BeyondVC

More reasons to watch your burn

Despite these tough times, there are still some bullheaded companies who think they can grow their way out of this mess or find the right M&A partner to bail them out.  I can guarantee you that this is a recipe for disaster.  I was on the phone today with the CEO of one our portfolio companies, and we were joking that we were in unprecedented times since we have been approached by a number of bankers about buying companies that are much larger than us.  So if these bigger private companies are hawking themselves looking for a deal, where does that leave a small startup?

It goes back to my one of my themes about building a business - focus on what you can control and don't try to find a savior by looking at external forces.  What this means is figure out what your core business is and take a scalpel and lop off the areas where you do not see an immediate return on investment.  If you believe you will find a strategic partner to buy you, forget about it because every other private company that has been funded during the last 5 years is trying to do the same.  In addition, I can also promise you that any large or small company looking to buy a startup does not also want to pick up a large burn rate.  Even on a private-private merger, most of these VC-backed companies will do nothing unless the deal is cash flow positive on Day 1.  Do yourself a favor, build an expense line where getting profitable can happen with the cash that you have.  This way you can control your own destiny and also even make yourself a more attractive strategic partner to any company in the future.  One other point for all of those advertising related startups-go find some other revenue streams like becoming a platform for partners via cobranding or hosting fees which scale with usage or find some other premium model because the ad market is drying up and the dollars will flow to some of the larger, more established platforms.

A ray of light in this environment?

I did an interview with Rich Maguire of Datamation last week which he just posted yesterday.  While the markets seemed to get excited for a day about the bank bailout, attention is turning toward an even bigger problem for startups, a potential recession.  The consumer no longer has that ATM called their house and confidence and spending to boot are down.  So what's an entrepreneur to do these days and are there any pockets of opportunity?  Trust me, I am not going to give the party line that it is great to start a company now because, you know what, it really is hard to go out and do that.  However, if you are brave and bold enough to do so, I will tell you that you could be well positioned 18 months from now when the economy does get back into gear.  This market will truly separate out those who are just in it for the money, and those who are out their to build an insanely great product or service.  As for the article from yesterday, here is an excerpt and hope you enjoy.

“We know that whether it’s media consumption, content consumption or even enterprise application, that we’re going to be more and more connected. Speeds on wireless devices will get faster, networks will get faster. Devices will get better. They’ll be more and more to do out there.”

Human activity on the Web creates an explosion of consumer data – every nugget of which is worth something to someone. “Data is everywhere,” Sim says. “Every time you turn on your computer, every click you make, everything you do is a piece of data that’s logged somewhere.”

There’s profit in figuring out “How you take that data and turn it into real information, and use it to sell subscription services, target better from a profiling perspective, etc. So I think the data-driven Web is going to be another opportunity.”

His enthusiasm for the Web, however, doesn’t mean he’ll be funding such Web-centric ventures like Facebook-style sites. We don’t need another Facebook, he points out.

“I think the point is that social networking is weaved into the very existence of all the things we do. You see apps getting weaved into your email. People are getting more and more connected out there, and used to that, because of Facebook.”

This saturation will result in consumer behavior being adapted in large businesses. The potential marriage of social networking and the enterprise has piqued investor interest. “How do you take this social networking and information sharing stuff – the clip and blog and share – is there any opportunity to benefit the enterprise? On a content layer? So I’ve looked at some companies along that spectrum as well.”

Be prudent but don't panic!

The alarm bells are ringing in Silicon Valley and start-up land today with Sequoia Capital and Ron Conway telling companies to prepare for the economic meltdown and to raise cash by cutting their burn.  This is not new news as being in New York we started to feel the real economic impact in mid-September as Lehman melted down and as Merrill Lynch was bailed out by Bank of America.  This is all prescient advice and something I have been espousing to my portfolio companies for awhile - see my last post from mid-September on Doing More with Less, a mantra that all startups should live by.  All that being said, it is not time to hit the panic button.  Don't go out and fire everyone wholesale and skinny down just because everyone else is. Do it because it is right for your business and because all of your leading indicators tell you to do so.  Do it the right way by not making a 20% cut across the board but by thoughtfully thinking about your business, your priorities, and where you need to focus your capital and resources to grow your revenue but conserve cash.

The good news is that many companies I have seen have learned their lessons from the last bubble bursting and rather than subscribe to the "if you build it they will come" model have turned towards the "release early and release often" model of gaining customer traction sooner rather than later and at much lower costs than before.  As I look at the current landscape, obvious areas of concern are any companies with high fixed costs and heavily reliant on direct sales whether it be advertising related or enterprise related.  It is clear that for these big ticket sales that many corporations are in the mantra of doing nothing rather than doing something and that startups should adjust their budgets accordingly to reflect this reality.  For those companies that live by the frictionless sales model and that are capital efficient with a low fixed cost base, take another hard look at your organization and priorities and haircut unneccessary expenses.  Once you do all of that and feel that you have 18+months of runway, look on the positive side as there will be many great people on the market.  Yes, cash is king and if you have it and conserve it, there will be some phenomenal opportunities to pick up some great talent.

Delivering on Q3 forecasts!

I received some incredible news last night from two portfolio company CEOs updating me on our Q3 numbers.  They not only hit their respective forecasts set early in the year, but they beat them.  Normally I expect our portfolio companies to hit their numbers, but I am ecstatic because we delivered in the midst of the largest financial crisis we have ever seen.  While much news on the technology world is of doom and gloom, and while I too have been advising portfolio companies to conserve cash, it is nice to see that companies are still willing to spend if you deliver a strong value proposition.  More importantly these numbers speak to the commitment of the respective teams to do anything possible to deliver on the Q3 forecasts.  In each company, sales reps and executives flew out to key prospects and knocked off obstacle upon obstacle until they walked away with an order.  Ok, it is not as dramatic as it sounds as there were numerous meetings and technology proof of concepts before getting a sale, but the point remains that the companies that delivered did not wait for the orders but went out and got them.  There were a number of stories of sacrifices that were made including one sales rep who was expecting his third child yesterday but was at a prospect getting the contract inked and another one of a sales rep and sales engineer who camped out at a client's office all day and wouldn't leave until they had a signed contract.  Extraordinary times require extraordinary measures, and I hope that stories like these inspire you to keep fighting the good fight and to go out and make things happen.  Startups need to be scrappy and tough to survive!

Doing more with less

Being in New York, it is hard to escape the realities of the ailing financial sector.  When I took the train into the city this morning I could see the somber look in people's eyes knowing what had just happened to Lehman Brothers and the uncertainty of the financial markets and economy.  Given this state of play, it is clear that capital is becoming scarcer by the minute and that we don't know when we may come out of this mess.  The mantra for most businesses is to just wait and see rather than make any real decisions, especially when that requires a commitment of capital.  Then I get an email from Bill Morrison at ThinkEquity today outlining his views that we are in Phase II of a Media Recession:

In our experience, media recessions typically develop in three phases. First, marketers reduce spot market activity and eliminate quarterly budget flushes. Then, marketers begin canceling "up-front" commitments and previously signed advertising contracts. Lastly, marketers begin to rationalize/reduce budgets for future years. Our research suggests that we entered phase two of the current media recession during 3Q. Our recent conversations with online publishers revealed a significant number of advertisers that have cancelled contracts or significantly reduced commitments for the second half of 2008. The majority of industry contacts we spoke with this quarter said fundamentals weakened from 2Q to 3Q.

Trust me, I am not a doom and gloom guy and on the contrary believe that now is a great time to invest and build for the future.  That being said, it is also time to be smart and highly efficient. It is a great time to look internally and think about your priorities, your processes and whether or not you can do things better. 

In this backdrop, I had a couple of board meetings last week and as you might have guessed, one of the recurring themes was needing more resources.  While the companies were quite different, I seemed to be in the same meeting with each department head giving an overview and goal tracking from the previous quarter and each presentation ending with, "I need more resources."  It's not that I am against hiring more people for portfolio companies, since I am all for it.  My only point for all entrepreneurs and managers is that when you put together the hiring plan to make sure you think about the fact that you should always be under resourced and have more things to do than can get done.  What this really means is that you have to do an incredible job of prioritizing your goals. Always ask yourself how you can do more with less and you will find that you and your team will become incredibly resourceful and stretch your dollars a lot farther than anticipated. 

Speaking from experience, I have repeatedly seen situations where managers ask for additional hires, we tell them to wait a quarter, and then they miraculously are able to manage for the quarter. In fact, I was joking at one meeting the other day saying that it was incredible that we had half the staff from a year ago and have more revenue today that we did before.  If we cut in half again, I mused, perhaps we could grow even more.  OK-that is quite extreme, and we did agree to end up hiring a few more resources in various departments.  What really struck me was the fact that when we hit the wall over a year ago everyone thought we weren't going to be able to make it and grow our business.  What changed was that management became maniacally focused in prioritizing opportunities, not chasing every customer, being ruthless about how they spend their time, and consequently reengineering a number of their internal processes.  We are now a much healthier company with a better operational platform that merits more investment.  While I am not advocating that you starve your business and recognize that every company is different, I am suggesting that doing more with less is a mantra that you should subscribe to regardless of the economic environment and that in the long run it will yield tremendous results for you.

M&A - it ain't over till it's over

The economy is clearly slowing down and the IPO market is nonexistent.  As I have always said, this is the time to hunker down and tweak your business to get your model right.  If you are interested in exiting today, M&A continues to be the only viable path along that front.  Having been through a number of acquisitions and potential acquisitions through the years, one point I must remind you of is that any deal isn't over until its over.  On the surface, this seems so obvious.  And yes, once a term sheet is signed and a price and general terms are agreed to, you are in great shape.  But recently, through discussions with other VCs and entrepreneurs, I am hearing about more situations where strategic buyers may significantly change the deal terms after more serious due diligence or even potentially walk away from a deal.  This can be especially painful if you have spent a number of months meeting with the strategic and going through due diligence in lieu of running your business. Trust me, this happened to one of my portfolio companies last year and reasons cited can include we had a change of strategic priorities and or look at the economy, there is no way we can value you like we did when we started the deal.

While I can offer you no protection from this happening to you, all I can say is to be prepared and skeptical, be willing to walk away, and make sure that you both do enough diligence and meet with the right decision makers before you sign any term sheet and embark on the extended process.  Once the term sheet is signed, run like hell to get the deal closed because the longer a deal lingers the more opportunity there is for it not to happen.  Keep the hammer down and always have next steps and a defined timetable.  In addition, to the extent that the strategic acquirer has made other aquisitions in the past, I would try to leverage your personal network to reach out to some of the VCs or entrepreneurs involved to get a flavor for how the strategic will run their due diligence process and what doozies or surprises the strategic throw at you.  Before you start spending your money from the acquisition, remember there is a lot that can change and that probably will change so keep that in the back of your mind as you go through the process.

Your reputation matters - how to handle reference calls

The world that we live in trades on reputation.  What that means is that eventually whether you are raising capital or landing new customers, your references will matter.  If you are an entrepreneur, a VC will want to do some deep reference checks on you and also on any major customers or partners.  If you are trying to land that big customer, naturally the sales propsect will ask to speak with other customers to get a better understanding of the technology and your service.  How you handle and manage these reference calls is crucial to moving to the next step in a funding round or to closing a sale.  I have seen some entrepreneurs take the nonchalant approach, feeling quite secure in their relationships, and freely passing on contact information for their personal references and partners/customers.  Many times these calls will turn out just fine but there is still a big chance that they might not turn out as planned.

In my opinion, the best way to deal with reference calls is to carefully manage the process.  First, I would identify the 4 or 5 best references (customers/partners/personal) and have a call with them to make sure they are willing and have the right attitude and to pre-screen them with questions to make sure they convey the right information to the interested party.  Secondly, I would make sure that you don't inundate your references with too many calls as they may tire of helping you after awhile.  Finally, I would also set expectations and be quite clear with the VC or potential customer about what to expect from the call.  For example, I was talking to a CEO yesterday, and he mentioned that our strategic partner would take a call from a VC but that the partner was not the most effusive individual and would clearly state the facts but nothing more.  Well, if that is your only reference for that partner, make sure you convey this to the interested party to set expectations (see my earlier post about that). 

As a side note, a couple of my portfolio companies gave pretty big discounts to their first customers but also made sure that as part of the deal they would serve as lead references for other prospective customers and for VCs.  The discounts got the customers to take the leap of faith to buy the portfolio companies' products and also got them quite excited to freely promote our technology to others.  The point is that you should always think about your reputation, who will be your best reference, and then to cultivate them to really make sure that they can help you grow your business.

Raising capital and meeting expectations

What I like to tell portfolio companies is that on average it will take 6 months to raise capital with some cycles being shorter and some being longer. Given that, it is imperative for a company to start thinking about its next round well ahead of time and the milestones it needs to hit to have the right momentum to get potential investors excited. One area that I would like to caution entrepreneurs is being too aggressive on the milestones and revenue forecast, particularly in the near term.

Let me explain. Like any other VC, I love to invest in companies going after big markets with huge revenue potential. That being said, I also like to see plans grounded in reality as well. Rather than get me excited, showing a revenue ramp from $1mm to $17mm to $65mm will actually do the opposite for me, raising more questions and concerns than general excitement. Along those lines, it is also imperative that when you share your plans with investors that you are pretty confident that you will realize your milestones or hit your numbers in the next 6 months as investors like to see if you can deliver on your promises. One cardinal sin is being overly optimistic in the near term and falling flat on your face in the due diligence process. It is much better to position yourself in a way that you can meet and exceed expectations during the due diligence process than the other way around. When this happens the rest of your forecasts become more believable.

Developing your way to success or failure...

During the last month, I have been in board meetings and thinking to myself about what was going well and what wasn't.  And when the discussion came to revenue, one common theme that always seemed to surface was a focus on the next product.  What I mean is that when discussing why our current product wasn't selling as well as it should have or getting as many users as projected, the answer was always focused on the next product or feature.  Granted, I have always believed that one needs an insanely great product or service to generate sustainable revenue and that constant iteration is key to success.  However, it is also important to understand why a current product or service is or isn't doing as well as you thought.  In addition, entrepreneurs must also think about how they are going to get the product to the market and come up with the right messaging.  I have seen a number of situations where entrepreneurs can get too focused about developing and releasing the next product or feature without spending as much or even more time and resources in getting it out to the market.  Then when management and the board sit down to evaluate what went wrong, the answer seems to be that people clearly didn't care.  That can be a huge failing because the product or service may actually be phenomenal but just may have had no marketing or support in reaching potential customers.

So my advice is that before you place all of your bets on the next product or feature, make sure you put enough effort into crafting the right message and value proposition and that you put just as many resources into getting it out to the market.  In other words, give your product a chance to succeed and don't starve it to death.  Constantly developing new technology without having a well-thought out plan to get it to market can spell doom!  Developing your way to success can work only if you realize that it is only part of the battle.   

Direct ad sales and startups

I have recently met a number of startups with interesting consumer applications or services.  As expected, many of these startups have a vision to rely on advertising to pay the bills.  And like many startups, a number of these companies have plans to add a direct ad sales staff over time.  That makes a ton of sense, but what I believe is that many entrepreneurs underestimate the direct capital and management costs necessary to build such a team.  In many ways, building a direct ad sales team is similar to building an enterprise sales team.  These thoughts may seem quite basic to you but here they are nevertheless.  First, don't ramp up your sales team too quickly until you have a product to sell.  That means if you don't have scale or enough eyeballs you are better off using Google Adsense.  If you don't heed this advice you may quickly burn yourself out of business.  Secondly, I know that many startups may not know what kind of ad units to sell but be careful of not having a standard product list or rate sheet when you go out to the market.  Yes, I know you have to be creative if you have a new service and listen to your customers, but at the same time don't base your business on selling one-off ad units for each advertiser because this can be a huge drain on your technical resources over time.  Next, make sure you never forget that what is right for your users is right for your business.  Many times I have seen companies that are trying to meet the advertiser's inventory requirement make the ads much too prominent and sacrifice usability in the long run.  While this may drive some initial short-term results, it may come to bite you in the ass in the future. 

The bottom line is that Google Adsense works well for a reason-it has scale-it has tons of eyeballs, it has a huge customer list of advertisers, and is therefore more likely to get you great pricing and ad targeting.  Yes, I don't disagree that over time you want your own sales team and don't want to solely rely on one partner for your revenue, but just go into this with your eyes wide open and don't ramp up before its time.  The direct costs, management costs, and hidden strains on your infrastructure may be more than you can handle if you ramp up too quickly.  Start slowly, figure out what it is that advertisers love about your service or product, figure out what kind of units deliver the best results, and then ramp.  Here is an earlier post on ramping up an enterprise sales team as there are many similarities to direct ad sales and direct enterprise sales.