Tag Archives: unicorn

How To Get Your Startup a Halo

How would you like your startup to win deals not only when you win a customer evaluation, but when you tie — and even sometimes when you lose?

That sounds great.  But is it even possible?  Amazingly, yes — but you need have a halo effect working to your advantage.  What is a halo effect?  Per Wikipedia,

The halo effect is a cognitive bias in which an observer’s overall impression of a person, company, brand, or product influences the observer’s feelings and thoughts about that entity’s character or properties

There’s a great, must-read book (The Halo Effect) on the how this and eight other related effects apply in business.  The book is primarily about how the business community makes incorrect attributions about “best practices” in culture, leadership, values, and process that are subsequent to — but were not necessarily drivers of — past performance.

I know two great soundbites that summarize the phenomenon of pseudo-science in business:

  • All great companies have buildings.” Which comes from the (partly discredited) Good To Great that begins with the observation that in their study cohort of top-performing companies that all of them had buildings — and thus that simply looking for commonalities among top-performing companies was not enough; you’d have to look for distinguishing factors between top and average performers.
  • “If Marc Benioff carried a rabbit’s foot, would you?”  Which comes from a this Kellblog post where I make the point that blindly copying the habits of successful people will not replicate their outcome and, with a little help from Theodore Levitt, that while successful practitioners are intimately familiar with their own beliefs and behaviors, that they are almost definitionally ignorant of which ones helped, hindered, or were irrelevant to their own success.

Now that’s all good stuff and if you stop reading right here, you’ll hopefully avoid falling for pseudo-science in business.  That’s important.  But it misses an even bigger point.

Has your company ever won (or lost) a deal because of:

  • Perceived momentum?
  • Analyst placement on a quadrant or other market map?
  • Perceived market leadership?
  • Word of mouth as the “everyone’s using it” or “next thing” choice?
  • Perceived hotness?
  • Vibe at your events or online?
  • A certain feeling or je ne sais quoi that you were more (or less) preferred?
  • Perceived vision?

If yes, you’re seeing halo effects at work.

Halo effects are real.  Halo effects are human nature.  Halo effects are cognitive biases that tip the scales in your favor.  So the smart entrepreneur should be thinking:  how do I get one for my company?  (And the smart customer, how can I avoid being over-influenced by them?  See bottom of post.)

In Silicon Valley, a number of factors drive the creation of halo effects around a company.  Some of these are more controllable than others.  But overall, you should be thinking about how you can best combine these factors into an advantage.

  • Lineage, typically in the form of previous success at a hot company (e.g., Reid Hoffman of PayPal into LinkedIn, Dave Duffield of PeopleSoft into Workday).  The implication here (and a key part of halo effects) is that past success will lead to future success, as it sometimes does.  This one’s hard to control, but ceteris paribus, co-founding (even somewhat ex post facto) a company with an established entrepreneur will definitely help in many ways, including halo effects.
  • Investors, in one of many forms:  (1) VC’s with a strong brand name (e.g., Andreessen Horowitz), (2) specific well known venture capitalists (e.g., Doug Leone), (3) well known individual investors (e.g., Peter Thiel), and to a somewhat lesser extent (4) visible and/or famous angels (e.g., Ashton Kutcher). The implication here is obvious, that the investor’s past success is an indication of your future success.  There’s no doubt that strong investors help build halo effects indirectly through reputation; in cases they can do so directly as well via staff marketing partners designed to promote portfolio companies.
  • Investment.  In recent years, simply raising a huge amount of money has been enough to build a significant halo effect around a company, the implication being that “if they can raise that much money, then there’s got to be a pony in there somewhere.” Think Domo’s $690M or Palantir’s $2.1B.   The media loves these “go big or go home” stories and both media and customers seem to overlook the increased risk associated with staggering burn rates, the waste that having too much capital can lead to, the possibility that the investors represent “dumb money,” and the simple fact that “at scale” these businesses are supposed to be profitable.  Nevertheless, if you have the stomach, the story, and the connections to raise a dumbfounding amount of capital, it can definitely build a halo around your company.  For now, at least.
  • Valuation.  Even as the age of the unicorn starts to wane, it’s undeniable that in recent years, valuation has been a key tool to generate halos around a company.  In days of yore, valuation was a private matter, but as companies discovered they could generate hype around valuation, they started to disclose it, and thus the unicorn phenomenon was born.  As unicorn status became increasingly de rigeur, things got upside-down and companies started trading bad terms (e.g., multiple liquidation preferences, redemption rights) in order to get $1B+ (unicorn) post-money valuations.  That multiplying the price of a preferred share with superior rights by a share count that includes the number of lesser preferred and common shares is a fallacious way to arrive at a company valuation didn’t matter.  While I think valuation as a hype driver may lose some luster as many unicorns are revealed as horses in party hats (e.g., down-round IPOs), it can still be a useful tool.  Just be careful about what you trade to get it.  Don’t sell $100M worth of preferred with a ratcheted 2 moving to 3x liquidation preference — but what if someone would buy just $5M worth on those terms.  Yes, that’s a total hack, but so is the whole idea of multiplying a preferred share price times the number of common shares.  And it’s far less harmful to the company and the common stock.  Find your own middle ground / peace on this issue.
  • Growth and vision.  You’d think that industry watchers would look at a strategy and independently evaluate its merits in terms of driving future growth.  But that’s not how it works.  A key part of halo effects is misattribution of practices and performance.  So if you’ve performed poorly and have an awesome strategy, it will overlooked — and conversely.  Sadly, go-forward strategy is almost always viewed through the lens of past performance, even if that performance were driven by a different strategy or affected positively or negatively by execution issues unrelated to strategy.  A great story isn’t enough if you want to generate a vision halo effect.  You’re going to need to talk about growth numbers to prove it.  (That this leads to a pattern of private companies reporting inflated or misleading numbers is sadly no surprise.)  But don’t show up expecting to wow folks with vision. Ultimately, you’ll need to wow them with growth — which then provokes interest in vision.
  • Network.  Some companies do a nice and often quiet job of cultivating friends of the company who are thought leaders in their areas.  Many do this through inviting specific people to invest as angels.  Some do this simply through communications.  For example, one day I received an email update from Vik Singh clearly written for friends of Infer. I wasn’t sure how I got on the list, but found the company interesting and over time I got to know Vik (who is quite impressive) and ended up, well, a friend of Infer.  Some do this through advisory boards, both formal and informal.  For example, I did a little bit of advising for Tableau early on and later discovered a number of folks in my network who’d done the same thing.  The company benefitted by getting broad input on various topics and each of us felt like we were friends of Tableau.  While sort of thing doesn’t generate the same mainstream media buzz as a $1B valuation, it is a smart influencer strategy that can generate fans and buzz among the cognoscenti who, in theory at least, are opinion leaders in their chosen areas.

Before finishing the first part of this post, I need to provide a warning that halo effects are both powerful and addictive.  I seem to have a knack for competing against companies pursuing halo-driven strategies and the pattern I see typically runs like this.

  • Company starts getting some hype off good results.
  • Company starts saying increasingly aggressive things to build off the hype.
  • Analysts and press reward the hype with strong quadrant placements and great stories and blogs.
  • Company puts itself under increasing pressure to produce numbers that support the hype.

And then one of three things happens:

  1. The company continues delivering strong results and all is good, though the rhetoric and vision gets more unrelated to the business with each cycle.
  2. The company stops delivering results and is downgraded from hot-list to shit-list in the minds of the industry.
  3. The company cuts the cord with reality and starts inflating results in order to sustain the hype cycle and avoid outcome #2 above.  The vision inflates as aggressively as the numbers.

I have repeatedly had to compete against companies where claims/results were inflated to “prove” the value of bad/ordinary strategies to impress industry analysts to get strong quadrant positions to support broader claims of vision and leadership to drive more sales to inflate to even greater claimed results.  Surprisingly, I think this is usually done more in the name of ego than financial gain, but either way the story ends the same way — in terminations, lawsuits and, in one case, a jail sentence for the CEO.

Look, there are valid halo-driven strategies out there and I encourage you to try and use them to your company’s advantage — just be very careful you don’t end up addicted to halo heroin.  If you find yourself wanting to do almost anything to sustain the hype bubble, then you’ll know you’re addicted and headed for trouble.

The Customer View

Thus far, I’ve written this post entirely from the vendor viewpoint, but wanted to conclude by switching sides and offering customers some advice on how to think about halo effects in choosing vendors.   Customers should:

  • Be aware of halo effects.  The first step in dealing with any problem is understanding it exists. While supposedly technical, rational, and left-brained, technology can be as arbitrary as apparel when it comes to fashion.  If you’re evaluating vendors with halos, realize that they exist for a reason and then go understand why.  Are those drivers relevant — e.g., buying HR from Dave Duffield seems a reasonable idea.  Or are they spurious —  e.g., does it really matter that one board member invested in Facebook?  Or are they actually negative — e.g., if the company has raised $300M how crazy is their burn rate, what risk does that put on the business, and how focused will they stay on you as a customer and your problem as a market?
  •  Stay focused on your problem.  I encourage anyone buying technology to write down their business problems and high-level technology requirements before reaching out to vendors.  Hyped vendors are skilled at “changing the playing field” and trained to turn their vision into your (new) requirements.  While there certainly are cases where vendors can point out valid new requirements, you should periodically step back and do a sanity check:  are you still focused on your problem or have you been incrementally moved to a different, or greatly expanded one.  Vision is nice, but you won’t be around solve tomorrow’s problems if you can’t solve today’s.
  • Understand that industry analysts are often followers, not leaders.  If a vendor is showing you analyst support for their strategy, you need to figure out if the analyst is endorsing the strategy because of the strategy’s merits or because of the vendor’s claimed prior performance.  The latter is the definition of a halo effect and in a world full of private startups where high-quality analysts are in short supply, it’s easy to find “research” that effectively says nothing more than “this vendor is a leader because they say they’re performing really well and/or they’ve raised a lot of money.” That doesn’t tell you anything you didn’t know already and isn’t actually an independent source of information.  They are often simply amplifiers of the hype you’re already hearing.
  • Enjoy the sizzle; buy the steak.  Hype king Domo paid Alec Baldwin to make some (pretty pathetic) would-be viral videos and had Billy Beane, Flo Rida, Ludacris, and Marshawn Lynch at their user conference.  As I often say, behind any “marketing genius” is an enormous marketing budget, and that’s all you’re seeing — venture capital being directly converted into hype.  Heck, let them buy you a ticket to the show and have a great time.  Just don’t buy the software because of it — or because of the ability to invest more money in hand-grooming a handful of big-name references.  Look to meet customers like you, who have spent what you want to spend, and see if they’re happy and successful.  Don’t get handled into meeting other customers only at pre-arranged meetings.  Walk the floor and talk to regular people.  Find out how many are there for the show, or because they’re actual successful users of the software.
  • Dive into detail on the proposed solution.  Hyped vendors will often try to gloss over solutions and sell you the hype (e.g., “of course we can solve your problem, we’ve got the most logos, Gartner says we’re the leader, there’s an app for that.”)  What you need is a vendor who will listen to your problem, discuss it with you intelligently, and provide realistic estimates on what it takes to solve it.  The more willing they are to do that, the better off you are.  The more they keep talking about the founder’s escape from communism, the pedigree of their investors, their recent press coverage, or the amount of capital they’ve raised, the more likely you are to end up high and dry.  People interested in solving your problem will want to talk about your problem.
  • Beware the second-worst outcome:  the backwater.  Because hyped vendors are actually serving Sand Hill Road and/or Wall Street more than their customers, they pitch broad visions and huge markets in order to sustain the halo.  For a customer, that can be disastrous because the vendor may view the customer’s problems as simply another lily pad to jump off on the path to success.  The second-worst outcome is when you buy a solution and then vendor takes your money and invests it in solving other problems.  As a customer, you don’t want to marry your vendor’s fling.  You want to marry their core.  For startups, the pattern is typically over-expansion into too many things, getting in trouble, and then retracting hard back into the core, abandoning customers of the new, broader initiatives.  The second-worst outcome is when you get this alignment wrong and end up in a backwater or formerly-strategic area of your supplier’s strategy.
  • Avoid the worst outcome:  no there there.  Once in awhile, there is no “there there” behind some very hyped companies despite great individual investors, great VCs, strategic alliances, and a previously experienced team.  Perhaps the technology vision doesn’t pan out, or the company switches strategies (“pivots”) too often.  Perhaps the company just got too focused on its hype and not on it customers.  But the worst outcome, while somewhat rare, is when a company doesn’t solve its advertised problem. They may have a great story, a sexy demo, and some smart people — but what they lack is a core of satisfied customers solving the problem the company talks about.  In EPM, with due respect and in my humble opinion, Tidemark fell into this category, prior to what it called a “growth investment” and what sure seemed to me like a (fire) sale, to Marlin Equity Partners.  Customers need to watch out for these no-there-there situations and the best way to do that is taking strong dose of caveat emptor with a nose for “if it sounds too good to be true, then it might well possibly be.”

Thoughts on the Coupa S-1

It’s been a while since I dove into an S-1 and while I almost never get all the way through, here we go with another quick romp through a recent S-1.

Coupa, a ten-year old company that sells cloud-based spend management software and who pitches “value as a service” (ugh) recently filed its S-1.  Before diving in, I wonder if I should mention the potential irony in a company that sells “spend management” software running with a 40% operating loss.

But, remember the average SaaS business, per research from my friends at JMP, has negative operating margins at IPO time:  the median is -21% and the mean -36%.   So cheap jabs aside, Coupa is running a bit on the high side and, more importantly, in a time where I thought the markets were demanding better profitability than in the past.  That’s the interesting part.  From an operating margin perspective, Coupa is looking like a typical IPO in a market that was supposedly setting a higher bar.

Coupa’s most recent $80M private round put it in unicorn status (i.e., meaning that it was raised at a $1B+ valuation).

Estimating the shares outstanding after the offering is frankly quite confusing (e.g., share counts in the summary P&L seem to not include conversion of the preferred) and after spending 20 minutes trying to figure this out, I think there will be something like 180M shares outstanding after the offering.

Normally that might suggest a reverse split prior to IPO (as Talend recently did, an eight-for-one) but since I can’t find any evidence to suggest that, I’ll have to assume that Coupa and its bankers are bullish on valuation.  Otherwise, if I’ve got the right share count, any valuation less than about $1.8B will put them in single-digit stock price territory (which is the condition companies do reverse splits to avoid).

Highlights from the first pages of the S-1:

  • They connect 460 organizations (customers) with over 2M suppliers, globally
  • They estimate they have saved their customers $8B to date, on a cumulative basis
  • Fiscal year (FY) ends 1/31
  • FY15 revenues of $50.8M, FY16 of $83.7M, 65% YoY growth
  • FY15 net losses of $27.3M, FY16 of $46.2M, 68% YoY growth
  • 1H16 revenues of $34.5M, 1H17 of $60.3M, 75% YoY growth – accelerating

Now, let’s look at the income statement, which I’ve cleaned up and color-highlighted.

coupa1

Income statement comments:

  • Approximately 90%/10% mix of subscription to services, generally good
  • $83.7M revenues in last full FY is appropriate IPO scale by recent historical standards
  • 75% accelerating YoY growth in 1H17 over 1H16 is pretty strong
  • Subscription gross margins running 77% to 80%, pretty standard
  • Services gross margins of -89% in FY16 and -59% in 1H17 are horrific.  Happily it’s only 10% of the business.
  • Overall gross margins run around 60%, which strikes me as a bit low, but according to my JMP data, is roughly on target
  • 1H17 R&D of 25% of revenues, at the mean
  • 1H17 S&M of 58% of revenues, 7% above the mean
  • 1H17 G&A of 17%, 4% below the mean – but after running at a shocking 32% in 1H16
  • 1H17 total opex of 100% of revenues, about 3% above the mean
  • 1H17 operating margin of -39%, about 3% below the mean

They also present a non-GAAP operating loss which I can’t easily benchmark. They define it as:  operating loss before stock-based compensation, litigation-related costs and amortization of acquired intangible assets.  There was about a $12.9M delta between GAAP and non-GAAP operating income in FY16, which reduces to only $3.8M in 1H17.

Back to highlights from the S-1 body copy:

  • They typically do 3-year contracts
  • They say “we rely heavily on Amazon Web Services (AWS)” as a risk in the risk factors
  • 29% of revenues from international in 1H17
  • They had a “material weakness” in their FY14 audit, unusual
  • 25 pages of risk factors in total, normal
  • They’ve raised $165M in venture capital, and have $80M in cash
  • Almost $7M in litigation costs in FY15
  • They claim an estimated LTV/CAC that exceeds 6.0 in each of the past 3 years
  • They do an interesting analysis of their 2013 customer cohort concluding that its contribution margin was -249% in FY13, but 75% in FY14-16. (Page 53.)
  • Average ARR/customer up from $138K in FY15 to $183K in FY16

Here are the quarterly numbers; things look pretty consistent except for 2QF15, where among other things, they had $7.5M in stock-based compensation expense.

coupa2

More highlights

  • Operating cash burn of about $4M/quarter (page 67)
  • The CEO made $660K in cash comp in FY16, $320K and $340K bonus
  • The EVP of sales made $497K in cash comp in F16, $250K base and $247K commissions

Let’s take a closer look at the unicorn round:

  • It raised $80M at $4.18/share (page 119)
  • The beneficial ownership analysis (page 121) is based on 162.8M shares outstanding as of 7/31/16, but I believe excludes 61M shares associated with granted and un-granted stock options (page 43)
  • 162.8M + 61M = 223.8M shares on a fully diluted basis x $4.18/share = $935M
  • Not a unicorn you cry! ($935M < $1B)
  • But remember these claims are usually based on post-money valuation
  • $935M + 80M = $1.015B
  • So the math appears to hold up, but it’s also pretty clear Coupa was holding out for a valuation that squeaked them into the club

# # #

Be sure to read my disclaimers.

Too Much Money Makes You Stupid — Let’s Make an Alec Baldwin Viral Video

There are two sayings I like when it comes to the unicorn bubble:

  • “Too much money makes you stupid”
  • “Any idea’s a good one when you’ve got $100M burning a hole in your pocket.”

Startups are supposed to be focused.  Startups are supposed to need to prioritize ideas and opportunities.  Just as startups weren’t supposed to buy Superbowl ads, startups aren’t supposed to have hundreds of millions of dollars to plow through in the name of creating brand mystique either via huge-budget events like Domo’s Domopalooza or would-be viral videos, like the one below.

But wait, you protest, didn’t Salesforce always do aggressive marketing and wasn’t that risk-taking part of their greatness?  Well, yes and no.  A good part of their early marketing was guerrilla PR done on the cheap.  Yes, they also ran big events, but they mostly found a way to pay for them — Salesforce raised $53M in VC before going public.  Domo has raised nearly 10x that.

Now, I have no particular beef with Domo. Other than being next-generation BI, I must admit to always having had some trouble figuring out what they do — in part due to the abnormal secrecy they had in their early days.  I know they don’t compete with Host Analytics so I have no beef there.  I also know they have sexed-up the BI category a bit, and they’ve certainly done a great job of positioning themselves as a cool company and have created a lot of buzz in the market.

But at what cost?

Domo has raised $483M.  It does cause one to wonder about their capital-to-ARR ratio, which is a great overall capital efficiency metric and one that no ever seems to talk about.

  • While I don’t know in Domo’s case, I’d guess for many unicorns that this ratio is 10 to 20x — where the company is running a kind of perpetual motion machine strategy where you generate the Halo Effects hoping to drive the sales that justify the valuation that you got on your last financing.  This strategy, as many will discover, works well until it doesn’t.  If the epitaph of Bubble 1.0 was about Network Effects, that of Bubble 2.0 will be about Halo Effects.  Remember Warren Buffet’s famous quote:  “only when the tide goes out can you see who’s swimming naked.”
  • I know for a reasonably capital-efficient SaaS business the capital-to-ARR ratio might be 2-3x.  Perhaps an order of magnitude difference.

Back to our core topic — what’s an example of something that looks like a good idea when you have $483M burning a hole in your pocket that, well, might not look like such a good idea if you were forced to lead a more frugal marketing existence?

How about  a YouTube mini-series with Alec Baldwin?  That’s exactly what Domo did.

Here’s episode 1 about “rancid data” which, among several issues, breaks the fundamental rules about how to make a successful viral video.

Congratulations to MarkLogic on Unicorn Status

Congratulations to MarkLogic on achieving “unicorn” status with yesterday’s announcement of a $102M financing at a $1B+ pre-money valuation.

CB Insights now has MarkLogic officially on their unicorn tracker where they are in the company of a rather amazing other 102 startups all with $1B+ valuations, with a combined valuation of a staggering $371B.

Congratulations to the many team members with whom I worked during my time there (2004 to 2010), and a few names immediately spring to mind in that regard:  Max, Ian, Paul, Ron, Wayne, Mary, Ponz, Larry, Mark, Randall, Chris, Enrique, Dave, Ann, JT, Josh, Kelly, Matt, Norm, Denise, and of course, Brother Makely.

And I should also thank MarkLogic, in particular Bob and Dale, for being a Host Analytics customer — one of many high-growth, high-tech companies that choose Host Analytics as a cloud-based EPM system that you won’t outgrow.