Friday, June 29, 2007

Startup 101: Staying Funded

The number one job of a startup CEO is to secure funding for his or her company. Most early stage startups need external investment to cover costs, so without funding, there is no company. The number one question a startup CEO needs to be able to answer is "how are you going to get to the next round of funding?" If there is no credible answer to that question, there is going to be a very unpleasant road ahead. I ran out of money at JRad, and didn't run out of money at ActiveGrid, and believe me, there's a big difference! Following are the three variables at the disposal of a CEO in order to secure the next round of funding: timing, traction, and positioning.

  • Timing - Startups generally have 12-18 months of cash between funding rounds. You have to raise money while you still have 6 months of cash in the bank or you are going to get tooled as potential investors wait you out in order to increase their leverage. The math is simple: if there is 12 months of money in the bank, 12-18 months - 6 months = 6-12 months, leaving 6-12 months to get the business to a point where it is set up to raise its next round of funding. 6-12 months is not a long time, which is why startups have to move at a very accelerated pace.

  • Traction - The best way to raise money is to grow revenue quarter to quarter, hopefully exponential revenue growth. If the market is still maturing and the revenue has yet to materialize, an exponential growth of users that will one day lead to revenue is the next best thing to revenue. Generally a market category will have a ratio to apply to these metrics to value a company, such as 6x trailing revenue or $1/user, so you can point to other deals to establish the value of your company.

  • Positioning - If neither revenue or user growth is in the cards before the 6 month window hits, all that is left is positioning. In this case, everything in the company needs to line up to the 6 month funding window so that you can have a credible story as to why your startup is going to capture a high-growth market. Tools you can use include shipping early access versions of new technology in a new market or on a new platform, guerrilla marketing campaigns to get buzz, and partnership deals where other companies leverage your technology.

    Not following the guidelines above will usually lead to very unpleasant situations like shut downs, fire sales, and down rounds. If you do not have enough time before the six month window hits, take the financing hit early while you still have 12-18 months of money in the bank and some leverage. Your existing investors may extend your last round to give you a bit more runway, but only if there is a credible story as to how the company is going to achieve the necessary traction or positioning with the new timing based on the bridge capital. As a VC that I once had on my board liked to say, "we do bridges, but we don't do piers."
  • Startup 101: Getting Funded

    Raising venture capital for a new business is not easy, but fortunately the process is very predictable. First time entrepreneurs often do not understand the process, or think that they are above it, which leads to a lot of frustration, and in the end, no venture financing. If your business doesn't meet these criteria, it doesn't mean it is a bad business, just that it probably isn't going to be venture backed. If you want to raise venture capital, get out of your own way and navigate the following process.

  • Domain Expert - The most important thing for a startup to have is a domain expert. When people start a company in a business that they know nothing about, you end up with disasters like So it is critical that a startup has an expert in the market it is trying to penetrate. There is no such thing as a "visionary," just people who know a market very well and can therefore make a much more educated guess as to where it is going to go next than a layperson. If you don't have a domain expert on board, you are going to get decimated during due diligence. So either get a domain expert or don't raise venture capital.

  • Big Market - There has to be a there there. VC's want to fund new entrants in emerging markets, ideally markets that have had several large exits. If your product is more of a feature of an existing product, it is going to be tough to get it funded. Focus on a product that is something that customers will actually need to buy in order to grow their business, not a feature they will expect to get in a year from their existing vendors. If VC's are starting to see more deals in your market segment, that is actually a good thing, since other domain experts are sensing that there is something that is going to change, and you are now part of a market wave.

  • CEO - Most startups fall apart on execution. Having someone on board who has raised capital, built a team, shipped product to market, and created a liquidity event massively diminishes risk for investors. If you don't have someone like this on board, do your absolute best to recruit one. If you can't recruit a CEO, be very upfront that a big part of what you expect from the VC is to help you recruit an excellent CEO.

  • Product - If you are not shipping product yet, raise a seed round instead of an A round. If you have a CEO and a domain expert targeting a big market with a good product idea, chances are that you can raise your seed round from a venture firm. If you are missing one of these things either fill the gaps or raise a round from angels.

  • Market Pull - Is the market responding to your product? Do customers want it? When they get a trial version are they actually using it and requesting features? Are most customers like the ones trying out your product? If the answer is no, fix the product until the answer is yes. If the answer is yes, then you will have an A round!

    Venture capital is actually a ruthlessly competitive business, so sometimes you can skip the seed part if you have a hot deal or a VC has a good gut for the market. In my opinion, this is a bad move. You can get excellent terms on a seed deal if you are in a position to be able to skip it, and everyone is happier and better off that you prove out the product before scaling up the business. The point of all of this is to build a viable business, not to raise venture capital.

    There are always exceptions to the rule, but you are much better off just following the standard VC process. It is much more predictable, a lot less stressful, and you don't waste a bunch of time in meetings that are not going to go anywhere.
  • Thursday, June 28, 2007

    Java Lives, My Apologies to Sun :)

    Well there have been a few comments that I owe an apology to Sun for all of the "badmouthing" I did to Java a couple of years ago. After 10 years of working on Java at startups like JRad and NetDynamics and at the mothership Sun itself, I saw that Java was not responding to market trends and was in a slow, lumbering death spiral. I definitely did criticize Java, particularly in three areas:

    #1 - Open Source

    I have stated emphatically for years that Sun should open source Java, for a myriad of reasons. There was a lot of talk about fracturing Java which in reality was just talking points, and in the end Sun did open source Java and is now making nice with Linux distributions. Cudos!

    #2 - Scripting Language Support

    I feel strongly that loosely typed languages are much more suited than strongly typed languages for a lot of mainstream application development, particularly when dynamically building HTML or working with loosely structured data like XML. This is an argument that I had when I worked at Sun, and that I continued after I left Sun. Sun has recently helped out with JRuby thanks to Tim Bray and has now shipped a scripting language of its own, JavaFX. Again, Cudos!

    #3 - Lightweight Servers

    The Java enterprise edition is cumbersome, obtuse, and just too much for a lot of applications, what I dubbed a "muffin" architecture back in 2003. The alternative is a "donut" architecture of grids of lightweight servers, which the open source community has created with projects like Spring, Hibernate, and Mule. On this one Sun has had no leadership since Tomcat, and server side Java is essentially fractured with all leadership coming from a myriad of open source projects, with the JCP playing catch up.

    What has happened in the marketplace? .Net has become a viable competitor and Adobe dominates the rich client space, with Microsoft as an up-and-comer. Virtually all of the smart, innovative Web 2.0 startups who choose a clean slate have gone the LAMP or Ruby route. The only thing that has prevented this mass defection from happening in the enterprise is that lightweight Java became a viable alternative and the switching cost away from Java was too high. The past 5 years have not been good for Java, mainly because it was so slow in responding to the three trends listed above.

    So do I feel bad for having criticized Java? Not at all. I think that the blogging community played a big part in changing the direction of Java towards open source and scripting languages. I did have a bit of fun with it all, for which I do apologize. In hindsight, perhaps I should have just kept my mouth shut and LAMP would have had more traction in the enterprise! :)

    Thursday, June 07, 2007

    Startup 101: Sell to Users

    In the last few years, there has been a remarkable shift in how software is sold to businesses: by the time a salesperson is talking with a prospect, they are already a user! Numerous successful businesses do not have a single salesperson until there are a groundswell of customers that want to purchase their software at a relatively high pricepoint. Successful companies concentrate on getting users to use fully functional software for download or browser use and then upselling those users. This is a sharp contrast with the time consuming and expensive style of effectively selling incomplete software door to door to the Global 2000 and then fixing the software after the customer has bitten.

    Following are the characteristics of a successful 21st century software business:

  • Self-Service Product - Software must be easy to install and a service must be easy to run from a browser. Anything that these products do that is already well known (ie, add a customer in CRM) must be brain-dead easy and intuitive for someone to use, since users have almost zero tolerance for software that make simple things hard. Your team should have the domain expertise to create a product that intuitively offers the major, well known features of your target domain. If your product does not meet these criteria, concentrate on fixing the product, not sales.

  • Downloads, Not Meetings - Use email campaigns, adsense, webinars, and limited telesales to drive downloads so that you create users, and then upsell those users. If a company has a product that users can not successfully use on their own, it is not a product yet. Setting up meetings or WebEx's with prospects to "sell" them your product is not selling, it is customer research, so hire a product manager instead of salespeople and again, concentrate on fixing the product, not sales.

  • Sell to Users - As numerous SaaS and open source companies have shown, it is easy to find users if you build the right product. If people are not using your product after already having tried it out, fix the product to the point where they want to pay you, don't waste cycles trying to convince them to buy software they already know doesn't work for them. If people are actively using your product but not paying, add some additional features that a subset will pay for and make sure that your product is suitable for an audience that actually occasionally pays for software. Again, concentrate on fixing the product to the point where users that would pay for it would use it, not sales.

  • Feed the Channel - Systems integrators follow the money. If you can feed them business with your product, they are as happy as clams. If you want them to use your product to drum up business on their own, they don't need you, although they will be happy to meet, do a Barney "I love you, you love me" press release, and be partners. They just won't get you any money - you have to feed _them_ business. So unless you are calling on a systems integrator with a prospect in tow, (again!) concentrate on fixing the product to get that prospect, not channel sales.

    Infrastructure software like ESB's (Mulesource) and CRM (Salesforce, SugarCRM) that used to be extremely high touch and expensive is now sold self-service at much lower pricepoints. Companies like Tealeaf that are solving extremely complicated problems such as replaying a customer's browser when they call a helpdesk can sell direct at a very high pricepoint.

    A startup needs to figure out whether it is selling direct at a high pricepoint or self-service at a low pricepoint and follow that playbook. Selling direct at a low pricepoint is a nonstarter, even if one day you expect to be able to raise the pricepoint. VC's are not interested in that business model and your competitors will be selling a similar solution self-service and will therefore have a more scalable business model.

    In summary: keep it simple. Make software that is sexy with major features are easy to use, get people to come and check it out, and then tweak it to the point where people want to pay for it. Software today is decidedly product focused rather than sales focused. This is great, since building excellent product quickly is the competitive advantage of a startup. As a wise board member I served with said, "IBM already has a sales force, don't compete with it."
  • Tuesday, June 05, 2007

    Startup 101: The Platform Game

    I have been advising a few startups over the past few months and thought it might be useful to share some startup advice in a series I will call "Startup 101".

    The ability to identify a new trend early, turn on a dime, and capitalize on a market shift is what distinguishes a startup from a large company. A lot of what startups do is not actually new, but rather something old for a new platform. For example, NetDynamics/WebLogic/Kiva were appdev/deployment for Java/Internet, ActiveGrid was appdev/deployment for LAMP, MySpace is BBS for the web, Skype is phone for the Internet, Salesforce is CRM for SaaS, etc.

    The latest in vogue platform is Facebook's F8 platform, which is a supercool way for startups to deliver social features without having to build a social network. Kudos to iLike, which as one of the early adopters of the Facebook F8 platform has massively increased their number of users (850K new users in less than a week). iLike retained the ability to respond aggressively to market shifts even after years of survival mode through the .com bust. Following is a quote from Ali Partovi, iLike's CEO:

    "Our President, Hadi Partovi (my twin brother) took very little time to decide this was a huge strategic priority. That was a month ago. We re-prioritized everything else, and started moving our people off other projects onto this. First two or three people, then a few more, and by the end it was a huge group of engineers pulling back-to-back all-nighters for a week-long sprint to the launch." [BlogForward Q&A with iLike on Facebook]

    I have worked at startups that were able to move quickly to capitalize on shifts, and others that were not. Looking back, it is interesting to try to figure out the difference. Following are four characteristics that prevent a platform shift at a startup:

  • Age - One factor is the age of engineers. Younger engineers are much more willing (and often eager) to get yanked off of a project and put onto something new and interesting. Older engineers not so much, so before hiring them, make sure that older engineers have benefited from a sudden platform shift in the past and are amenable to having there tasks changed quickly.

  • Cultural Origin - People "fresh off the boat" from countries such as Russia and Israel with a culture of deep technical talent have a very high level of NIH and do not like to rely on unproven, emerging technology. Yes, Windows/Java/LAMP/Flash/JavaScript/Silverlight/F8 is new and has a lot of bugs. No, it is not as functional as the existing, proven technology platform. The reality is there is a bigger opportunity for a startup to deliver _less_ functionality on a new platform then _more_ functionality on the old platform. IBM is already delivering a ton of functionality on the old platform! So definitely hire smart technical people from other countries, just make sure they are somewhat acclimated to Silicon Valley startup culture.

  • Zig Zag Management - You can only change the platform once or twice if the age and cultural origin factors are not in play. After that, management loses all credibility and engineers just throw new initiatives under the bus. If your company is stuck on a deadend platform and is unable to zig or zag to a new platform, you are left with only two choices: package up what you have and try to flip the company or do a full restart to get to the new platform.

  • MBA Management - If a decision to support the emerging platform is made after a SWOT analysis, meetings with analysts, a series of management and board offsites, all day company alignment meetings, and customer focus groups, you will be lucky if you beat IBM to market, let alone startup competitors. This technique can only be successful when solving a new problem like SOX compliance. Shipping CRM for SaaS a year after Salesforce has launched is a nonstarter - another CRM opportunity did not open up until SugarCRM offered CRM for open source.

    Change is good. Very rarely do startups execute on a business plan from start to finish. Particularly with the accelerating pace of innovation of the past few years, the best of startups are agile and can capitalize on, rather than simply react to, platform shifts.