Category Archives: Social

Veterans vs. Up-and-Comers in Startups

The conventional Silicon Valley /  venture capital (VC) wisdom is that startups should not bet on first-time managers in just about any position, but particularly at the executive team level.  It’s best captured by the statement:  a high-growth startup is not the place to learn how to do your job.

This is the conventional wisdom because, while counter-intuitive to some, VCs are not actually risk-takers, they are risk-isolators.  A typical VC is trying to isolate risk down to one thing:  the unique value proposition behind the startup.  Those value propositions can vary considerably:

  • Sometimes, it’s about the technology.  Mark Logic, for example, is a technology disruptor.
  • More in vogue these days, it’s about the business model.  Salesforce disrupted the on-premises, perpetual license business model with SaaSMySQL disrupted the traditional license model with open source.
  • Sometimes, it’s about both.  My friends at Clearwell will rent you an appliance that includes an innovative e-discovery application.

But the point is that VCs are trying to isolate risk down to the one key value proposition.  They do that by setting every other lever in the business to standard.  For example, per the conventional wisdom, a SaaS BI business model disruptor should:

  • Hire standard managers with experience in big BI companies, and use equity to lure them from their cozy jobs.
  • Develop a standard BI application/product that contains the features users expect.
  • Build a standard enterprise sales force, hiring salespeople from the established BI vendors
  • Implement a standard BI partnering strategy, with the usual suspect technology and systems integration partners
  • Devise a standard marketing strategy, typical of those used by other BI companies but with a key emphasis on the unique value proposition.

Like most VC wisdom, at the first order the approach makes a lot of sense.  At the second order, however, it presents some problems.

  • It encourages cronyism, where the first such experienced manager knows a whole clan of other folks who also are looking for jobs, often for the same reason he or she was (e.g., recent of acquisition by Oracle, a new CEO, a strategy shift).  While one of the benefits of hiring experienced managers is undoubtedly their networks, I’ve seen this work out both quite well and spectacularly badly.    The key issue boils down to whether you are hiring drivers or passengers.  Was the company from which you’re hiring successful because of these people, regardless of these people, or indeed in spite of them?  Are you hiring real results drivers or people who, Fooled by Randomness, have great resumes and think very highly of themselves, but who are incapable of solving your company’s problems?
  • This cronyism often creates a divisive environment that drives out your top existing talent.  As the “Company X” mafia takes over, they typically show insufficient respect for those who got the company where it is, ridicule some past practices, and talk boisterously how easy it’s going to be to fix all this.  While problems in operational practices are easy to spot and fix, this approach overlooks the startup’s need for process maturity (e.g., size relative to Company X) and the startup’s strategic position in its market.  I remember when the experienced (manufacturing-oriented) managers from ASK took over Ingres (then a ~$200M company) and decided that implementing a heavyweight quality process was the answer to our problems.  In reality, our problem was strategic:  in a land-grab market we’d made some poor technology choices (e.g., Quel vs. SQL) that hampered sales and we had been too conservative about grabbing land.  Just as the Ingres executive team’s only hammer was technology, the ASK executive team’s only hammer was process.  Neither, unfortunately, was called for given the company’s situation.
  • It limits career growth for talented up-and-comers within the company:  either individuals with management potential or existing managers with executive staff potential.  If every new management job will be filled by an experienced outsider, then insiders quickly feel trapped and unable to advance in their careers, making them — particularly the more ambitious ones — more likely to leave the company.

The answer to managing all this is, of course, balance.  Both the CEO and the executive team need to take some calculated risks in betting on up-and-comers in a number of posts.  This generally will cost the CEO some political capital (debited at promotion time and never credited back, even if the up-and-comer is highly successful), but will help him or her retain both institutional memory and some key people for the future of the company.

Having a stronger-than-usual preference for up-and-comers, I’ve developed a few rules for managing this process.

  • Always do a external search.  You can turn the dial on how hard — from a check-the-network or calling a few contingency recruiters all the way up to a retained search — but you should always expend energy to see “who’s out there” so you have a sense of the market in making the veteran vs. up-and-comer decision.  You owe this to yourself, your board, and your shareholders.
  • Run up-and-comers through the same process as the external candidates.  The only exception here is when you are restructuring in which case many people may be changing roles without following an interview process.
  • Keep a mental balance of how many up-and-comer chits you have used and how many you think you have left.  You need to view them as a scare resource, because they are.
  • Ensure the up-and-comer is “all in.”  If you are going to bet political capital on someone they can’t either be [1] telling you what you think you want to hear or [2] be unsure of whether they can do the job.  You should only bet on up-and-comers who are certain they can be successful, and so certain that they will probably quit in the not-too-distant future if not offered opportunities.
  • Limit up-and-comers’ ability to bet on other up-and-comers.  Force them to prove they merit their posts by demonstrating how they can bring in veterans.  This is a both a solid practice and a great test.  The worst outcome is that your up-and-comer hires no veterans for his team and you end up with a whole multi-level hierarchy of inexperienced people.  (I’ve seen this happen, too, though happily not in my department and it’s one heck of a mess because there is typically no organizational awareness that anything’s even wrong! )

10 Lessons from a Failed Startup

I found this great post on VentureBeat, 10 Lessons from a Failed Startup, where entrepreneur Mark Goldenson tells you the ten things he learned from his failed internet TV network for games, PlayCafe.

Here’s a summary of the ten things Mark learned:

  • Find quick money first
  • Content businesses suck (or, do it for love and expect to lose money)
  • Know when to value speed vs. stability
  • Set a dollar value on your time
  • Marketing requires constant expertise
  • Control and calculate user acquisition costs
  • Form partnerships early, even if informal
  • Plan costs conservative and err on the side of raising too much [money]
  • The key to negotiating is having options
  • Knowing isn’t enough

You can read the complete post here, which is passionate and full of first-hand, hard-earned wisdom.

Let’s hope Mark has better fortunes on his next try which, per the bio, is going to be an innovative venture in web health care. Good luck with it!

Built to IPO, Flip, or Last?

While it’s taken me a while to post on this Wall St Journal article, it’s still as relevant today as it was back in July. The article discusses the recent dearth of IPOs, arguing that the long-closed IPO window is changing the way startups think about themselves, they way venture capitalists think about startups, and threatening the great Silicon Valley venture-capital-driven innovation machine.

In a blog that generally offers more critique than praise, I’d simply say: I think the author’s right. Fewer startups run the gauntlet to IPO and I think that’s the result of three things:

  • The SOX “tax” – an estimated $2M-$3M annual nut – which all but wipes out the bottom line of what were previously IPO-ready companies and reduces market caps. Example: for a 50% growth company with a 1.0 PEG ratio, $3M in SOX expense wipes out $150M in market cap.
  • Lack of demand in the public markets. As mentioned here before, when you look the Software Equity Group’s IPO pipeline, you can impute that the IPO window is what I call 50/50/0 — i.e., $50M+ in TTM revenues, 50%+ growth, and 0% EBITDA. But, while that may be the window to make it potentially worth filing – make no mistake – the IPO market is currently closed.
  • Industry consolidation. The article surprisingly misses this point, but the software industry has sufficiently consolidated that plunking down $75M to buy a plateaued startup is nothing, and even paying $300M – $500M to buy someone on a roll is basically chump change. And, if you’re SAP, Oracle, Google, or Microsoft, even $1B isn’t much to buy your way out of a strategic headache – and heck – since goodwill is no longer amortized and they’re typically buying with stock and can cut enough costs to make the acquisitive instantly accretive, it’s effectively “free” anyway.

The last point sometimes makes me wonder if software will end up like pharma or biotech where it seems that big companies have effectively outsourced innovation to startups. The big guys are willing to pay big dollars for the few who succeed in order to avoid billions of R&D that it takes to find the winners. Simply put (and from quite a distance) it seems they’ve outsourced the financing of innovation to venture capitalists.

If I were at one of the big software oligopolists, I probably do the same thing. I’d watch ten startups, let 3 fail, let 3 fail into mediocrity and buy them for chump change, and pay 10x revenue for the one that went red hot. You win some, you lose some. And – even when you lose you win – because you are so much larger than your targets that you can let them grow to even $200M in revenues and still buy them without much pain.

That’s a new dynamic.

This prompts the question: is the next-generation of VC-backed startups built-to-flip instead of built-to-last? Frankly, I think the answer’s a mix.

Increasingly, I think web 2.0 startups that take relatively little capital are running a different formula than classical enterprise software vendors. The latter might raise $30M in VC, hoping to go public with a $500M market cap. The former might raise only $10M, hoping for a quick sale at $50M. This changes venture economics, but the system can still work.

Prior to Mark Logic, I’ve worked at only three software companies: Ingres, Versant, and Business Objects. All three were venture backed. All three went public. And all three went public – more or less – in the year in which they did $30M in revenues. My, how things have changed!

By contrast, let’s look at Endeca, a player in enterprise search who started out in e-commerce search, bringing OLAP-style dimensional navigation to the content world. Later, the company branched into more areas (seemingly too many if the recent stuff I’m reading about spend management, other apps, and a DBMS-like positioning is correct).

Per a recent 451 Group report Endeca did about $100M in revenues in 2007, growing 70% over 2006, with 500 staff, 500 customers, an average deal size of $350K and a 90/10 direct/indirect channel model. They’re silent on profitability, though they recently raised a $15M venture round bringing total investment to about $65M, suggesting they’re still burning cash. The numbers, with the exception of the unknown profitability and the high direct sales dependency (which are quite possibly linked), overall look pretty good.

But Endeca first talked about an IPO in 2006 and 2+ years later they’re still all dressed up with nowhere to go. Why? I’d guess it’s a combination of the IPO window closure and (perhaps) some process issues related to compliance, which these days are another leading cause of IPO stall-out and an indirect form of SOX tax.

Frankly, I think it’s too bad. While I want to crush Endeca in the relatively few deals in which we compete (and complement them in the relatively few where we do that as well), I nevertheless believe that Joe Investor should be able to buy their stock. By forcing the de facto IPO bar ever higher, the US is locking out individual investors from participating in early-stage technology companies. That’s not good.

Why’d we do it, then? Because of the excesses of the web bubble and the early 2000s, one says. But, when I think about that era, the problems fall into two distinct classes:

  • Investors awarding $1B valuations to startups with $5M in revenues. While I think this was ostensibly insane, it should nevertheless be permissible – no one forces you to buy a share of in 1999. No one forces an investor to participate in a speculative bubble. Some would argue they’re a normal market phenomenon. They shouldn’t be outlawed. Caveat emptor.
  • Fraud a la Enron. This needs to be wiped out. No question. (For an interesting perspective on Enron, read Open Secrets by Malcom Gladwell.)

Somehow, I think we mixed up the two different problems along the way by enacting laws that throw the early-stage baby out with the anti-fraud bathwater. The result is that individual investors are denied access to early-stage growth companies and, the Journal argues at least, that we are threatening the health of the Silicon Valley innovation machine.

Startup Zeitgeist

Seedcamp, a London-based, week-long camp for European entrepreneurs recently did an interesting exercise. They took the several hundred applications they received for their event and made tagclouds. Here’s what they found.

What are you creating?

How will you make money?

What tools will you use?

(I’d love to see XQuery in the toolset, but happy to see that database, server, and XML are already there.)

And who says you can’t do interesting analytics on content? I thought this was fascinating. Check out Seedcamp’s blog post about the exercise, here.