Friday, April 28, 2006

Business Plan Dependencies

In designing a business plan, it pays to ask, "what are the business plans' dependencies on variables beyond the company's control?" Why? Because the probability of success is inversely proportional to the number of exogenous variables.

Let's assume the business is dependent on five market factors materializing and each independent variable has a 50% chance of occurring - the odds of failure are then 1-(.5^5), or 96.875%. Not good. The odds of start-up success are already daunting; making the odds even more daunting by attempting to execute a plan overly dependent on external variables is a recipe for frustration.

What do I mean? Well, if a business plan requires
  • distribution deals to reach the end-market (ex. wireless carriers)
  • deployment of new networks, infrastructure, and network devices (ex. wimax, rfid readers)
  • new device proliferation (ex. Windows Mobile only)
  • new technology (broadband over powerline)
  • etc...
Too often, I see great entrepreneurs looking to fund businesses that face massive external market adoption dependencies. Skating to where the puck will be is critical, but I would just make sure the rink is built before you strap on your skates.

Thursday, April 27, 2006

America's Competitiveness

Today, the NVCA announced Magnet USA, a program designed to strengthen America's competitive position in the global economy. I am all for programs designed to stimulate and encourage innovation. Innovation creates jobs, wealth, and increased social utility. However, America's long term security and capacity to support innovation is under tremendous pressure.

Bill Gross' recent column compares the future fate of America to the current state of GM. Gross attributes GM's malaise to uncompetitive labor costs and the burden of pension and health care liabilities. He argues that we are glimpsing America's future in the GM's current struggle to remain solvent, reduce its fixed costs, and reduce future pension and healthcare obligations via employee buyouts. It is a worthwhile and scary read.

Is this overly negative thinking? I went to and read through the OMB's assessment of America's future to find out. Unhappily, I found the following:

"While the near-term outlook for shrinking deficits is encouraging, the long-term picture presents a major challenge due to the expected growth in spending for major entitlement programs. In only two years, the leading edge of the baby boom generation will become eligible for early retirement under Social Security. In five years, these retirees will be eligible for Medicare. The budgetary effects of these milestones will be muted at first. But if we do not take action soon to reform both Social Security and Medicare, the coming demographic bulge will drive Federal spending to unprecedented levels and threaten the NationÂ’s future prosperity.

No plausible amount of cuts to discretionary programs or tax increases can help us avert this major fiscal challenge. As the accompanying chart shows, assuming mandatory spending continues on its current trajectory and the tax burden is held at historical levels, by 2040 Federal spending will accelerate to a level at which mandatory outlays and debt service would consume all Federal revenue. By 2070, if we do not reform entitlement programs to slow their growth, the rate of taxation on the overall economy would need to be more than doubled, placing a crushing burden on the economy that is required to produce the revenues to support the Government programs in the first place."

Wow. According to the OMB, by 2040 all our tax revenue will go to entitlement spending and debt service. How we will invest in the future - research, education, infrastructure - if we are seeing an ever smaller amount of US government revenues available for discretionary spending?

The technology market feels good right now - new companies, models, and innovation is strong. What frightens me is when the OMB and major bond holders forecast a financial meltdown and the eventual devaluation of the US currency, rising interest rates, and a social contract (entitlement spending) that will literally break the bank.

As the VC industry discusses globalization and the merits of offshore investing, a key part of the conversation may be the fundamental, long term macro trends that are shaping the face of future opportunity and innovation. Certainly, the OMB paints a bearish view of America and a compelling reason to start thinking about offshore investing and non-US dollar holdings.

I recently heard someone argue that capital is a coward - it seeks refuge in safe-havens. Unless, we in America are able to make difficult decisions and reduce the fixed costs in the governmemt budget, as GM is laboring to do today, capital will eventually flow out the US and to more attractive safe harbors. Hopefully, unlike energy policy/problems, these entitlement burdens will become part of the political discourse while we still have time to make painful choices to avert painful outcomes.

Tuesday, April 18, 2006

Concept to Company Update - Great Event

Tonight, VLAB and Hummer Winblad hosted a wonderful panel at Stanford Business School titled Concept to Company: Strategies for Swimming with the Sharks.

This year's Concept-to-Company event focused on the business formation of Cittio, a network management software company founded in 2001 and funded by Hummer Winblad last year. Ann Winblad moderated the panel, Jamie Lerner, Cittio's CEO served as the keynote speaker, and the panelists included Sandeep Johri, Oblix's founding CEO and currently HP Software's VP Strategy and Business Planning, Deborah Magid, IBM Software's Director of Strategy, and Elisabeth Rainge, IDC's Network Management analyst.

The evening's conversation centered on how start-ups best can enter mature markets dominated by incumbents. Network management is a $5+bn software market owned by IBM, HP, BMC, and CA. Jamie set out to answer how best to archetype an offering innovation, sales and delivery model, and marketing message that resonates with buyers in a market long controlled by larger vendors.

Jamie's advice centered on when to raise VC money, how to pick your VC partner, how to pitch VCs, how to sell against giants, and how to handle incumbents' FUD.

When To Raise VC Money
Jamie believes in bootstrapping companies. While I believe this is not a requirement, Jamie believes start-ups are best served by eliminating key market, customer, and product risks prior to soliciting venture firms. Jamie calls his strategy the "just add water approach;" walk in to meetings having validated a big market, shipped a solid product, sold paying customers, operated a well managed business, and hired a good team. He believes entrepreneurs should validate the following five hypotheses:
  • Demand - select a large, established market to operate in and prove the innovation
  • Product - develop a complete and working product
  • Customers - referenceable accounts, good logos, and revenues
  • Profitability - prove efficiency, discipline, and frugality
  • Team - key players in place to grow
It is worth noting that Jamie met all five criteria before he looked for funding. Quite simply put, he focused on providing easy to use, easy to deploy, easy to install, and simply priced products into a market long burdened by bloated products that poorly served the customer. The pain proved to be so great that he sold Gymboree and First Republic on full enterprise deals before he hired a single employee.

How to Pitch VCs
Jamie suggested the following structure for good pitches:
  • 10 slides
    • be crisp, clear, and articulate about the market need, offering innovation, and sales and delivery model
  • 5 year GAAP pro formas
    • commit to the intellectual exercise of building, with the management team, and model that lays out in detail the business model and key assumptions that drive the model
  • Demo
  • Raise amount and use of proceeds
  • Be comfortable talking extemporaneously about the business
  • Practice and iterate

Not All VCs are Created Equal

Jamie suggests that entrepreneurs select VC firms that match the following criteria:
  • Domain expertise - mentorship, advice, market knowledge, relationships, strategy, been there/done that
  • Relationship - mutual trust and respect, genuine friendship, gut instinct positive
  • Everyone rows - access to all members of the investing firm
  • Patience - recognition that there is no deadline for success and that the best plans may take longer than originally forecast
  • BOD - work hard to ensure a productive BOD dynamic and use VC BOD members to recruit value-added independents
  • Remember that you need the BOD and VCs when things go wrong and having experienced VC investors and strong relationships will be critical in navigating the storms
Selling Against the Big Guys
In order to sell against giants, Jamie laid out the following suggestions
  • He joked that selling against incumbents is more like jetskiing with whales than like swimming with sharks
  • Focus on competing with bloated products that are overly complex to install, overly complex to price, and where the cost of sale requires very large deal sizes
  • Sell into a market frustrated, scarred, and damaged by the incumbent vendors - lots of shelfware and history of failed implementations
  • Pick markets where the incumbents illustrate a history of incompetence evidenced by frequent CEO changes, failed mega acquisitions, failed customer projects, etc
  • Don't bloody your nose - sell where they cannot afford to compete (mid market or via delivery models they cannot afford to mimic). Don't take them head on - nip at their heels
  • Sell deal sizes their sales teams, cost of sales, and quota models cannot support
  • Leverage start-ups strengths
    • Speed, agility, service
    • Executive sponsorship
    • Pricing flexibility
    • Attention and support
  • Fight FUD and vendor viability attacks
    • Sell your business fundamentals when they question your viability and staying power
    • Walk the customer through the clear demand for the product, customer references and case studies, profitability or revenue run rate, and quality of the team
Jamie and the panel did a great job and for those of you who could not make it, I hope the notes above provide some insights into Jamie's great advice and bases for his great success to date.

Wednesday, April 12, 2006

Venture Stats

VentureSource, a division of Dow Jones, just released their Venture Capital Industry report for 2006. The report is co-authored with Ernst & Young.

For those who follow the VC industry, below are some interesting 2005 statistics:

  • Commitments to VC Funds, $22.2 bn. Up 18.7% from 2004
  • VC Financings, $22.1bn. Up 2.8% from 2004
  • IT Financings, $12 bn. Down 4% form 2004
  • Software Financings, $5.11bn, Down 6% from 2004
  • Number of Active Firms, 1,417
    • Down 49% from 2000, 61% if you define active as > 4 deals per year.
  • Number of exits, 397.
    • IPOs: 41, down 38% from 2004, with $2.24bn raised via IPO
    • M&A: 356, down 12% from 2004, with $27bn in total exit value
  • Number of private companies funded since 2000 net of 2005 exits: 5,406 with $132bn invested in them
    • Average of $24.4m invested in companies
    • At current exit rate, will take 13.6 years to get through backlog
  • Median M&A exit $47.5m
  • Median Pre-moneys
    • Seed $2m
    • A $5.4m
    • B $14m

Tuesday, April 11, 2006

Concept to Company

Next Tuesday April 18th at Stanford, Hummer Winblad and VLAB are hosting a great event titled Concept to Company.

For anyone considering starting a company and navigating how to take an idea to fruition, I strongly suggestion you attend. A write-up from VLAB follows:

"Every year, the MIT/Stanford Venture Lab (VLAB) has the honor of hosting a special session, called Concept-to-Company, moderated by Ann Winblad, co-founder of Hummer Winblad Venture Partners. Ann Winblad is a well-known and respected software industry entrepreneur and technology leader who has been chronicled in many national business and trade publications.

This years Concept-to-Company event will focus on the business formation of Cittio, a network management software company founded in 2001. No doubt, many people may question the viability for a startup to enter this mature market - where IBM, HP and other large companies own a majority share. Why would any VC decide to fund a start-up in this space? What strategies can be implemented to increase the chances of success? Hummer Winblad's investment in Cittio demonstrates how investors and entrepreneurs find clever ways to disrupt a mature industry.

In this panel, you will hear from the CEO of Cittio about their business formation strategies including; fund raising, product development and sales. We have also invited key representatives from IBM and HP to talk about how the incumbents plan to defend their turf."

Click here to read more on the panel.

Click here to register.

Friday, April 07, 2006


Start-ups are by definition young, in constant motion, and experiencing massive change. The start-up environment and pressure to attract capital, talent, customers, and partners makes it challenging to take the time to plan carefully and wisely. I often notice post Series A close a sense of chaos amidst the hope and a need to quickly triangulate on key metrics to manage to and to report against.

Data-driven start-up management appears to be an oxymoron - there is by definition little data and hardly any trending possible. Despite the rapid changes, founders should move to quickly put in place templates, reports, and best-practices to manage with in order to reduce risk in the plan and unwise capital consumption.

Data can quickly overwhelm young companies and the real skill in management is to identify the key variables that drive value and progress. Every company is unique, however, a few useful first steps follow:

  • Develop an operating plan
    • I suggest the team develop, in concert with the BOD, a 18-36 month operating plan
    • At a high level, the operating plan defines the business model - what drives bookings, revenues, margins, headcount, and cash...
    • Develop a linked monthly income statement, cash flow, and balance sheet model that specifies, among other variables:
      • Key assumptions regarding bookings, revenue recognition, gross margin, op ex by department, headcount hires and cost per hire, rent, benefits, T&E, IT costs, programmatic marketing spending, cash, accounts receivable, payables, deferred revenue, capital expenditures, etc
  • Develop a compensation and incentive plan
    • Incentives drive behavior. Accordingly, it is important for young companies to think through sales compensation plans that drive desired results.
    • Similarly, senior management's compensation can be tied to critical corporate objectives, such as revenue, operating income, and period ending cash.
  • Develop an option budget that maps to the hires forecast in the operating plan
    • Post funding, start-ups typically reserve an unallocated option pool of ~20%.
    • Based on the hires in the operating plan, it is prudent to develop an option pool budget that allocates appropriate levels of budget grants to the forecast hires.
    • A cardinal sin is to blow through the option budget with key hires still TBD
  • Develop a reporting template
    • Data can overwhelm and distract. Accordingly, develop a one page tear sheet that summarizes the key financial performance indicators
    • A dashboard that compares actuals, for a given reporting period, to the operating plan (this is typically called variance analysis) along:
      • customer orders/bookings, average sales price, revenue, gross margin, op ex by department, operating income, total spending (net income plus capex), cash, accounts receivable, days sales outstanding, accounts payable, deferred revenue, and headcount
  • Develop a pipeline and forecasting methodology
    • Pick a sales forecasting methodology and build a sales pipeline that drives a forecast
  • Develop a sales rep performance review template
    • List sales reps, territories, months with the company, current quarter actual bookings per rep, year to date bookings per rep, current quarter quota per rep, total annual quota per rep and for whole team, and percentage of actual bookings to total quota for the given reporting period
    • Detail rep analysis helps to understand ramp times (how quickly a rep becomes effective), which reps are performing (which begs the question why), and which reps are not performing

While this list may be exhausting, it is by no means exhaustive and I am sure people can easily add to the list. If the team lacks the financial, planning, and analysis skills required to build the models and reports, one axiom of venture capital is that hiring a part-time CFO or FP&A analysis is rarely a bad investment. Rather, taking the time to build the right plans and reporting packages can save significant capital and help keep the team and BOD focused on the material strategy issues rather than using the BOD meeting attempting to discern the financial state of the business and if management is watching the store.

Tuesday, April 04, 2006

Enterprise Start-up Strategy

Today, I attended Software 2006, an enterprise software conference organized by the Sand Hill Group. The conference highlighted several important strategy concepts related to how to architect a next-generation enterprise software start-up. Keynote speakers included Ray Lane, a McKinsey & Co partner, and Dave DeWalt. The following were my take-aways on salient points.

First, enterprise software start-ups must be designed cognizant of current marketplace realities. While much has been written on the subject, Ray Lane summed up the startup vendor challenges well:

  • challenge of access to buyers
  • long evaluation cycles and committee based buying
  • integration requirements
  • customization requirements
  • installability
  • ROI analysis and business case/spend justification development
  • business model and licensing
  • renewals

Second, vendors cognizant of the challenges above need to architect solutions that foot to the following McKinsey equation:

  • software success = customer need x offering innovation x sales and delivery model.
  • What is the need? What is the product's advantage over the current state of the art? How is the product sold and deployed?

Third, speakers highlighted certain key characteristics for success; the need to identify whitespace, build products that install quickly and easily, a linear value realized/cost relationship, an entry strategy that adds value to single users (immediate value and short and distributed decision cycles) while scaling organically to hundreds, and a total enterprise value that grows with the cumulative user count.

There was significant discussion with regards to how Web 2.0 will impact the enterprise. McKinsey posits four key areas of opportunity:

  • Timely access to information and content (ex Google and Flickr)
  • Improved decision making via better use of data and presentation of relevant information (ex. Zillow)
  • Enhanced communication (ex. Skype, Yahoo! IM)
  • Better collaboration (ex. Socialtext, Jotspot, and Typepad)

Finally, Greg Gianforte, Rightnow's CEO and founder, offered some useful insights into enterprise go-to-market strategies for SaaS companies. His key point is that large customers require choice and levels of parameterization not required by the SMB market. He laid out five types of choice to consider:

  • Deployment choice (on-premise and hosted)
  • Payment choice (monthly term, term net thirty, and perpetual). He made the interesting point that payment choice allows vendors to tap both capital and operating budgets.
  • Upgrade choice. He believes that forced upgrades are rejected by large companies, accordingly, upgrade customization is important. This demands a competency in multi-tenant, multi-version support, with customer driven elections to upgrade from version to version.
  • Integration choice. If a system of record is hosted, think through integration options and ensure pooling of relevant data is possible.
  • Customization choice. Push configuration but be prepared to allow for presentation layer customization

All in all, a good day and one full of important ideas to consider when building and designing enterprise start-ups.