Category Archives: Uncategorized

Kellblog’s Greatest Hits 2016-2019 per the Appealie SaaS Awards

I’ll be speaking at the APPEALIE 2019 SaaS Conference and Awards in San Francisco on September 25th and I noticed that in their promotions the folks at APPEALIE had assembled their own Kellblog’s Greatest Hits album from 2016 to 2019, complete with its own cover art.

appealie

When I looked at the posts they picked, I thought they did a good job of identifying the best material, so I thought I’d share their list here.  They also called me “a GOAT software blogger” and after playing around with acronyms for about half an hour — maybe Groove, OpenView, AngelVC, Tunguz? — my younger son swung by and said, “they called you a GOAT?  Cool.  It means greatest of all time.”  Cool, indeed.  Thanks.

Here’s the APPEALIE Kellblog’s Greatest Hits 2016-2019 list:

 

If Rebranding’s the Answer, What was the Question?

From time to time, every CMO faces a key question:  to brand or not to rebrand?

Often, it’s right after joining a company and you want to make a big splash.  Sometimes, it’s after you’ve been with a company for a while and you and some told-timers are bored with the current branding and want something new.

My general advice to those considering rebranding is “don’t do it” because I think it’s a siren’s call for several reasons:

  • Branding projects are usually big and expensive. They cost a lot money.  Lots of important people get involved, for example, in Post-It oriented workshops to help determine brand values and the real inner spirit of the company.  You’ll need a new corporate identity so everything from business cards to email footers to booth signage to social media icons to collateral layout all needs to get re-done.  And, of course, you’ll need to completely overhaul your website.  It’s easy for a $30M company to spend $400K on a rebranding and not hard for a larger company to spend millions.
  • Branding projects are highly visible. Everyone from customers to board members to employees to spouses to competitors to analysts is going to have an opinion on the new brand.  There’s no opportunity for quiet failure as you’d find with testing a new message or experimental online campaign.  Rebranding is a performance without a net in the center ring of the circus with the whole market watching.
  • Branding projects are risky. Part of the risk comes from the fact that they’re expensive and visible.  When rebranding includes renaming, there’s a whole additional level of risk around the name in terms of unknown meanings and homophones, missed trademark conflicts, problems with URL and/or social media handle availability (e.g., Netflix’s Qwikster debacle), or simply poor choices (e.g., PWC’s renaming to “Monday” [1A]).  Agencies often compound the risk by insisting on keeping everything secretive during the process, resulting in unveilings that tend to work either really well or really badly when they finally occur [1B].  Finally, if you mess up a rebranding project, it’s nearly impossible to walk it back.  When Business Objects did a dubious multi-million-dollar rebranding under the slogan, “Let There Be Light” and literally tried to trademark biblical content, there was no going back.
  • Rebranding is usually not the most important priority of the business. If your sales force is starving for pipeline or the industry analysts aren’t placing you in their leader quadrants, sales probably wants you investing in demand generation or analyst relations, not rebranding.  They’ll see rebranding as marketing for marketing’s sake more designed to impress other marketers (e.g., “we won an award”) than to help the business.  And they’ll see the CMO who led it as “ivory tower” and misaligned with their needs.

For these reasons, we can say that it’s a pretty bold decision for a CMO to undertake a rebranding project.  And CMOs should never forget the maxim about pilots:  “there are old pilots and bold pilots, but no old, bold pilots.”

What is a Brand?
Since brand is a highfalutin word that marketers often toss around with a certain arrogance – as if only they understand its meaning — let’s take a minute to bring branding back down to earth.

In short, a company’s brand involves four things:

  • Name (what I call it)
  • Corporate identity (what it looks like)
  • Brand values (what it stands for)
  • Corporate voice (what it sounds like)

The Joy of Naming
The fact is that in high-tech, naming doesn’t matter much.  Plenty of technology companies have been successful with pretty bad names.  For example, one of today’s hottest companies has one of the worst names ever, MongoDB, which works in English but in several European languages translates roughly to RetardDB [2].

Does anyone believe the success of Red Hat, SAP, or Veeva was due to an outstanding company name?  Or the success of Hashicorp, Zuora, or New Relic – each of which are just twists on the founder’s name [3]?

Pretty much any name that passes these tests works:

  • Short, ideally 3 or fewer syllables (especially if used as product name prefix)
  • No unintended meanings in other languages
  • Clear on trademark conflicts
  • Available URLs and social media handles
  • Easy to pronounce (people avoid saying words they’re not sure how to pronounce)
  • If descriptive, won’t becoming limiting and/or misleading over time [4]
  • If multi-word, doesn’t form an awkward acronym (even if you add I or C for “Inc.” or “Corp.”)

In my opinion, names fall into four buckets:

Bad, due to unintended meanings, pronunciation difficulty, length (too many letters and/or syllables), or being descriptive but misleading.  Examples:  MongoDB, Versant, Business Objects, and Ingres [5].  These can slow you down, but they certainly can’t stop you — which is why, when you compare brand equity to the risk and cost of renaming, it’s usually not worth it to change.  Unless it’s early days, simply accept you have a bad name and move on to more important matters.

Potentially problematic, descriptive but potentially limiting in the mid- or long-term.  Examples:  Microsoft, PeopleSoft, Salesforce.com, VMware, and Zendesk [6].  As the examples show, you can easily overcome the limits of such names, but they’re still not objectively great names in the first place.  These companies have simply overpowered the description in the names and turned them into meaningless brands over time [6A].

Good enough. These are typically meaningless – which is fine – and they obey the above rules well.  If they are descriptive, they’re broad enough to last long-term, given the company’s vision.  Examples: Okta, Veeva, Marketo, Atlassian, Coupa, Intacct, Siebel, Zuora, New Relic, Ooma, Medalia, GainSight, PagerDuty, and FloQast [7].  If you’re doing a renaming, good enough should be your practical goal.

Good.  I think we all like names that are either suggestive or broadly descriptive (and are thus good for the long haul).  Examples:  Anaplan, Oracle, Uber, Workday, Splunk, Kustomer, Airtable, Cisco, and Snowflake [8].  These are hard to find and you can waste a lot of time striving for a good name when you already have several good-enough candidates, and good enough is really all you need.

No discussion of technology naming would be complete without a reference to the epic episode of HBO’s Silicon Valley where Bachman decides to pick a new company name by going to the desert on a “vision quest” and eating psilocybin mushrooms to foster his creativity in so doing (NSFW).

The moral of the naming story is simple. There are bad names and good names and company success seems pretty much uncorrelated to them.  Your goal should be to get a good-enough name and then stop obsessing.

Elements of Corporate Identity
Corporate identity is what you look like, the idea being that I could see your booth from a distance, look at your website from across the room, or see one of your brochures without my glasses on and still know it’s you.

Corporate identity thus deals in defining:

  • Your logo, and its approved derivative forms
  • Your standard color palette
  • Your standard imagery
  • The templates for your website
  • The templates for collateral (e.g., data sheets, white papers)
  • The template for your PowerPoint presentations
  • The templates for business cards and email footers
  • Your social media icons

This is all very graphic design-y and it consists of defining the identity, documenting it in a graphic design manual which can be given other graphic designers to ensure they produce identity-consistent material, re-flowing all existing content into the new templates, and of course, re-implementing your entire website.

This alone can run in the hundreds of thousands of dollars, even when you’re executing on a budget.  And the fact is few people notice it.   Yes, there is a basic professionalism bar that you need to surpass, and a light brand refresh from time to time to fix problems (that really should have been caught on the first go-round) is probably OK.  But spending $1M on a corporate identity makeover is rarely appropriate, welcomed by sales, or a good use of money – unless your image is really, really out of date.

Understanding Brand Values
Quick, what does Coupa stand for?  How about Microsoft?  Or Adobe?  Or New Relic?  What’s the Oracle brand promise when you do business with them?

The reality is that most tech companies don’t stand for anything and don’t deliver much of a brand promise.  You could say the Atlassian stands for developers, FireEye for security, or GainSight for customer success, but that’s more a description of what they do than their brand values.

And Oracle’s brand promise?  Do they have one?  They seem to think it’s all about “simple, authentic, adaptive, …” and such.  If you asked ten Oracle customers about the Oracle brand promise, I think you’d more likely hear:  “they promise to extract as much money from me as they possibly can each year.”

I make a distinction between brand values which are external, customer-facing and usually involve some sort of promise and corporate values which internal, employee-facing, and try to guide employees in decision making.  Yes, there should be some linkage between the two and while virtually all technology companies have corporate values, they are also all too often empty words, not lived day-to-day and not reinforced in the culture [9].

So when it comes to brand values and technology companies, there’s not a lot to talk about.  I think one notable exception is Salesforce.com.  Salesforce understands branding, invests in it, trains new hires on it, and most importantly actually stands for something in the minds of customers.  What does Salesforce stand for?  In my opinion:

  • Philanthropy.  Exhibited both by Benioff personally and, as importantly, in the company’s 1-1-1 model where, among other things, employees get both paid time off (PTO) and volunteer time off (VTO) each year.
  • Trust.  Well ahead of its time and drilled into employees like a mantra, “nothing is more important than the trust of our customers.”

They may stand for other things as well.  But the interesting part is that they actually stand for something, which most technology companies simply don’t.

To understand brand value, it’s thus easier to look at consumer examples.  In my mind, brand value is what you sell in the store.  To pick some controversial examples, in the store, I think Chick-Fil-A sells a quality chicken sandwich.  While the founder had strong religious views which, for example, drove the decision to close on Sundays – I don’t think they’re selling a religious experience.  And when they crossed their wires, they seem to have learned from it, effectively saying they’ll leave policy to government and continue to focus on making quality chicken sandwiches and giving back to the communities in which they operate.

SoulCycle, to stay with controversial examples, on the other hand apparently sells more than a workout, but a lifestyle, or as this Washington Post story put it, “an idealized version of you.”  I’m not a customer so I can’t speak first-hand on this, but it appears that SoulCycle’s value proposition was bigger than a great spin class, selling values that their parent company owner visibly eschewed.  That caused a customer uproar which drew this response.  Quote:

This is about our values. So today, we are responding in the best way we know how—with diversity, inclusion, acceptance, and love.

Speaking with a Consistent Corporate Voice
If you think it’s hard to differentiate on visual identity or brand values, think about how hard it is to define a corporate voice.  It’s really hard.  Few companies do it.  Most companies strive to sound, well, like companies.  They want to be professional.  They want copy written by 50 different people to read and sound like copy written by one.  Towards these ends, companies usually produce Style Guides to drive such consistency, in matters from capitalization to spelling to diction to writing strategies [11].

But it’s rare in my experience to have an enterprise software company sound different from its peers.  Yes, I’d say open source and developer-oriented companies sound a bit different from applications companies.  But the only enterprise software company that I ever noticed having a unique corporate voice was Splunk, back in the day when Steve Sommer was CMO.  Splunk’s copy always had a certain approachable snark that I always enjoyed and that made it pretty unique and recognizable.  Some example Splunk slogans:

  • Finding your faults, just like mom
  • All bat-belt; no tights
  • Winning the war on error
  • CSI: logfiles
  • Take the sh out of IT

But most technology companies sound like technology companies and there’s nothing really wrong with that.  Just be professional and consistent.

To Net It All Out
My proudest accomplishment as a CMO was that in over 10 years I never instigated a major rebranding.  I ran a huge rebranding project — but it was started before I joined — and I’ve run several brand refreshes.

Wholesale rebranding is expensive, visible, and risky.  And it’s rarely the top priority of the business.  So I have a strong presumption-of-guilt bias when it comes to rebranding – it’s something marketing wants to do because marketing likes doing it.

To overcome that presumption, I’ll need to see sales alignment (i.e., they support it as a top priority) and real, hard reasons why it needs to happen.  Remember it’s not only a huge direct cost, but there’s a large opportunity cost as well — the entire time you’re re-implementing your website, re-laying out all your collateral, and refreshing your campaigns, you’re not making new content, collateral, and campaigns.

Looking at rebranding from my four perspectives, I think:

  • Renaming should be undertaken rarely. As we have shown, there are few names that can’t be overcome.  Be good enough.
  • Refreshing corporate identity is appropriate from time to time. Minimize change both to stay recognizable and reduce costs associated with re-implementation – see the delicate evolution of Chick-Fil-A’s logo over 50+ years, below.  Keep changes light.
  • Putting a lot of work into brand values at any enterprise software company below $1B (and arguably above $1B) is probably a waste of time. Yes, you should have corporate values and live them.  If you do, your customers will notice the visible ones and they will form the eventual basis for your brand values, if and when you formally define them.
  • While you should establish (and continually enhance) a written Style Guide early in your marketing evolution, I wouldn’t invest much in defining a corporate voice unless you happen to have a gifted marketer who has the knack.  Odds are you’ll end up sounding like everyone else, anyway, and that’s OK.  It’s technology marketing — differentiate with your message, not your voice.

chick-fil-a-logo-history-512x1024

# # #

Notes
[1A] Think:  “We’re going to meet the guys from Monday on Tuesday.”

[1B] Agencies like unveilings because it makes their life simpler.  Just get the CMO, the CEO, and maybe some small branding committee to say yes and they’re on their way.   They are typically terrified of open voting, town halls, and other such forums to solicit wide input.  If the unveiling fails, the agency can walk away and they were still paid, handsomely in most cases.  You don’t have that luxury.

[2] The name originally comes from the word, huMONGOous.  Apologies for using the R word, but it is the translation and the shock value is kind of the point.

[3]  Founded by Mitchell Hashimoto, Tien Zuo, and Lew Cirne (which is an anagram of New Relic).

[4]  Which is a great argument to avoid descriptive names in the first place.  They’re also harder to register as trademarks.

[5] MongoDB has unintended meanings, Versant and Ingres are non-obvious to pronounce, Business Objects has too many syllables and is misleading-descriptive (to object-oriented programming).

[6] Microsoft meant software for microcomputers and isn’t a great name for server and/or cloud software.  PeopleSoft meant HR software, not a great name for their financials application.  Salesforce now does marketing and service, not just sales.  VMware was about virtual machines and is not a great name as we move into a world of containers and serverless architecture.  Zendesk was a great name for help desk software, but less so for sales.

[6A] Meaningless, not in the sense that the brands don’t mean anything – e.g., saying “Microsoft” evokes meaning and feelings – but in the sense that the original words don’t mean anything.  You don’t immediately think, “the microcomputer software company.”

[7] I’m assuming Marketo wants to stay in marketing, Intacct wants to stay in accounting, and PagerDuty – the most potentially limiting name on this list – wants to stay in pagers and notifications.

[8] Most are self-explanatory, but on the more subtle side, Splunk suggests deep diving a la spelunking and Snowflake suggests data warehouses which are often built using snowflake schemas.

[9] One problem with core values is that they’re often all the same.  For example, these are five of the most common:  teamwork, customer service, lead-by-example, operational excellence, accountability.  This alone tends to hollow them out.

[10] This blog lists the Chick-Fil-A brand message:  part of the community, serving great food, giving back.  They’re selling great chicken sandwiches, not religious experiences.

[11] Example writing strategy:  Avoid using Business Objects in the possessive.  Say:  the people who work at Business Objects, not:  Business Objects’ people.

Avoiding the Ten-Year Stock Option Trap (and Other Stock-Option Considerations)

I’ve increasingly spoken to startup employees who find themselves in a difficult trap.  Let’s demonstrate it via an example:

Say you joined a startup in September 2009 as an early employee and immediately received a stock-option grant of 400,000 shares with a strike price of $0.10 when you joined.  The company, while having experienced some ups and downs over the years, has done very well.  At its last 409a valuation, the common stock was valued at $10/share [1].  You feel great; after all, you’re a paper millionaire, with an option worth about $4M [2].

What could possibly be the problem in this seemingly great situation?  Well, sometime in the next 45 days that stock-option is going to vaporize and become worthless.  

More scarily, what needs to happen for that option to become worthless?  Absolutely nothing.  Nobody has to say or do anything.  No notices need to be sent.  Sometime in the next 45 days that option will silently cease to exist [3].  If the company gets acquired two years later at $20/share and you’re expecting an $8M payout you’re going to be rudely surprised to find you get nothing.

The Silent Killer
What happened?  What is this silent killer of stock option value?  Expiration.  The option expired ten years after its grant date.

The vast majority of Silicon Valley stock option plans feature options that expire after ten years.   In this example, your option was granted in September 2009 which means that by October 1, 2019 that option will be expired.  And the really scary part is that nobody needs to tell you it’s about to happen.

While some companies are undoubtedly more proactive than others in both helping employees avoid getting into this situation and warning them as it approaches, in the end, it’s up to you to make sure you don’t get caught in this trap.  Technically, the company doesn’t need to say or do anything.  And – to be clear — because it’s a relatively new phenomenon in Silicon Valley the company may not even have noticed it’s happening and, even if it does, it may remain silent because it doesn’t really have any good remediation options.  It’s a tough situation on both sides because there are no easy wands that anyone can wave to fix this.

If you think you should stop reading here because you’re only at year two of your vesting, don’t.  If you resign (and/or get fired) from your job your stock options will typically expire in just 90 days, so you’ll be facing these same issues — just on a greatly shortened timeframe.

Who Is The Evil Genius Who Set This Up?
None.  There is no evil genius.  It’s simply an unwelcome artifact of Silicon Valley history.  In olden days it took about 4 years for a startup to hit a liquidity event [4] [5].  That’s why stock options vest over 4 years.  It’s also why they expire after 10 years.  All options need to have an expiration date and back in the day, 10 years approximated infinity [6].

As employees, we benefit from the artifact of 4-year-vesting.  However, if we’re not paying attention, we can get crushed by the artifact of 10-year expiration.

What Can I Do About It?
First, this is a tough situation and you may have few or no good options.

Second, I’m not a financial advisor [7]; you’ll need to see your financial and/or tax advisors to figure this out.  In this post, I’ll walk through what I see as some of your options – which will itself demonstrate the problem.

Third, short timeframes are not your friend.  If you see this problem coming I recommend you start thinking hard about it at least 12 months in advance; when you’re down to 30 days left your available choices may be extremely limited.

Here are some of your available options for handling this situation.

1. Exercise the stock-option before it expires. You’ll need to find $40K to pay the company for the exercise, but that’s not the hard part.  Because the fair market value (FMV) of the stock is $10/share you’re going to face a tax bill of somewhere between $1.1M and $1.9M on the exercise, even if you hold the stock (i.e., you don’t sell it) [8].  This is, in fact, the problem statement.

2. Exercise the option before it expires and sell enough to a third-party to pay the tax bill. This means, if you’re selling in the private market (e.g., EquityZen, Sharespost) at the FMV of $10, that you exercise 400K shares and then sell about 150K of them to cover your tax bill [9] [10A].  That leaves you holding 250K shares of stock.  This, however, requires (a) the existence of such a market and/or your ability to independently find a buyer, (b) the stock to be not restricted from you selling it without company approval (or the company granting such approval), and (c) you paying I’d guess $10K or more in legal and/or other transaction fees to make it happen [10].

3. Exercise the option with the support of a specialist fund (e.g,. ESOfund) that cuts rather exotic deals to solve this and related problems [10A]. For example, one of these (typically very boutique) funds might say:  “I’ll give you the cash both for the exercise and to pay your tax bill, if you give me the shares.  When we eventually sell them, I’ll keep 100% of proceeds until I get my money back, 50% until I get 3x my money back, and 25% after that [11].”  These funds are hard to find and the deals can be very hard to understand.  Legal bills can rack up quickly.  And you’ll need to be a major shareholder; no one wants to do a lot of complex work for 2K shares. 

4. Use a company liquidity program, if offered, to avoid getting into the situation.  Some companies periodically offer employees the right to sell shares in order to demonstrate to everyone that liquidity is possible.  Don’t be so busy doing your job that you forget to consider these programs.  While you may think the valuations offered are too low, if there is no secondary market for the stock and/or the company restricts selling the stock after its purchase, you may have no choice but to use such a program.  It’s a far better deal than letting the options expire worthless.

5. Live in Belgium. I believe Belgium has a great law whereby you pay a modest tax at the time you receive a stock option grant and then no tax on either exercise or sale [12].  I’m telling you this not to encourage you to start learning to enjoy moules frites and making immediate plans to move to Brussels (it’s probably too late) — but to remind my international readers that I’m writing from a US point of view and that stock option taxation, in particular, varies a lot from country to country.  If you happen to live in Belgium and the law hasn’t changed, it’s a particularly good place to get stock-options in early-stage startups.   But the main point is to be sure you understand the law of your country before making any plans or decisions when it comes to stock options (or any other tax matter).

6. Avoid the problem in the first place via an early-exercise with section 83b election. Some companies will allow you to exercise your options before they vest by effectively reversing the stock option – you pay the exercise price, the company gives you the shares, and the company retains a right to buy back the shares from you (at the exercise price) which declines by 1/48th per month over four years.  In addition, if you file a section 83b election within 30 days (and the grant was not in-the-money) then you pay no tax at exercise time and incur tax liability only when you eventually sell the shares, which if it’s more than a year away, results in long-term capital gains tax treatment [13].  Wow, this sounds awesome – and it is.

What’s the downside?  (a) Ideally, you need to do this up-front so it’s not necessarily a good solution if you’re in year three, (b) you need enough money to pay the exercise price which typically works well at early-stage startups (400K shares at $0.01/share = $4K) and a lot less well at later stage ones (100K shares at $5/share = $500K), (c) if the company gets in trouble [14] your common stock could well end up worthless and you won’t get your money back – you are effectively destroying the option-value of your option by exercising it, (d) if you don’t file your section 83b in a timely manner and/or lose your records of having filed it you could end up in a very bad position tax-wise [15].

7. Mitigate the problem via regular exercises along the way (laddered). While I don’t think this is a great strategy, it’s simple to understand, and mixes preserving option value while periodically exercising (and incurring taxes) along the way – so it’s going to be expensive to execute; but nevertheless way less expensive than a forced exercise in year 10.  The two nice things about this strategy are (a) you shouldn’t need company approval to execute it and (b) you can stop along the way and still own some of your options — it only gets very expensive in years 3 and 4.  Here’s a spreadsheet to show it (including some comments not in the image below) which you can download here.

ladder vs. panic

Of course, you may find other strategies, proactive companies may offer programs with other strategies, you might be able to execute a derivative of one of these strategies (e.g., number 3 with a rich uncle), and you can combine the above strategies (e.g., laddering plus early-exercise) as you see and your financial and tax advisors see fit.

I should note that later-stage startups may offer restricted stock units (RSUs) instead of options.  Though some of the same principles can apply (e.g., section 83b elections also relate to RSUs), RSUs work differently than stock options and bring different complexity which is beyond our current scope.

In this post, I’ve alerted you to the ten-year stock option expiration trap and given you a few ideas on how to avoid it.  Moreover, remember that if you resign (or get terminated) that this distant ten-year expiration problem becomes a 90-day problem.  Finally, I’ll point you to my favorite book on this subject (which covers both stock-options and RSUs), Consider Your Options 2019, and which has a nice website as well.

Remember to always talk to your financial and tax advisors before making key decisions about equity-based compensation.

# # #

Notes

[1]  Most private startups get an annual 409a valuation once a year to establish the fair market value (FMV) of their common stock so they can appropriately set the strike price on newly granted stock options, without being accused of granting in-the-money options (as some companies were accused of doing during the dot-com bubble).  409a valuations are always lower than “headline valuations” that companies often announce as part of financing rounds, because headline valuations take the price of a newly issued preferred share and multiply it by the entire share pool (common and preferred).  409a valuations first value the business overall, then subtract any debt, and then subtract the value of “preference stack” in arriving at a value for common stock in aggregate, and then per-share.  Because (a) of how they are calculated, (b) various valuation methodologies produce ranges, and (c) there is a general desire to preserve a low common stock price for as long as possible, 409a valuations not only differ from headline valuations (which are arguably calculated incorrectly) but they tend to produce a low-side estimate for the value of the common.

[2] And maybe a lot more than that because many private, hot-company stocks sometimes trade well above the 409a value in secondary markets.  In fact, in many cases it trades a little or no discount to the price of the last preferred round, and in some cases above it which, unless a lot of time has passed since the last round, strikes me as kind of crazy.

[3] That is, in the 45 days after August 15, 2019 – the day I wrote the post.

[4] For example, Business Objects was founded in 1990 and went public in 1994.

[5] If Silicon Valley were reinvented today, options would probably vest over 12 years, because that’s about how long it takes to get to an IPO.  However, that’s unlikely to happen as the ten years is the maximum duration under law for an ISO option.  This isn’t a VC-change kind of thing; it’s a write your Congressional Representative sort of thing.

[6] The definition of a (call) stock option is the right to buy N shares at price P by date D.  Expiration dates are inherent to options.

[7] See disclaimers in my FAQ and terms of use.

[8] Math is approximate.  On the low side, I’m assuming it’s an ISO option and the tax is all AMT at 28% and you’re in a tax-free state.  On the high side, I’m assuming it’s an NQ option, and a combined marginal rate of 49%.  See your tax professional for your situation.  The main point here:  it can be a huge number.

[9] Bear in mind, per earlier comments, the FMV tends to run on the low side and particularly for red-hot companies, prices in the secondary market can be well above the FMV, e.g., in this case, let’s say $20.  While this will help you on the sale side (you’ll need to sell half as many shares), it could bite you on the tax calculation because you’ll simultaneously be arguing that the stock is worth $10 for tax calculation purposes while actually selling it for $20.  See your tax professional.  Good luck.

[10] I’ve seen and/or heard of cases where companies charge a $5K administrative fee for people selling shares in this manner.  Some companies like it and make it easy.  Some don’t and make it anywhere from hard to impossible.

[10A] There is zero endorsement of any vendor or fund mentioned here.  I provide examples simply to make things concrete in terms of classification.

[11] This is a somewhat flawed representation of such deals, but you get the idea.  The fund effectively becomes your partner in owning the stock.  These can be expensive deals, but for the stock-optionee some value is better than none, which is what they will have once the option expires.

[12] This works particularly well for early-stage startups because I believe you pay a tax of either 9% or 18% of the aggregate value (shares x strike price) of the option at grant time, and the shares are worth next to nothing.  (It works less well if you get a grant of 100K shares valued at $100/share.)

[13] You must, must, must see your tax advisor on this.  You have only 30 days to file an election and if you don’t, you lose the benefits of this approach and can put yourself in a very bad situation.

[14] And trouble doesn’t have to mean bankruptcy.  It simply means any situation where the sale price of the company is less than the sum of debt to be repaid plus the preference stack.  In these situations, the common stock becomes worthless.  Note to the wise:  while it’s often the case, you cannot assume the preference stack is simply the amount VCs have invested in preferred stock.  In some cases, you have multiple liquidation preferences where VCs (or PEs) get 1.5x to 2.0x their investment back before the common gets anything.

[15] See [13].   I won’t go into the details of what happens because it’s complicated, but if you are going to go the section 83b route, you need to file within 30 days and keep very good records that you did.  You remember when people went bankrupt on AMT taxes due to buying-and-holding ISO options in Bubble 1.0?  You could end up rekt in a similar way if you get this wrong.

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

# # #

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.

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.

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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?