EBITDA, there was a gate. If we didn't hit 90% of our EBITDA target, nothing else got paid. So there was this real clear alignment between you got to solve for profit at the end of the day, all this other stuff, besides self. I assume those are the same metric you see broadly across your software companies in terms of setting executive bonuses?

Jeff Epstein (29:17):

Well, most companies have a three-part compensation plan. There's a salary, there's an annual bonus, and then there's long-term compensation, which is usually stock options or restricted stock. And so we're talking about just one component of total compensation annually.

Randy Wootton (29:29):

Yes, absolutely.

Jeff Epstein (29:31):

The problem with tying the bonus to the budget is the budget then becomes a compensation negotiation.

Randy Wootton (29:38):


Jeff Epstein (29:38):

So everyone says, "I want the lowest possible budget so I can achieve it and make my bonus." And then if you're heavily weighting the budget to achieving compensation, then you're not achieving the other goals of the budget, which are allocating resources appropriately and forecasting accurately and things like that. So the alternative would be to have a compensation plan, which is actually not tied to the budget, which is actually what Oracle did. So Oracle, when I was the CFO of Oracle, I and the other executives, we got a percentage, a very small percentage of the increased dollars of operating income. So if Oracle operating income went up by $1 billion, I got X percent of that. If Oracle operating income went with zero, I got zero.


And if you were the Head of North American Sales for instance, you were measured on the revenue your team contributed minus the cost your team incurred, with no allocations for R&D or G&A and things like that. All the revenue in your control, all the cost in your control, you had an operating income number to deliver and same thing, you've got a percentage of the increase in that. And the way Larry Ellison thought about it is, "My goal is to increase the company's operating income. If I make more money, you make more money." We're very aligned in terms of the sentence. Now, in one year, you might make a zero bonus, but over the course of a longer career, if things go well, you'll do fine.

Randy Wootton (31:06):

Do you think at an earlier stage companies, so under $40 million, where there's a lot of volatility in terms of go-to-market churn, NRR, there are just all these other things at play... And I'm not denigrating or devaluing the challenges that Oracle faced, but maybe a bit more predictable. Of the 200 portfolio companies across Bessemer, how many are using a plan that is percent of profits or percent of contribution margin versus more of what I described as aligned to budget for the executive team?

Jeff Epstein (31:40):

Most companies set compensation with the annual bonus to budget, and some companies have multiple factors, which I think is too complicated. I think the optimal is maybe two factors. So often it's 50% revenue, 50% profit, or sometimes if you want more revenue growth, maybe it'll be two-thirds revenue, one-third profit, something like that. Or you could have a gate the way you described it where if you don't hit a certain profitability, you get nothing, but if you hit it, then you get the revenue. So there's variations, but I think two elements is probably the optimal number for the annual bonus.


The Twilio, interestingly, for many years didn't have an annual bonus because the founder believed, and Jeff Lawson and I agree with that, people think of a bonus as an entitlement. If someone's making $100,000 salary and a $30,000 bonus and you don't pay the bonus, they feel like you've taken something away from them. They feel like it's really their money and they're angry. And so the philosophy was if they're going to be upset taking it away, you might as well just give them a higher salary and have no bonus and then just stop attending.

Randy Wootton (32:49):

Well, then how do you drive incentives like all the MBO programs, OKRs, John Doer, trying to get people motivated to go achieve because you could have a bonus tied to MBOs or OKRs? Does Twilio not have any bonus at all? And then if so, how do they, what we were talking about before, align teams to feel motivated to stretch?

Jeff Epstein (33:14):

Right. Well, the first 15 years it didn't have any bonus at all. Now we've gone back to it because so many other companies do it, so we're trying to be similar to other companies to be competitive, but the answer to that question was promotions were based on that. So if you do a great job, you get promoted and you have a great career.

Randy Wootton (33:31):

Got it. What is your sense? I think there's also this tension between quantitative and qualitative. So we were just talking about OKRs versus hardcore budget metrics, and if you don't hit your budget, it's a tough year, but people worked really hard. Now, I appreciate effort versus results. You're not rewarding effort, especially at the executive team level, but if you're working at a director level and you have less control fingers on the knobs to control how much we're investing and how we're cutting costs, if you're totally tied to the corporate budget as your bonus, that feels weighted in the wrong direction as well.


What have you seen in terms of maybe at the executive level or the leadership cadre level and then director level in terms of split between hardcore quantitative numbers versus more qualitative representing the work that you're doing to move the company forward tied to the bonus?

Jeff Epstein (34:30):

I think the bonus has two components. One is as a motivator for you personally, something that's in your control where you're rewarded if you do well. And the other I think of as this profit sharing, the company's doing great, we're all getting richer, we should share the wealth. And if you missed your numbers, but the company did great, you feel bad that somehow everyone else is getting rich and you're not, even though you're part of the team. And there's the balance of how much of this is your individual effort and accomplishment versus how much of it is teamwork?


So I do think there's some element... I think the best companies do have a company-wide factor in their bonus for people at all levels of management, but I think that if you're a director or a manager level, it should be primarily based on your personal achievement.

Randy Wootton (35:15):

That's great. I like that distinction between the personal versus the profit sharing and makes sense as you get more senior. So the other question I find when I'm going to companies or I'm advising folks is this idea of the budget never changes, and I fundamentally believe that. You agree at the beginning of the year, you set your budget, and then all of a sudden you move into a forecasting motion and you're reporting your actuals against budget and forecasts throughout the year, but at the end of the year, you need to come back and say, "This was our budget and this is what we did." I think you say that in your article as well.


You also though provide the caveat, which I think a lot of companies went through last year, which was like, "Oh my God, the market just..." We went through a B2B recession and most of your companies missed their budget, but it's an annual budget. So you don't have that opportunity unless there's a mechanism to do a back half plan like an H2 plan dynamic, but then the board's like, "Well, then why do we do the budget?"


How do you think about that tension in terms of setting the annual budget, making sure the executive team 100% is focused on delivering that, but then probably after six months doing a reality check on where you are and what is it going to take to deliver perhaps a different outcome but still a good outcome?

Jeff Epstein (36:31):

If you think about these three different benefits of a budget, one is forecasting what's going to happen. Second is allocating resources, and third is tying into comp. The first two, you handle with forecast. So many companies do quarterly forecasts, some do monthly forecasts. At Oracle, we actually had a weekly forecast where every week we would forecast the new revenue for the full year. So that would give us a sense of where we are. We'd have a good finger on the pulse of how things are happening, and then we'd reallocate resources based on the forecast.


If halfway through the year, you're completely missing your budget and you have a new more accurate forecast, the question is how do you motivate people for the last half of the year? And what many companies do there is they just say, "Well, look, the first half of the year, we missed our numbers. We get zero bonus for the first half of the year. There's no way we're going to make our bonus for the second half of the year. So instead of making it non-motivational, let's come up with a new bonus plan just for the second half of the year, and then we can make our new bonus," which would be half the level of the original bonus because it's only for half the year. And I think that's what many companies do.

Randy Wootton (37:38):

Yeah, I think that's fair. You should have blind of sight in your first six months. And so if you totally tank it, shame on you for you not setting up a good plan. To that point, one of the things I was going to talk about as well with setting budgets, they don't sit in isolation for the year. I think as much as you're looking forward to the next three to five years, it's also super important to include at least an eight-quarter look back so that you now are looking at trends in terms of all the different key operating metrics and thinking about seasonality year over year, quarter over quarter. So you're triangulating on the budget in terms of what's your historical performance? The other thing you can layer in is benchmarks. So benchmark reports that are produced, what's happened over the course of the year?


And then if you have investors on the board, they also are going to come to the table with specific benchmarks that they're seeing broadly across their portfolio companies, similar type vertical B2B SaaS companies. And so the negotiation uses these different inputs to help you set the budget realistically, and to your point, with as much certainty as you can have. And usually that's, I don't know, six months and then you hope from there that things are trending.

Jeff Epstein (38:55):

That's right.

Randy Wootton (38:55):

And the last thing you talked about, which I think is in your article, or at least that I took away, was around debt covenants. And so you said that a CFO's primary responsibility is about maintaining cash. Part of that's tied into the debt that you've taken on, and are you going to be able to hit your obligations in recent days or recent, I don't know, 12, 18 months? People are taking debt at interest rates that they may have never thought about before. How do you think about debt covenants and budget and the final check? Are you going to be able to stay solvent?

Jeff Epstein (39:27):

Well, some loans don't have covenants, but if you have covenants, you want that to be 100% achievement. You never want to be in a position to violate your covenants and losing control of the company. If you're a public company, you also would like to have a much higher probability of achievement because you're making public promises to your shareholders. And so often, for public company first year guidance, CFO's have a 90% level of probability. So those are special use cases, either public guidance or where you set your covenants for a company that has level of loans.

Randy Wootton (40:08):

Well, awesome. Well, Jeff, we're wrapping up. We didn't even get to have the conversation around benchmarks, but you have a great article on there. We'll include in the show notes. In the last two minutes, quick question for you, so this is our speed round. What's your favorite metric and why?

Jeff Epstein (40:21):

I think the Rule of X is my favorite metric. In fact, I'll make sure we send you that link to the Rule of X. It's because it combines revenue, growth and profitability and there's always that tension and that trade off. Should we grow faster and invest more or should we try to get more profitable sooner? And both the CEO and the CFO, that's one of the key resource allocation decisions they make. And another way to think about it is it's short term versus long term. You need to do both. You need to both achieve your goals this year and build the company for the long term. And the Rule of X captures both concepts.

Randy Wootton (40:57):

Yeah, I think it's not the tyranny of the or, it's the mystery of the and, right? That's why we get paid the bucks we do as operators. What makes it fun is there is no right answer, but you got to hold two things in tension. And I think that as you become an executive is one of the hardest things to learn is how can you... It's never black and white, it's gray, and how do you hold that in tension?


All right. Last two questions for you. One, do you have a favorite business book that you recommend to early-stage CEOs, CFOs that you think is a must read?

Jeff Epstein (41:27):

Not particularly for early-stage CFOs, but for anyone interested in business. I've been an admirer of Warren Buffett for a long time, and there's a terrific biography of him called The Snowball, which is about his life, and it gets started how he originally ran his hedge fund and then how he built Berkshire Hathaway, which is just an extraordinary achievement.

Randy Wootton (41:46):

I haven't read that one. The other one that you alluded to in our conversation was the Andy Grove book, High Output Management. I've read that. I haven't read it in a long time. I'm going to go back and look at that one more time. He absolutely is a seminal thinker and brilliant.

Jeff Epstein (41:58):

I'll add one more, which is Warren Buffett's partner Charlie Munger. There's a book that just was reissued called Poor Charlie's Almanac, which is many of the writings and speeches that Charlie has given over the years. It's also well worth reading.

Randy Wootton (42:12):

All right. I'm going to add that to my ever-increasing stack of books next to my bedside, which I fall asleep before engaging, but hope springs eternal. Look at your bookcase. You got an enormous amount of books back there, but hey Jeff, this has been great. Thank you so much for your time. Really appreciate the insights you've provided around budgeting and I learned a bunch just reading your article and the conversation we had. I hope people on the podcast will as well. And so thank you for helping to lead the way.

Jeff Epstein (42:41):

Terrific. Randy, it's a real pleasure. Thank you.