Category Archives: Startups

Things to Avoid in Selecting an Executive-Level Job at a Software Startup

This is a sister post to my recent one, Career Decisions:  What to Look For in a Software Startup.  That piece is all about what to look for when considering taking a job at a software startup.  This piece is kind of the opposite:  what to look out for when considering an executive job at a software startup.

This post isn’t simply the inverse of the other and I didn’t approach writing it that way.   Instead, I started blank slate, thinking what are the warning signs that would make me think twice before taking an executive-level job at a software startup.

Before jumping into the list, let me remind you that no startup is perfect and that unless your name is Frank Slootman that you are unlikely to get a C-level offer from a startup that has all eight of the things I say to look for and none of the eight I say to avoid.  The rest of us, to varying degrees, all need to make intelligent trade-offs in facing what is effectively a Groucho Marx problem [1] in our career management.

That said, here’s my list of things to avoid in selecting an executive-level job at a startup:

1. Working for TBH, i.e., working for a boss who is to-be-hired. For example, if a company’s board is leading the search for a new CMO while the CEO slot is also open, the CMO would be working for TBH.  Don’t do this.  You have no idea who the new CEO will be, if you will like them, and whether their first act will be to fire you.  Ignore any promises that “you will be part of the process” in hiring the new boss; you may well find yourself interviewing them as you notice an offer letter sticking out of their backpack, suddenly realizing that you’re the interviewee, not the interviewer.  Read my post on this topic if you’re not convinced.

2. The immediate need to raise money.  Particularly for a CEO job, this is a red flag.  The problem is that unless you are a tier 1 rockstar, investors are not going to want to back the company simply because you’ve arrived.  Most investors will want you to have about a year in the seat before considering investing.  If you’re immediately dispatched to Sand Hill Road in search of capital, you’ll be out pitching the company poorly instead of learning the business and making plans to improve it.  Moreover, to state the obvious, joining a company that immediately needs to raise money means joining a company that’s in the midst of running out of cash.  That means either the company gets lucky and does so (often via an inside round [2]) or it doesn’t and your first quarter on the job will be focused on layoffs and restructuring instead of growth.  Think:  “I love you guys; call me back once you’ve done the round.”

3. Key internal customer TBHs.  For example, the VP of Sales is the VP of Marketing’s key internal customer, so Marketing VPs should avoid taking jobs where the VP of Sales is not in place.  Why?  As your key internal customer, the VP of Sales has a lot of power in both assessing your performance and determining your continued employment [3], so you really want to know if you get along and see eye-to-eye before signing up for a new job.  Moreover, even if you are work-compatible, some Sales VPs like “travel with” their favorite VP of Marketing.  Think:  “Mary’s great.  I just want to work with Joe like I have done at my last two companies.”  Bye Mary.

4. Strategic “traveling” violations.  “Pivot” is one of my favorite startup euphemisms. While many great startups have indeed succeeded on their second try, after a strategic pivot [4], some startups seem to want to make the pivot into an annual event.  Let’s remember that pivots mean strategic failure and the virtual write-down of any VC that went into funding the failed strategy.  While pivots can save a troubled company from continuing to execute a doomed strategy, they’re not something you want to do at all, let alone on a periodic basis.  In basketball, you get called for traveling if you (a) take more than two steps without dribbling or (b) move an established pivot foot.  I call startups for traveling when they (a) do two or more strategic pivots or (b) pivot to a new strategy that has nothing to do with the old one [5] (i.e., moving both feet).

5.  Nth-place Vendors (for all N>=3).  Most high-tech markets have increasing returns effects because customers like to reduce risk by buying from market leaders.  In the early 2000s, these normal increasing returns effects were compounded by network effects [6] in many markets.  Today, machine learning is compounding increasing returns yet again [7].  In short, it sucks to be third in Silicon Valley, it always has, and it’s likely to suck more in the future than it does now.

Therefore avoid working at vendors who are not #1 or #2 in their category.  If you’re considering a #N vendor, then it should be part of it moving to a focus strategy to become #1 at a product or vertical segment.  Don’t get sold the idea that a mega-vendor is going to acquire #4 after being rebuffed by the market leaders or to get a better price.  Mega-vendors greatly prefer to acquire market leaders and recent history has shown they are more than willing to pay up to do so.  Tuck-ins and acqui-hires still happen, but typically for very early-stage companies and not at great valuations.

6. Sick cultures and/or dishonest leaders.  Silicon Valley companies often make a big deal about “culture” but too often they conflate culture with ping pong tables, free lunch, and company parties.  Culture, to me, is the often unwritten code [8] of what the company values and how business gets done.  Alternatively, to paraphrase Henry Ford’s thoughts on quality, culture is what happens when no one is watching.  While many Silicon Valley leaders — going all the way back to HP — are “true believers” trying to build not only unique products but also create unique places to work, there are unfortunately charlatans in our midst.  Some leaders are disingenuous, others dysfunctional, and a few downright dishonest.  If you sense cultural sickness during your interview process, back-checking references, or reading Glassdoor [9], then I’d say tread carefully.

7. Low post-money valuations.  You’ll hear this argument a lot with Nth-place companies:  “well, the good news is we only got an $80M post-money valuation on our last round of $20M, whereas we heard LeaderCo was valued at $240M — so if you come here you’ll start making money off $80M, not $240M.”  At one level, it’s persuasive, especially if you think LeaderCo and NthCo are similar in many respects — “it’s like buying shares at 2/3rds off,” you might think.  But that thinking basically assumes the venture capital market mispriced LeaderCo.  You might justify that position by thinking “valuations are crazy right now” but if LeaderCo got a crazy valuation why didn’t NthCo get one too, raising in the same market?  While some people will try to market low valuations as opportunities, I now see them as problems.

Think not:  wow, what a great arbitrage play.  Think instead:  (a) what don’t I know [10] such that the market priced NthCo at 1/3rd the price of LeaderCo, and (b) what effects that will have on future financing — i.e., it’s likely LeaderCo will continue to have better access to capital going forward.  (Remember, the IPO class of 2018 raised a median of around $300M.)

In olden days, the rule was if the market leader went public at a valuation of $1B, then number two was worth about $500M, and number three $250M (4x, 2x, 1x).  Today, with companies going public later, more access to capital, and stronger increasing returns effects, I think it’s more like $4.5B, $1.5B, and $300M respectively (15x, 5x, 1x).  Given that, and increasing returns, maybe a “crazy” early valuation gap isn’t so crazy after all.

8. First-time, non-founder CEOs.  First-time, founder CEOs are the norm these days and VCs do a good job of helping surround them with a strong executive team and good advisors to avoid common mistakes.  Personally, I believe that companies should be run by their founders as long as they can, and maybe then some.  But when a founder needs to replaced, you get a massive signal from the market in looking at who the company is able to attract to run it.  Back in the day, if you were Splunk, you could attract Godfrey Sullivan.  Today, if you’re Snowflake, you can attract Frank Slootman.

My worry about companies run by first-time, non-founder CEOs [11] is less about the difficulty for the first-timer in transitioning to the CEO job — which is indeed non-trivial — and more about the signaling value about who would, and more importantly, who wouldn’t, take the job.  Experienced CEOS are not in short supply, so if a company can’t attract one, I go back to what don’t I know / what can’t I see that the pool of experienced CEOs does?

That’s not to say it never works — we did a fine job building a nice business at MarkLogic under one first-time, non-founder CEO that I know [11].  It is to say that hiring a non-founder, first-time CEO should prompt some questions about who was picked and why.  Sometimes there are great answers to those questions.  Sometimes, things feel a bit incongruous.

# # #

Notes

[1] Marx often quipped that he wouldn’t want to be a member of any club that admitted him, the rough equivalent to saying that you wouldn’t take a C-level job at any startup that would offer you one.

[2] As one VC friend so tersely put it:  “our job isn’t to put more money into a company, it’s to get other people to put more in at valuations higher than the one we invested at.”  (This somehow reminds me of the  General Patton quote:  “the object of war is not to die for your country, but to make the other bastard die for his.”)

[3] The number one “cause of death” for the VP of Marketing is the VP of Sales.

[4] I particularly like when those pivots are emergent, i.e., when the company is trying one thing, spots that another one is working, and then doubles down on the second thing.

[5] In the sense that they moved an established pivot foot by changing, e.g., both the target customer and the target product.  Changing your strategy to sell a different app to the same buyer, or the same app to a different buyer feels much more like a pivot to me.

[6] Everyone wants to be on the social network that their friends are on, so the more your friends pick network A over B, the more newcomers want to pick network A.  Back when there was competition in consumer social networks, entire high schools went either Facebook or MySpace, but virtually none went both.

[7] Where machine learning (ML) is an important part of the value proposition, you have even stronger increasing returns effects because having more customers, which means having more data, which means having better models, which means producing superior results.

[8] In cases there may be a very public written code about company culture.  But, to the extent the written culture is not the one lived, it’s nothing more than public relations or a statement of aspiration.

[9] While Glassdoor has many limitations, including that reviewers are not verified and that most reviewers are recently-terminated job-seekers (because the requirement to look for a job is to write a review), I still use it in researching companies.  My favorite dysfunctional pattern is a litany of detailed, fact-filled, seemingly sincere negative reviews, followed by a modest number of summary, high-level, HR-buzzwordy positive reviews followed by someone saying “I can’t believe management is feeding positive reviews to people in order to up our ratings.”

[10] An economist friend once taught me that when economists studied established practices in any field, e.g.,  the need for a second-serve (as opposed to just hitting two first serves) in professional tennis, they start out assuming the practice is correct, i.e., that the professionals really do know what they’re doing, and then see if the statistics justify the practice.  One might apply the same philosophy to valuations.

[11] Yes, I was one at MarkLogic.  In terms of signaling value, I was at least CMO of $1B company before starting and while I’d not been a CEO before, I did bring an unusual amount of database domain expertise (i.e., Ingres, Versant) to the party.

Good CEO Habits: Proactively Update Your Board at the End of Every Quarter

I am surprised by how many startup CEOs leave the board hanging at the end of the quarter.  As a CEO my rule of thumb was that if a board member ever asked me about the quarter then I’d failed in being sufficiently proactive in communications.  In tight quarters I’d send a revised forecast about a week before the end of the quarter — hoping to pre-empt a lot of “how’s it going” pings.

And every quarter I would send an update within 24 hours of the quarter-end.  In fact, if we’d effectively closed-out all material opportunities before quarter-end, I’d send it out before the quarter was technically even over.

Why should you do this?

  • It’s a good habit.  Nobody wants to wait 3 weeks until the post-quarter board meeting to know what happened.
  • It shows discipline.  I think boards like disciplined CEOs (and CFOs) who run companies where the trains run on time.
  • It pre-empts one-of emails and phone calls.  It’s probably less work, not more, to send a quick standard end-of-quarter update that includes what you do know (e.g., bookings) but not what you don’t (e.g., expenses because accounting hasn’t closed the quarter yet).

What form should this update take?  I’d start with the board sales forecast template that I’ve already written about here.  (And I’d change Forecast to Actual and drop the Best Case and Pipeline Analysis.)

how-to-present-forecast-2.jpg

Since cash is oxygen at a start-up, I’d add a line about forecast cash flows, making sure they know the numbers are preliminary, with final numbers to follow at the upcoming board meeting.  I might add a little color on the quarter as well.

Here’s an example of a good end-of-quarter board update.

Dear Board,

Just a quick note to give you an update on the quarter at GreatCo.  We beat new ARR plan by $200K (landing at $1,700K vs. plan of $1,500K) and grew new ARR YoY by 42%.  We came in slightly under on churn ARR, landing at $175K vs. a plan of $200K.  The result is we ended the quarter $225K ahead of plan on ending ARR at $11,546K, with YoY growth of 58%.

Cash burn from operations is preliminarily forecast to be $240K ahead of plan at $2,250K and ending cash is just about at-plan of $10,125K (we were a little behind in 1Q and 2Q has caught us back up).

We had some great competitive wins against BadCo and WorseCo — I’m particularly happy to report that we won the Alpha Systems deal (that we discussed in detail at the last meeting) against BadCo for $275K.  Sarah will tell us how we turned that one around at the upcoming board meeting.

Finally, I did want to point out — given the concerns about sales hiring — that we ended the quarter with 12 quota-carrying reps (QCRs), only 1 behind plan. Sarah and Marty did a great job helping us catch almost all the way back up to plan.  That said, we’re still having trouble hiring machine-learning engineers and are nearly 5 heads behind plan to-date.  Ron and Marty will update the board on our plans to fix that at the meeting.

Overall, we feel great about the quarter and I look forward to seeing everyone in a few weeks.  Thanks, as always, for your support.

[Table with Numbers]

Cheers/Dave

# # #

New ARR and CAC in Price-Ramped vs. Auto-Expanding Deals

In this post we’re going to look at the management accounting side of multi-year SaaS deals that grow in value over time.  I’ve been asked about this a few times lately, less because people value my accounting knowledge [1] but rather because people are curious about the CAC impact of such deals and how to compensate sales on them.

Say you sign a three-year deal with a customer that ramps in payment structure:  year 1 costs $1M, year 2 costs $2M, and year 3 costs $3M.  Let’s say in this example the customer is getting the exact same value in all 3 years (e.g., the right for 1,000 people to use a SaaS service) – so the payment structure is purely financial in nature and not related to customer value.

Equal Value:  The Price-Ramped Deal
The question on my mind is how do I look at this from a new ARR bookings, ending ARR, CAC, and sales compensation perspective?

GAAP rules define precisely how to take this from a GAAP revenue perspective – and with the adoption of ASC 606 even those rules are changing.  Let’s take an example from this KPMG data sheet on ASC 606 and SaaS.

(Price-Ramped) Year 1 Year 2 Year 3
Payment structure $1M $2M $3M
GAAP revenue $1M $2M $3M
GAAP unbilled deferred revenue $5M $3M $0M
ASC 606 revenue $2M $2M $2M
ASC 606 unbilled accounts receivable $1M $1M $0M
ASC 606 revenue backlog $4M $2M $0M

When I look at this is I see:

  • GAAP is being conservative and saying “no cash, no revenue.” For an early stage startup with no history of actually making these deals come true, that is not a bad position.  I like the concept of GAAP unbilled deferred revenue, but I don’t actually know anyone who tracks it, let alone discloses it.  Folks might release backlog in some sort of unbilled total contract value (TCV) metric which I suspect is similar [2].
  • ASC 606 is being aggressive and mathematical – “hey, if it’s a 3-year, $6M deal, then that’s $2M/year, let’s just smooth it all out [3]”. While “unbilled A/R” strikes me as (another) oxymoron I see why they need it and I do like the idea of ASC 606 revenue backlog [4].  I think the ASC 606 approach makes a lot of sense for more mature companies, which have a history of making these deals work [5].

Now, from an internal, management accounting perspective, what do you want to do with this deal in terms of new ARR bookings, ending ARR balance, CAC ratio, and sales comp?  We could say:

  • It’s $2M in new ARR today
  • Ergo calculate this quarter’s CAC with it counted as $2M
  • Add $2M in ending ARR
  • Pay the salesrep on a $2M ARR deal – and let our intelligently designed compensation plan protect us in terms of the delayed cash collections [6] [6A]

And I’d be OK with that treatment.  Moreover, it jibes with my definition of ARR which is:

End-of-quarter ARR / 4 = next-quarter subscription revenue, if nothing changes [7]

That’s because ASC 606 also flattens out the uneven cash flows into a flat revenue stream.

Now, personally, I don’t want to be financing my customers when I’m at a high-burn startup, so I’m going to try and avoid deals like this.  But if I have to do one, and we’re a mature enough business to be quite sure that years 2 and 3 are really coming, then I’m OK to treat it this way.  If I’m not sure we’ll get paid in years 2 and 3 – say it’s for a brand-new product that has never been used at this scale – then I might revert to the more GAAP-oriented, 1-2-3 approach, effectively treating the deal not as a price ramp, but as an auto-expander.

Increasing Value:  The Auto-Expanding Deal
Let’s say we have a different use-case.  We sell a SaaS platform and year 1 will be exclusively focused on developing a custom SaaS app, we will roll it to 500 users day 1 of year 2, and we will roll it to 500 more users on day 1 of year 3.  Further assume that the customer gets the same value from each of these phases and each phase continues until the end of the contract [8].  Also assume the customer expects that going forward, they will be paying $3M/year plus annual inflation adjustments.

Oy veh.  Now it’s much harder.  The ramped shape of the curve is not about financing at all.  It’s about the value received by the customer and the ramped shape of the payments perfectly reflects the ramped shape of the value received.  Moreover, not all application development projects succeed and if they fall behind on building the customized application they will likely delay the planned roll-outs and try to delay the payments along with them.  Moreover, since we’re an early-stage startup we don’t have enough history to know if they’ll succeed at all.

This needs to be seen as an auto-expanding deal:  $1M of new-business ARR in year 1, $1M of pre-sold upsell ARR in year 2, and another $1M of pre-sold upsell ARR in year 3.

When you celebrate it at the company kickoff you can say the customer has made a $6M commitment (total contract value, or TCV [9]) to the company and when you tier your customers for customer support/success purposes you might do so by TCV as opposed to ARR [10].  When you talk to investors you can say that $1M of next year’s and $1M of the subsequent year’s upsell is already under contract, ergo increasing your confidence in your three-year plan.  Or you could roll it all together into a statement about backlog or RPO [11].  That part’s relatively easy.

The hard part is figuring out sales compensation and CAC.  While your rep will surely argue this is a $2M ARR deal (if not a $3M ARR deal) and that he/she should be paid accordingly, hopefully you have an ARR-driven (and not a total bookings-driven) compensation plan and we’ve already established that we can’t see this as $2M or $3M ARR deal.  Not yet, at least.

This deal is a layer cake:  it’s a three-year $1M ARR deal [12] that has a one-year-delayed, two-year $1M ARR deal layered atop it, and a two-year-delayed, one-year $1M ARR deal atop that.  And that, in my opinion, is how you should pay it out [13].  Think:  “hey, if you wanted to get paid on a three-year $3M ARR deal, then you should have brought me one of those [14].”

Finally, what to do about the CAC?  One might argue that the full cost of sale for the eventual $3M in ARR was born up-front.  Another might argue that, no, plenty of account management will be required to ensure we actually get the pre-sold upsell.  The easiest and most consistent thing to do is to treat the ARR as we mentioned (1+1+1) and calculate the CAC, as you normally would, using the ARR that we put in the pool.

If you do a lot of these deals, then you would see a high new-business CAC ratio that is easily explained by stellar net-dollar expansion rates (173% if these were all you did).  Think:  “yes, we spend a lot up-front to get a customer, but after we hook them, they triple by year three.”

Personally, I think any investor would quickly understand (and fall in love with) those numbers.  If you disagree, then you could always calculate some supplemental CAC ratio designed to better amortize the cost of sale across the total ARR [14].  Since you can’t have your cake and eat it too, this will make the initial CAC look better but your upsell CAC and net-dollar expansion rates worse.

As always, I think the right answer is to stick with the fundamental metrics and let them tell the story, rather than invent new metrics or worse yet, new definitions for standard metrics, which can sow the seeds of complexity and potential distrust.

# # #

Notes

For more information on ASC 606 adoption, I suggest this podcast and this web page which outlines the five core principles.

[1] I am not an accountant.  I’m a former CEO and strategic marketer who’s pretty good at finance.

[2] And which I like better as “unbilled deferred revenue” is somewhat oxymoronical to me.  (Deferred revenue is revenue that you’ve billed, but you have not yet earned.)

[3] I know in some cases, e.g., prepaid, flat multi-year deals, ASC 606 can actually decide there is a material financing event and kind of separate that from the core deal.  While pure in spirit, it strikes me as complex and the last time I looked closely at it, it actually inflated revenue as opposed to deflating it.

[4] Which I define as all the future revenue over time if every contract played out until its end.

[5] Ergo, you have high empirical confidence that you are going to get all the revenue in the contract over time.

[6] Good comp plans pay only a portion of large commissions on receipt of the order and defer the balance until the collection of cash.  If you call this a $2M ARR deal, you do the comp math as if it’s $2M, but pay out the cash as dictated by the terms in your comp plan.  (That is, make it equivalent to a $2M ARR deal with crazy-delayed payment terms.)  You also retire $2M of quota, in terms of triggering accelerators and qualifying for club.

[6A] This then begs the question of how to comp the $1M in pre-sold upsell in Year 3.  As with any of the cases of pre-sold upsell in this post, my inclination is to pay the rep on it when we get the cash but not on the terms/rates of the Year 1 comp plan, but to “build it in” into their comp plan in year 3, either directly into the structure (which I don’t like because I want reps primarily focused on new ARR) or as a bonus on top of a normal OTE.  You get a reward for pre-sold upsell, but you need to stay here to get it and you don’t year 1 comp plan rates.

[7] That is, if all your contracts are signed on the last day of the quarter, and you don’t sign any new ones, or churn any existing ones until the last day of the quarter, and no one does a mid-quarter expansion, and you don’t have to worry about any effects due to delayed start dates, then the ARR balance on the last day of the quarter / 4 = next quarter’s subscription revenue.

[8] Development is not “over” and that value released – assume they continue to fully exploit all the development environments as they continue to build out their app.

[9] Note that TCV can be seen as an “evil” metric in SaaS and rightfully so when you try to pretend that TCV is ARR (e.g., calling a three-year $100K deal “a $300K deal,” kind of implying the $300K is ARR when it’s not).  In this usage, where you’re trying to express total commitment made to the company to emphasize the importance of the customer, I think it’s fine to talk about TCV – particularly because it also indirectly highlights the built-in upsell yet to come.

[10] Or perhaps some intelligent mix thereof.  In this case, I’d want to weight towards TCV because if they are not successful in year 1, then I fail to collect 5/6th of the deal.  While I’d never tell an investor this was a $6M ARR deal (because it’s not true), I’d happily tell my Customer Success team that this a $6M TCV customer who we better take care of.  (And yes, you should probably give equal care to a $2M ARR customer who buys on one-year contracts – in reality, either way, they’d both end up “Tier 1” and that should be all that matters.)

[11] Or you could of the ASC 606 revenue backlog and/or Remaining Performance Obligation (RPO) – and frankly, I’d have trouble distinguishing between the two at this point.  I think RPO includes deferred revenue whereas ASC 606 revenue backlog doesn’t.

[12] In the event your compensation plan offers a kicker for multi-year contracts.

[13] And while you should factor in the pre-committed upsell in setting the reps targets in years 2 and 3, you shouldn’t go so far as to give them a normal upsell target with the committed upsell atop it.  There is surely middle ground to be had.  My inclination is to give the rep a “normal” comp plan and build in collecting the $1M as a bonus on top — but, not of course at regular new ARR rates.  The alternative is to build (all or some of) it into the quota which will possibly demotivate the rep by raising targets and reducing rates, especially if you just pile $1M on top of a $1M quota.

[14] This ain’t one – e.g., it has $6M of TCV as opposed to $9M.

Stopping Inception Churn: The Prospective Customer Success Review

I think for many sales-aggressive enterprise SaaS startups, a fair amount of churn actually happens at inception.  For example, back in 2013, shortly after I joined Host Analytics, I discovered that there were a number of deals that sales had signed with customers that our professional services (PS) team had flat out refused to implement.  (Huh?)  Sales being sales, they found partners willing to do the implementations and simply rode over the objections of our quite qualified PS team.

When I asked our generally sales-supportive PS team why they refused to do these implementations, they said, “because there was a 0% chance that the customer could be successful.”  And they, of course, were right.  100% of those customers failed in implementation and 100% of them churned.

I call this “inception churn,” because it’s churn that’s effectively built-in from inception — the customer is sent, along with a partner, on a doomed journey to solve a problem that the system was never designed to solve.  Sales may be in optimistic denial.  Pre-sales consulting knows deep down that there’s a problem, but doesn’t want to admit it — after all, they usually work in the Sales team. Professional services can see the upcoming trainwreck but doesn’t know how to stop it so they are either forced to try and catch the falling anvil or, better yet, duck out and a let partner — particularly a new one who doesn’t know any better — try to do so themselves.

In startups that are largely driven by short-term, sales-oriented metrics, there will always be the temptation to take a high-risk deal today, live to fight another day, and hope that someone can make it work before it renews.  This problem is compounded when customers sign two- or three-year deals [1] because the eventual day of reckoning is pushed into the distant future, perhaps beyond the mean survival expectation of the chief revenue officer (CRO) [2].

Quality startups simply cannot allow these deals to happen:

  • They burn money because you don’t earn back your CAC.  If your customer acquisition cost ratio is 1.5 and your gross margins are 75%, it takes you two years simply to breakeven on the cost of sale.  When a 100-unit customer fails to renew after one year, you spent 175 units [3], receive 100 units, and thus have lost 75 units on the transaction — not even looking at G&A costs.
  • They burn money in professional services.  Let’s say your PS can’t refuse to the implementation.  You take a 100-unit customer, sell them 75 units of PS to do the implementation, probably spend 150 units of PS trying to get the doomed project to succeed, eventually fail, and lose another 75 units in PS.  (And that’s only if they actually pay you for the first 75.)  So on a 100-unit sale, you are now down 150 to 225 units.
  • They destroy your reputation in the market. SaaS startup markets are small.  Even if the eventual TAM is large, the early market is small in the sense that you are probably selling to a close-knit group of professionals, all in the same geography, all doing the same job.  They read the same blogs.  They talk to the same analysts and consultants.  They meet each other at periodic conferences and cocktail parties.  You burn one of these people and they’re going to tell their friends — either via these old-school methods over drinks or via more modern methods such as social media platforms (e.g., Twitter) or software review sites (e.g., G2).
  • They burn out your professional services and customer success teams. Your PS consultants get burned out trying to make the system do something they know it wasn’t designed to do.  Your customer success managers (CSMs) get tired of being handed customers who are DOA (dead on arrival) where there’s virtually zero chance of avoiding churn.
  • They wreck your SaaS metrics and put future financings in danger. These deals drive up your churn rate, reduce your expansion rate, and reduce your customer lifetime value.  If you mix enough of them into an otherwise-healthy SaaS business, it starts looking sick real fast.

So what can we do about all this?  Clearly, some sort of check-and-balance is needed, but what?

  • Pay salespeople on the renewal, so they care if the customer is successful?  Maybe this could work, but most companies want to keep salespeople focused on new sales.
  • Pay the CRO on renewal, so he/she keeps an honest eye on sales and sales management?  This might help, but again, if a CRO is missing new sales targets, he/she is probably in a lot more trouble than missing renewals — especially if he/she can pin the renewal failures on the product, professional services, or partners.
  • Separate the CRO and CCO (Chief Customer Officer) jobs as two independent direct reports to the CEO.  I am a big believer in this because now you have a powerful, independent voice representing customer success and renewals outside of the sales team.  This is a great structure, but it only tells you about the problems after, sometimes quarters or years after, they occur.  You need a process that tells you about them before they occur.

The Prospective Customer Success Review Committee
Detecting and stopping inception churn is hard, because there is so much pressure on new sales in startups and I’m proposing to literally create the normally fictitious “sales prevention team” — which is how sales sometimes refers to corporate in general, making corporate the butt of many jokes.  More precisely, however, I’m saying to create the bad sales prevention team.

To do so, I’m taking an idea from Japanese manufacturing, the Andon Cord, and attaching a committee to it [4].  The Andon Cord is a cord that runs the length of an assembly line that gives the power to anyone working along the line to stop it in order to address problems.  If you see a car where the dashboard is not properly installed, rather than letting it just move down the line, you can pull the cord, stop the line, and get the problem fixed upstream, rather than hoping QA finds it later or shipping a defective product to a customer.

To prevent inception churn, we need two things:

  • A group of people who can look holistically at a high-risk deal and decide if it’s worth taking.  I call that group the Prospective Customer Success Review Committee (the PCSRC).  It should have high-level members from sales, presales, professional services, customer success, and finance.
  • And a means of flagging a deal for review by that committee — that’s the Andon Cord idea.  You need to let everyone who works on deals know that there is a mechanism (e.g., an email list, a field in SFDC) by which they can flag a deal for PCSRC review.  Your typical flaggers will be in either pre-sales or post-sales consulting.

I know there are lots of potential problems with this.  The committee might fail to do its job and yield to pressure to always say yes.  Worse, sales can start to punish those who flag deals such that suspect deals are never flagged and/or that people feel they need an anonymous way to flag them [5].  But these are manageable problems in a healthy culture.

Moreover, simply calling the group together to talk about high-risk deals has two, potentially non-obvious, benefits:

  • In some cases, lower risk alternatives can be proposed and presented back to the customer, to get the deal more into the known success envelope.
  • In other cases, sales will simply stop working on bad deals early, knowing that they’ll likely end up in the PCSRC.  In many ways, I think this the actual success metric — the number of deals that we not only didn’t sign, but where we stopped work early, because we knew the customer had little to no chance of success.

I don’t claim to have either fully deployed or been 100% successful with this concept.  I do know we made great strides in reducing inception churn at Host and I think this was part of it.  But I’m also happy to hear your ideas on either approaching the problem from scratch and/or improving on the basic framework I’ve started here.

# # #

Notes

[1] Especially if they are prepaid.

[2] If CROs last on average only 19 to 26 months, then how much does a potentially struggling CRO actually care about a high-risk deal that’s going to renew in 24 months?

[3] 150 units in S&M to acquire them and 25 units in cost of goods sold to support their operations.

[4] I can’t claim to have gotten this idea working at more than 30-40% at Host.  For example, I’m pretty sure you could find people at the company who didn’t know about the PCSR committee or the Andon Cord idea; i.e., we never got it fully ingrained.  However, we did have success in reducing inception churn and I’m a believer that success in such matters is subtle.  We shouldn’t measure success by how many deals we reject at the meeting, but instead by how much we reduce inception churn by not signing deals that we never should have been signed.

[5] Anonymous can work if it needs to.  But I hope in your company it wouldn’t be required.

Ten Ways to Get the Most out of Conferences

I can’t tell you the number of times, as we were tearing down our booth after having had an epic show, that we overheard the guy next door calling back to corporate saying that the show was a “total waste of time” and that the company shouldn’t do it again next year.  Of course, he didn’t say that he:

  • Staffed the booth only during scheduled breaks and went into the hallway to take calls at other times.
  • Sat inside the booth, safely protected from conference attendees by a desk.
  • Spent most of his time looking down at his phone, even during the breaks when attendees were out and about.
  • Didn’t use his pass to attend a single session.
  • Measured the show solely by qualified leads for his territory, discounting company visibility and leads for other territories to zero.

slack boothDoes this actually happen, you think?  Absolutely

All the time.  (And it makes you think twice when you’re on the other end of that phone call – was the show bad or did we execute it poorly?) 

I’m a huge believer in live events and an even bigger believer that you get back what you put into them.  The difference between a great show and a bad show is often, in a word, execution.  In this post, I’ll offer up 10 tips to ensure you get the best out of the conferences you attend.

Ten Ways to Get the Most out of Conferences and Tradeshows

1. Send the right people.  Send folks who can answer questions at the audience’s level or one level above.  Send folks who are impressive.  Send folks who are either naturally extroverts or who can “game face” it for the duration of the show.  Send folks who want to be there either because they’re true believers who want to evangelize the product or because they believe in karma [1].  Send senior people (e.g., founders, C-level) [2] so they can both continue to refine the message and interact with potential customers discussing it.

2. Speak.  Build your baseline credibility in the space by blogging and speaking at lesser conferences.  Then, do your homework on the target event and what the organizers are looking for, and submit a great speaking proposal.  Then push for it to be accepted.  Once it’s accepted, study the audience hard and then give the speech of your life to ensure you get invited back next year.  There’s nothing like being on the program (or possibly even a keynote) to build credibility for you and your company.  And the best part is that speaking a conference is, unlike most everything else, free.

3. If you can afford a booth/stand, get one.  Don’t get fancy here.  Get the cheapest one and then push hard for good placement [3].  While I included a picture of Slack’s Dreamforce booth, which is very fancy for most early-stage startup situations, imagine what Slack could have spent if they wanted to.  For Slack, at Dreamforce, that’s a pretty barebones booth.  (And that’s good — you’re going to get leads and engage with people in your market, not win a design competition.)

4. Stand in front of your booth, not in it.  Expand like an alfresco restaurant onto the sidewalk in spring.  This effectively doubles your booth space.

5. Think guerilla marketing.  What can make the biggest impact at the lowest cost?  I love stickers for this because a clever sticker can get attention and end up on the outside of someone’s laptop generating ongoing visibility.  At Host Analytics, we had great success with many stickers, including this one, which finance people (our audience) simply loved [4].

I LOVE EBITDA

While I love guerilla marketing, remember my definition:  things that get maximum impact at minimum cost.  Staging fake protests or flying airplanes with banners over the show may impress others in the industry, but they’re both expensive and I don’t think they impress customers who are primarily interested not in vendor politics, but in solving business problems.

6. Work the speakers.  Don’t just work the booth (during and outside of scheduled breaks), go to sessions.  Ask questions that highlight your issues (but not specifically your company).  Talk to speakers after their sessions to tee-up a subsequent follow-up call.  Talk to consultant speakers to try and build partnerships and/or fish to referrals.  Perhaps try to convince the speakers to include parts of your message into their speech [5].

7. Avoid “Free Beer Here” Stunts.  If you give away free beer in your booth you’ll get a huge list of leads from the show.  However, this is dumb marketing because you not only buy free beer for lots of unqualified people but worse yet generate a giant haystack of leads that you need to dig through to find the qualified ones — so you end up paying twice for your mistake.  While it’s tempting to want to leave the show with the most card swipes, always remember you’re there to generate visibility, have great conversations, and leave with the most qualified leads — not, not, not the longest list of names.

8. Host a Birds of a Feather (BoF).  Many conferences use BoFs (or equivalents) as a way for people with common interests to meet informally.  Set up via either an online or old-fashioned cork message board, anyone can organize a BoF by posting a note that says “Attention:  All People Interested in Deploying Kubernetes at Large Scale — Let’s Meet in Room 27 at 3PM.”  If your conference doesn’t have BoFs either ask the organizers to start them, or call a BoF anyway if they have any general messaging facility.

9. Everybody works. If you’re big enough to have an events person or contractor, make sure you define their role properly.  They don’t just set up the booth and go back to their room all day.  Everybody works.  If your events person self-limits him/herself by saying “I don’t do content,” then I’d suggest finding another events person.

10.  No whining.  Whenever two anglers pass along a river and one says “how’s the fishing?” the universal response is “good.”  Not so good that they’re going to ask where you’ve been fishing, and not so bad that they’re going to ask what you’ve been using.  Just good.  Be the same way with conferences.  If asked, how it’s going, say “good.”  Ban all discussion and/or whining about the conference until after the conference.  If it’s not going well, whining about isn’t going to help.  If it is going well, you should be out executing, not talking about how great the conference is.  From curtain-up until curtain-down all you should care about is execution.  Once the curtain’s down, then you can debrief — and do so more intelligently having complete information.

Notes

[1] In the sense that, “if I spend time developing leads that might land in other reps’ territories today, that what goes around comes around tomorrow.”

[2] In order to avoid title intimidation or questions about “why is your CEO working the booth” you can have a technical cofounder say “I’m one of the architects of the system” or your CEO say “I’m on the leadership team.”

[3] Build a relationship with the organizers.  Do favors for them and help them if they need you.  Politely ask if anyone has moved, upgraded, or canceled their space.

[4] Again note where execution matters — if the Host Analytics logo were much larger on the sticker, I doubt it would have been so successful.  It’s the sticker’s payload, so the logo has to be there.  Too small and it’s illegible, but too big and no one puts the sticker on their laptop because it feels like a vendor ad and not a clever sticker.

[5] Not in the sense of a free ad, but as genuine content.  Imagine you work at Splunk back in the day and a speaker just gave a talk on using log files for debugging.  Wouldn’t it be great if you could convince her next time to say, “and while there is clearly a lot of value in using log files for debugging, I should mention there is also a potential goldmine of information in log files for general analytics that basically no one is exploiting, and that certain startups, like Splunk, are starting to explore that new and exciting use case.”

Career Decisions: What To Look For In a Software Startup

So, you’re thinking of taking a job at a startup, but are nervous about the risk, perhaps having trouble telling one from another, and unsure about knowing what’s really important in startup success.  In this post, I’ll share what I consider to be a great checklist for CXO and VP-level positions, which we’ll try to adapt a bit to be useful for all positions.

1. Great core/founding team.  Startups are about people.  We live in a founder-friendly VC era.  Thus, there is a good chance one or all of the founding team will be around, and in influential positions, for a long time.  If you’re CXO/VP-level, make sure you spend time with this team during your interviews [1] and make sure you think they are “good people” who you trust and who you’d want to work with for a long time [2].  You might well be doing so.

2. Strong investors.  In venture capital (VC) land, you should view investors as long-term partners in value creation.  Their investments give them contractual rights (e.g., board seats) and you can assume they will be around for a long time [3].  Companies need two things from their investors:  advice (e.g., the wisdom acquired from having built a dozen companies before) and money.  While good advice is always important, money is absolutely critical in today’s startup environment where a hot category can quickly evolve into a financial arms race to see which company can “buy” the most customers the fastest [4].

While I won’t do a tiering of Silicon Valley VCs here, you want to see investors with both deep pockets who can fund the company through thick (e.g., an arms race) and thin (e.g., inside rounds) and strong reputations such that other VCs are willing and eager to invest behind them in future rounds [5].

3. Newer company/technology.  I’ll give you the hint now that this is basically a list of key factors ranked by difficulty-to-change in decreasing order.  So the third hardest-to-change key factor is technology.  If you’re considering going to work at a twelve-year-old startup [6], understand that it’s very likely built on twelve-year-old technology premised on a twelve-plus-year-old architecture.  While the sales-and-marketing types will emphasize “its proven-ness” you will want to know how much technical debt there is associated with this old architecture.

Great startups are lead by strong technologists who ensure that technical debt is continuously addressed and retired via, e.g., trust releases.  Bad startups are feature addicts who pile feature upon feature atop a deteriorating architecture, creating an Augean Stables of technical debt. But even in good startups, routine debt-retirement doesn’t prevent the need for periodic re-architecture.  The best way to avoid an architectural mess of either type is to go to a newer startup, led by strong technologists, where the product is most probably built atop a modern architecture and where they definitionally cannot have accumulated a mass of technical debt [7].  

4. Clean cap table.  I once took a job at a company where a VC friend of mine said, “they have a good business, but a bad cap table.”  Since I didn’t entirely understand what he meant at the time, I took the job anyway — but, wow, do I wish I’d spent more time trying to understand the phrase “bad cap table.”

A capitalization table (aka “cap table”) is simply a list of investors, the type and amount of shares they hold, shares held by founders, shares allocated to the stock option pool, warrants held by suppliers and/or debtholders, and along with information about any debt the company has acquired.  So, strictly speaking, how could this table be inherently good or bad?   It just “is.”  Nope.  There are good cap tables and bad cap tables and here’s a partial list of things that can make a cap table bad in the eyes of a future investor.

  • Upstream investors who they don’t know and/or don’t want to work with.  That is, who holds the shares matters.
  • Ownership division that gives either the founders or employees too few shares.  Most VCs have the right to retain their percentage ownership going forward so if the company is already 60% owned by VC1 after the Series A and 20% owned by VC2 after the Series B, the new investor may believe that there simply isn’t enough to go around.  Strong VCs truly believe in founder and employee ownership and if there isn’t enough of it, they may walk from a deal.
  • ARR not commensurate with total funding.  Say a company has consumed $50M in capital but has only $5M in ARR to show for it.  Barring cases with exceptional product development entry barriers, that’s not a great ratio and most likely the result of a pivot, where the company started out on hypothesis A and then moved to hypothesis B.  From the new investor’s perspective, the company spent (and wasted) $30M on hypothesis A before switching to hypothesis B and thus has invested only $20M in its current business.  While some new investors might invest anyway, others would want some sort of recapitalization to reflect the business reality before investing.
  • Parasites, such as departed founders or incubators.  Founders A and B, aren’t going to be that excited over the long term for making money for founder C while she is off doing a new startup.  And why would a future VC want to make money for founder C, when she has already left the company [8]?  These are problems that need to be addressed from the viewpoint of a new investor.
  • Network effects among investors.  If VC1 owns 40% and VC2 owns 20% and VC2 works almost exclusively with VC1, then you can assume VC1 has control of the company.   This may not be a deal killer, but it may make a new investor wary.
  • Undesirable structure.  While VCs almost always buy preferred shares (as opposed to the common shares typically held by founders and employees), the specific preferences can vary.  New VC investors typically don’t like structure that gives preferred shares unusual preferences over the common because they worry it can demotivate employees and founders.  Such structure includes participating preferencesmultiple liquidation preferences, and redemption rights.

And that’s only a partial list.  At the CXO level, I think you have the right to ask about the cap table, but it’s much harder for job titles below that.  So I understand that you won’t always be able to access this information, but here’s what you can do:  (1) look at Crunchbase for financial history to try and identify some of these problems yourself, and (2) try to find a VC friend and get his/her opinion on the company.  VCs, particularly those at the bigger firms, are remarkably well informed and look at lots of deals, so they can usually give you an inkling about potential problems.

5. Strong market opportunity.  I’ve always done best when the need for the product was obvious.  Best example:  Business Objects in the 1990s — data warehouses were being built and it was obvious that there were no good tools to access them.  Business Objects eventually sold for nearly $7B.  Best counter-example:  MarkLogic in the 2000s — several years after Gartner wrote a note called XML DBMS:  The Market That Never Was.  That nearly twenty-year-old company is still not liquid, though through exceptional execution it has built a nice business despite strong headwinds; but there was nothing either obvious or easy about it.  In my other direct experience, the markets for Ingres (RDBMS), Salesforce.com, and Host Analytics (cloud EPM) were obvious.  The market for Versant (ODBMS) was not.

Another test you can apply to the market is the Market Attractiveness Matrix, which positions the type of buyer vs. the need for the product.  Selling SFA to sales, e.g., would be in the most attractive category while selling soft productivity improvement tools to HR would be in the least.

mam

Finally, I also like markets where the pricing is tied to something that inherently goes up each year (e.g., number of salespeople, size of stored documents, potentially usage) as opposed to things that don’t (e.g., number of HR or FP&A people, which increases — but in a more logarithmic fashion).

6. Strongest competitor in the market.  The problem with obvious market opportunities, of course, is that they attract multiple competitors.  Thus, if you are going to enter a competitive market you want to ensure the company you’re joining is the leader in either the overall market or a specific segment of it.  Given the increasing returns of market leadership, it is quite difficult to take away first place from a leader without they themselves faltering.  Given that hope is not a strategy [9], unless a runner-up has a credible and clear plan to be first in something [10], you should avoid working at runner-up vendors.  See the note below for thoughts on how this relates to Blue Ocean Strategy [11].

7.  Known problems that you know how to fix.  I’ve worked at epic companies (e.g., Business Objects, Salesforce) and I’ve worked at strugglers that nearly clipped the tree-tops on cash (e.g., Versant) and I can assure you that all companies have problems.  That’s not the question.  The questions are (1) do they get what really matters right (see previous criteria) and (2) are the things that they get wrong both relatively easy to fix and do you know how to fix them?

Any CXO- or VP-level executive has a set of strengths that they bring to their domain and the question is less “how good are you” than “does the company need what you bring?”  For example, you wouldn’t want a sales-and-marketing CEO — no matter how good — running a company that needs a product turnaround.  The key here is to realistically match what the company (or functional department) needs relative to what you can bring.  If you’re not a CXO- or VP-level executive, you can still apply the same test — does the company’s overall and functional leadership bring what the company needs for its next level of evolution?

8. Cultural compatibility.  Sometimes you will find a great organization that meets all these criteria but, for some reason, you feel that you don’t fit in.  If that happens, I’d not pursue the opportunity because you are likely to both be miserable on a daily basis and not succeed.  Culture runs deep in both people and in companies and when it’s a not a fit, it’s very hard to fake it.  My favorite, well-documented example of this was Dan Lyons at HubSpot, detailed in his book Disrupted.  HubSpot is a great company and I’m pretty sure Dan is a great guy, but wow there was a poor fit [12].  My advice here is to go with your gut and if something feels off even when everything else is on, you should listen to it.

I know it’s very hard to find companies that meet all of these criteria, but if and when you find one, I’d jump in with both feet.  In other cases, you may need to make trade-offs, but make sure you understand them so you can go in eyes wide open.

# # #

Notes

[1] A lack of desire to spend time with you during the recruiting process should be seen as a yellow/red flag — either about you as a candidate or their perceived importance of the position.

[2] In this context, “a long time” means 5-10 years.  The mean age of high-growth SaaS IPO companies in last year’s IPO class was 14 years.

[3] While “shareholder rotations” are possible (e.g., where firm B buys out firms A’s position) they are pretty rare and typically only happen in older companies (e.g., 10 years+).

[4] In my opinion, VC a few decades back looked more like, “let’s each back 5 companies with $20M and let the best operators win” whereas today it looks more like, “let’s capitalize early and heavily on the increasing-returns effects of market leadership and stuff (i.e., foie-gras) our startups with money, knowing that the market winners will likely be those who have raised the most cash.”  Note that while there is debate about whether this strategy yields the best returns (see foie gras link), there is less debate about whether this generates large companies in the market-leader pack.

[5] As one later stage investor told me:  “we prefer to work with syndicates with whom we’ve worked before” suggesting larger firms with more deals are preferable upstream and “if it ends up not working out, we’d much rather be in the deal with a highly respected firm like Sequoia, Accel, Lightspeed, or A16Z than a firm no one has ever heard of.”  Your upstream investors have a big impact on who is willing to invest downstream.

[6] Quip:  what do you call a twelve-year-old startup?  Answer:  a small business.  (Unless, of course, it’s high-growth and within striking distance of an IPO.)

[7] I would argue, generally, that newer startups tend to be built with newer business model assumptions as well.  So picking a newer company tends to ensure both modern architecture and contemporary thought on the business model.  For example, it’s hard to find a five-year-old enterprise software company built on an on-premises, perpetual license business model.

[8] Or, if an incubator makes itself a virtual cofounder in terms of common stock holdings in return for its incubation services.

[9] i.e., hoping the other company screws up.

[10] Either a segment or a segment that they believe will grow larger than today’s overall market.

[11] I feel obliged to mention that not all non-obvious market opportunities are bad.  As a big fan of Blue Ocean Strategy, I’d argue that the best market opportunities are semi-obvious — i.e., obvious enough that once you dig deeper and understand the story that they are attractive, but not so obvious that they attract a dozen ocean-reddening competitors.  Of recent enterprise software companies, I’d say Anaplan is the best example of Blue Ocean Strategy via its (emergent) strategy to take classic financial planning technology (hypercubes) and focus on sales planning in its early years.

[12] Note that I am not saying HubSpot is a perfect company and we can argue at great length (or more likely, quite briefly) about the strengths and weaknesses in typical Silicon Valley cultures.  And that’s all interesting academic debate about how things should be.  What I am saying is that when it comes to you, personally, for a job, why make yourself miserable by joining an organization where you know up-front that you don’t fit in?

Appearance on the Twenty Minute VC: Financing Thoughts, The Private Equity Sales Process, and More

Today famed venture capital podcaster and now venture capitalist at StrideVC, Harry Stebbings, released a new episode of the Twenty Minute VC podcast with me as his guest.  (iTunes version here.)

dk harry 500

Harry’s interview was broad-ranging, covering a number of topics including:

  • Financing lessons I’ve learned during prior bubble periods and, perhaps more importantly, bubble bursts.
  • The three basic types of exits available today:  strategic acquirer, old-school private equity (PE) squeeze play, and new-school PE growth and/or platform play.
  • A process view of exiting a company via a PE-led sales process, including discussion of the confidential information memorandum (CIM), indications of interest (IOIs), management meetings, overlaying strategic acquirers into the process, and the somewhat non-obvious final selection criteria.

The Soundcloud version, available via any browser is here.  The iTunes version is here.  Regardless of whether you are interested in the topics featured in this episode, I highly recommend Harry’s podcast and listen to it myself during my walking and/or driving time.

Oh, and if you like the content in this episode, don’t miss my first appearance on the show.