Beware The Consultant

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Once you obtain funding, it will be worse than hitting the Lottery. Instead of hearing from your long lost third-cousin, you will be inundated with an avalanche of ‘congratulatory’ emails, calls and letters from people who want to relieve you of the burden of your hard-earned equity round. Many such ‘congratulations’ will come from consultants.

An entrepreneur’s two most important assets are her time and money. There is nothing under the sun that will suck up your time and money faster, more prodigiously and less effectively than a consultant.

Please Look at My Watch and Tell Me What Time it Is

Jack Black was wrong. In the movie School of Rock, his irreverent character tells a group of teachers, “Those who can’t do, teach. Those who can’t teach, teach gym.” In fact, a more accurate statement would be, “those who can’t teach, consult.”

Can a fee-based consultant ever economically add value to a startup? I suppose so, but I haven’t ever seen it. Surely, among the tens of thousands of effective and honest consultants running about, a significant number of them are well positioned to help startups – right? Sadly, the answer is “No.”

Why are consultants usually an ineffective use of a startup’s funds?

Consultants are best suited for Big Dumb Companies (“BDC’s”) who want someone to tell them what they already know in order to substantiate a preordained course of action. For instance, many a BDC CEO has initiated a consultant to study cost cutting issues before announcing a significant layoff. In this way, the consultant becomes the scapegoat behind the tough decisions that the BDC’s do not have the guts to execute on their own. Startups cannot afford such scapegoat luxuries.

There is an inherent conflict in a consultant’s business model and the needs of a startup. Consultants trade their time for money whereas startups need to trade their money for results. In order to eliminate this conflict, any consulting relationships you establish must be performance-based. In this way, by tying compensation to results, your startup can trade its money for even more money.

For instance, if a consultant proposes to help you with public relations, pay them a commission equivalent to the greater of a flat fee per story placed or a percentage of revenue generated from the PR coverage. Tracking such revenue can be a challenge but is possible to approximate the revenue impact of PR activities via the use of unique URLs, customer surveys, etc.

If a consultant claims they can enhance your marketing efforts, pay them based on their direct impact on your incremental sales. Basing a consultant’s compensation on the incremental revenue they generate is a great example of a deal that is on The Fringe (for other creative approaches to partnering, see Agreements on The Fringe).

Performance-based deals are healthy for all parties. In the ‘normal’, non-startup world, a consultant will generally accept any engagement in which the client can pay for their services. The relative value of the consultant’s impact upon the client’s business is usually not the consultant’s primary consideration when evaluating whether or not to accept a particular engagement.

However, when you pull the consultant out on The Fringe and negotiate a performance-based deal, you are ensuring that they will only enter into an engagement with you if they believe that they can move the needle and make a real impact on your adVenture. The consultant will be compelled to vet your engagement based on their ability to drive concrete results, rather than your wherewithal to pay their invoices. Thus, performance oriented deals reduce the risk that your startup will waste its two most valuable resources.

I hope you are not thinking, “But John Greathouse, the consultant cannot take on my execution risk. What if they give me great advice and I cannot properly implement it?” If the consultant truly believes in you and your team, then they will be willing to share the execution risk with you.

Time Is Not Money, Time Is Everything

Performance-based deals can effectively mitigate your monetary risk of entering into a non-productive consulting relationship. However, it is more difficult to address the risk associated with the misuse of your time.

One of the best things about being an entrepreneur is that there are no rules. You can do anything you want with your time.

One of the worst things about being an entrepreneur is that there are no rules. You can do anything you want with your time.

Exactly.

The lack of rules and structure causes many entrepreneurs to work incessantly. Such entrepreneurs soon discover that no matter how hard they work, there is never enough time to do everything that has to get done. Given all the demands on your time, the hours spent educating a consultant regarding your business are costly. This time investment is even more expensive when you consider that the consultant’s edification will likely be lost to your organization once the engagement is terminated. Unlike employee training costs, which can typically be spread over years of service, the relative return from training a consultant is modest and pricey. In addition, when a consultant moves on to another client, any institutional knowledge they may have gained walks out the door with them.

Passion Cannot be Outsourced

Any function within your startup that involves iterative learning, passion and/or close proximity to your customers should not be outsourced. Such positions include: PR, Sales, Product Development, Lead Generation, Strategic Planning, Fund Raising, etc. As noted above, you can contract with a performance-based consultant to assist with PR, but never place sole responsibility for the execution of a passion-driven duty into the hands of a dispassionate third party.

The relative degree that passion is a prerequisite for success and the rate of iterative learning both diminish as your company expands. Thus, as your startup matures, many of your operational functions can be successfully outsourced. This is why BDC’s can often successfully outsource a wide variety functions. Their story, market positioning, products, etc. are well defined and broadly understood. BDC’s focus on executing defined tasks, not on defining the tasks to be executed, as is often the case at a startup. At the early stages of your company’s life, you cannot rely on disinterested, hired guns to define your company’s key tasks.

Pyramid Power

To fully appreciate why consultants often do not fulfill a startup’s needs, it is important to understand the typical consulting engagement sales cycle.

When a consulting firm tries to get their hand in your pocket, they usually lead with their Rainmaker. This is generally an engaging, glib, attractive person that you can almost guarantee you will not see again, once the Engagement Letter is signed. Instead of focusing on the welfare of your business, the Rainmaker will be off making rain somewhere else while your engagement is managed by worker bees who are likely biding their time as a Junior Consultant before earning their MBAs with the intent to graduate and become Rainmakers in their own right.

As described in Roping In The Legal Eagles, service firms are pyramids. A handful of Rainmakers sit at the top, while most of the ‘real work’ is done by less experienced and therefore less insightful folks. The larger the firm, the larger the pyramid. The larger the pyramid, the greater the distance between the Rainmaker who closes the sales and the worker bees who have to deliver on the Rainmaker’s promises.

Thus, do not be enamored by a service firm’s size. Size does matter, but in an inverse manner. The larger the firm: (i) the greater the disconnect between the Rainmaker and the workers, (ii) the higher the personnel turnover, and (iii) the more time you will be forced to expend training each new crop of MBA-wannabe’s. Remember – your adVenture’s time is precious.

Rhymes with a Type of Pasta

One startup I joined was very proud that they had been ‘accepted’ as a client by a prestigious Silicon Valley law firm whose name rhymes with a type of pasta (they are lawyers after all, so I have to be careful here…). Over the course of several months, our lead contact changed repeatedly as the various worker bees departed the firm to join dot-bomb startups. With each change in staffing, I was forced to reacquaint the latest Junior Lawyer with our business, re-explain the current legal issues we were in the midst of addressing, etc.

The final straw came when I asked the latest 25-year old a simple ‘yes / no’ question related to stock options. After I posed the question and my proposed response, he incredulously asked, “How do you know that is the correct approach?” I told him that I had previously taken a company public, but that it had been a couple of years since I had addressed the specific issue at hand. Unable to confirm if my proposed approach was correct, he indicated that he would have to check with his SEC group and that ‘someone’ would get back to me. ‘Someone’ never called and I fired the prestigious and inept firm shortly thereafter.

The ultimate irony is that when we later sold the Company for a substantial amount of money, it was discovered during due diligence that the prestigiously inept firm (whose name rhymes with a type of pasta) screwed up a basic corporate filing. This mistake, if left uncorrected, could have resulted in significant negative tax consequences for both our employees and the company.

The firm, (did I mention that the name rhymes with a type of pasta?) never admitted they had made a mistake (they are lawyers, after all) despite the fact that they put in a lot of non-billable hours trying to cover their collective backsides. This rookie error by one of their junior lawyers resulted in some truly unnecessary eleventh hour heartburn for everyone involved in the deal. Who knows what other egregious errors the inexperienced, under supervised junior lawyers would have made at the ‘prestigious’ law firm if we had not switched to a smaller, more capable firm in which our primary point of contact was a Senior Partner, who had over twenty-years of legal experience.

Get A Company on The Fringe

If you must work with a consultant, force them to join you on The Fringe by implementing one or more of the following suggestions:

Base their compensation upon quantified, clearly understood results; preferably something that can be measured in incremental gross revenue or direct cost savings; nebulous goals will lead to nebulous results and an ineffective use of your vital time and cash

Ensure that the Rainmaker is engaged in your engagement; include in the Engagement Letter periodic meetings and other regimented communications that ensure you are being given attention from the top of the pyramid

Allow the consultant to invest in your future success; in lieu of cash, grant them equity in the form of Non-qualified Options that vest based upon the attainment of quantifiable goals; keep in mind that adverse tax consequences may be associated with such equity grants, so check with your accountant before deploying this form of compensation

Negotiate a startup discount; you may be surprised how often you can get a break on such fees, especially if the service provider truly believes in your future viability

Pull a Blondin (see: Do They Believe?); make the service provider prove their belief in you by getting on your back as you step onto the proverbial entrepreneurial tightrope. Having consultants accept equity in lieu of cash, define their compensation based on concrete results and defer their payment until the attainment of certain milestones (including fundraising) are all ways you can execute the Blondin Test. If the consultant really believes in you, your team and the prospects of your adVenture, they will be willing to ‘get on your back’ and trust that you will make it to the other side unscathed.

In the end, if you determine that a consultant is just looking to exchange their time for your precious money, smile politely and give them your competitors’ contact information, followed by a short, sharp kick in their arse as you usher them out the door. Unlike many ‘lottery winners’, you are looking to turn your fundraising cash into a nice return for your shareholders, not a windfall for those who cannot teach.

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  • Interesting !

    I would add two basic fact, that are worth to remind : a consultant never execute, he just give advices. And the consequence is that they are not responsible at all of the execution result.

    For an entrepreneur, it is sometimes confortable to rely on someone else thoughts when you are not sure. But at the end, it’s your decision, your execution, you are the responsible.

    My own experience is quite different, we worked with consultant, but before raising funds. We had a product generating revenue, without understanding why it worked (hard problem, trust me…), and they helped us understanding our positionning. And a year later, they helped us raising funds, proving this positionning was not that bad 🙂

  • Very interesting article, at my Firm we share many of your insights, starting by performance based compensation (often linked to sweat equity). I guess not all “consultants” are equal afterall 😉

  • Just wanted to let you know that after a 2min meeting we decided to post extracts of your article on the blog of our consulting Firm

    http://blog.okuriventures.com/2009/04/ojo-consultores.html

    Thanks

  • Uncle Saul

    Luis,

    Glad to hear it! I am flattered that you posted parts of my article on your blog.

    Consultants that share in the rewards they help to generate are exactly the type of value added addVisors startups need.

    Keep up the good work.

    Uncle Saul

  • Lets hope more advisors that currently lack the second d start embracing change. As you definitely know from your experience at TMP many entrepreneurs can clearly leverage on the right support, but this requires an alignment of objectives

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  • Consultant

    Been breathing your own exhaust too long.

    I’ve done tech marketing and PR consulting for 20+ years – many clients with multi-year and (entrepreneurial) multi-business relationships. From billion-dollar firms down to the micro-startup. All depends on what you bring to the table.

    I’ve learned to avoid prospects with the attitudes expressed in this article. They know everything – just ask them. It’s called arrogance.

    Works out better that way – they only get the relationships that make their attitudes into self-fulfilling prophecies.

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  • I think you might need to differentiate between consulting companies,where most of the consultants are normally straight from university and have no hands-on experience, and a real consultant, someone who has significant domain expertise.

    For instance I am 95% certain I can make your start-up’s systems and technology scale for less money, be more effective and more reliable: and if you are the 5% already doing the right things I’ll tell you that and walk away. But if you need my expertise you need it at the early stages to get best value; at which point what will be your benchmark to assess my results?

  • John Greathouse

    Chris – I agree that there is a distinction between Advisors and Consultants. My confidence in an Advisor increases dramatically when they are willing to include a sizable percent of equity into their compensation.

  • John Greathouse

    Sounds like this entry cut a bit close to the bone for you 😉

  • B Milnes

    John,
    Sorry for my “sweary Mary” moment, and my crude analogy, but my other comments hold firm. And really, with your experience you should know that some of us who have been there and done it are perfectly able to produce it on behalf of clients, acting as consultants.
    Your brush stroke goes too wide.
    We’re all familiar with the big Consultancies (Accenture, KPMG, Delioittes) who charge you extortionate Partner rates and supply the 21 yr old MBA graduate (plus an intern if you’re lucky).
    Some of us just get our sleeves rolled up, get stuck and deliver, deliver and deliver.
    Cheers,
    Brian

  • John Greathouse

    Brian – your points are all well taken. Entrepreneurs need people who are willing to put their shoulder to the wheel, not merely people who tell them where to push. I agree that my words of caution are broad and that exceptions certainly exist.

    Thanks for chiming in here. 

  • John,
    We have an early stage startup here in Nashville called Enterstream. We have created an interactive platform for the movie industry that will generate revenue during production of a film, before the film is released. We created this company to help the industry make money before piracy. We are in Nashville which is not tech friendly. Our goal is to get to CA. We have talked with a couple of consultants, and like you said they are trying to trade their time for money, wanting us to pay them $175 an hour to work with us before they will even talk about equity.  We need to trade our money for results. What would be the best way to get results without hiring a consultant from Silicon Valley? Do you know anyone that can help us with a package for potential investors? We are tired of getting burned by people who do not do what they say.

  • John Greathouse

    Steve,

    You have the added complexity of being remote. A remote consultant who is paid in cash is the worst kind…

    Off-the-cuff, it seems someone on your team needs to head to CA. Working remotely, thorough surrogates, will likely be more expensive and less efficient. Once you are ‘in market’, your ability to locate someone who will work with equity will increase considerably. Consultants will be more inclined to take some equity up-front after you establish the Bro Factor with them. It is next to impossible to Bro up from afar.

    I wish I had a contact I could turn you onto, but film is not an industry I know well.

    Good luck.

    John

  • John,
    Thanks for the advice so quick…Our company is actually in  Social Entertainment. It is like a social gaming platform but for entertainment. We decided to start with the movie industry, then move into other genres of entertainment…I reread my post and it does sound like we are in the film industry.Do you know of anyone in the social media marketplace that might be able to help? I really appreciate your time and advice…
    Thanks again,
    Steve

  • John Greathouse

    My bad. Got it now.

    Email me via the website and we can pick this up one-on-one.

  • John,
    Which website Rincon or Revupnet?
    Thanks,
    Steve

  • John Greathouse

    Either will work, but go with Rincon. Thanks

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  • Jrzarco2001

    Interesting article if only it is too black and white.  If one follows Coase’s Theory of Firm, a company would hire full time a consultant for its staff if it is cheaper than hiring someone full time.  Also, by your definition, no company should hire outside accountants and attorneys simply because, by definition, they are consultants. Personnel are used as consultants because a company cannot hire them full time, and that individual cannot work for only a few hours a week — that includes attorneys as well.  In fact, I know of a company that hired a full time attorney for General Counsel in a situation where it was unquestionably cost effective to hire outside counsel (or consultants) in the few instances when legal advice was needed. 

    So my rule is not so severe — true, one looks at value.  Some consultants have nothing at stake and provide useless advice.  The compensation for such conditions is simple — minimal fees bolstered by equity of some sort.  Maybe if the usage is too much, then hire that person full time. But  a company must move forward with the limited capital under its belt and there are instances where a consultant is very much needed for the Coase’s “firm” to exist.  

    And do all consultants provide little or no value? Mitt Romney came from Bain & Company, a consulting company, and their clients’ savings derived from their consultancy were invested in Bain Capital, a VC.  Romney was appointed as the MD for the VC fund. It was enough savings and capital growth that earned Romney over $200 million.  So some consultancy does seem to work.    

  • Thanks for the feedback. My focus is the relative impact consultants can have on Startups. I do admit that there is a time and place for consultants at larger organizations. However, I have seen too many startups get ripped off by consultants who make big promises, pull cash out of the venture and then deliver little value.

    Re Romney, my limited understanding is that his Private Equity firm was primarily a financial investment vehicle, with “consulting” a secondary consideration, to the extent the could improve their financial performance with a particular portfolio company. Also, I assume most of the companies in which Private Equity becomes involved are pretty decent in size and tenure – not startups.

  • Jrzarco2001

    Let me add to the comments on law firms.  I have a JD/MBA — useful tools for startups, since a company has someone with 2 skill sets for the price of one.  In one fast growing telecom company, the Comptroller informed me that when I was General Counsel, the average outside legal fees averages $3-4k a month.  When a new management team took over, I was replaced.  The average costs for outside counsel exceeded $50k a month afterwards.  The company had operations in over 30 countries so it could not avoid legal fees.  But depending on the General Counsel and how outside attorneys are handled, a company can gain substantial costs savings.  After my departure, the company kept going more into the red, and finally filed for bankruptcy.  

    My advice to startups is to manage your legal costs.  I generally earmark no more than 3% of revenues for outside counsel costs. Law firms, by their own structure, are only motivated by the number of hours they can bill.  Associates are forced to bill as much as possible, for that is how the Partners monitor the performance of the associates — the more hours they bill, the fatter the profit margins.  I can count on one hand the law firms which I find that provide the best value for their work.  As corporate counsel, I have discharged law firms where I did not receive the best value.  I myself have written contracts and I know how long it takes, as an example of my understanding billing time management by attorneys.

    So a start up can be killed with legal bills. As corporate counsel, I did monitor those expenses, I negotiated with law firms, I always sought the best lawyers for the dollar.  I myself worked for law firms and corporations. There is an advantage having this experience to help control these legal expenses.  Someone described me as a businessman’s lawyer — I thought of the cheapest, fastest means to get something done.  But you don’t find that type of lawyer across the board.   

    I sympathize with JG’s experience with the poor performance outside counsel. I generally spot those things way before I hire the lawyers. My advantage is that I am able to recognize the value. I wouldn’t kill all the lawyers.

  • Jrzarco2001

    I was referring to Bain’s genesis in 1984 when it would invest in companies and used consulting to improve operations.  At that time. it raised only $37 million — not enough for Private Equity. Of course, over time, Bain Capital operated more and more as a financial firm. 

  • Good advice. I have written a bit about handling lawyers as well, including here: 
    http://johngreathouse.com/roping-in-the-legal-eagles/

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