Lessons from Joost

I am not going to rehash Om Malik's excellent summary of "What went wrong with Joost" but I did want to dive deeper into a few points.  As I have always said, raising too much money can be a curse and not a blessing.  Here is an excerpt from my post in 2006

Trust me, I love having well capitalized companies.  However, having too much money can be a curse, not a blessing.  More often than not, I see management lose financial discipline and avoid making hard decisions when capital is abundant and not scarce.  To many executives, money does solve all problems.  And yes, having money allows an entrepreneur to do many things with his business like hire more talent, scale the back-end infrastructure, and ramp up sales and marketing.  On the other hand, when an entrepreneur has too much money, the tendency is to throw more money to fix a problem.  Sales are not ramping up quickly enough so let's hire more sales people.  Marketing is not generating enough leads so let's spend more money on lead generation.  Engineering keeps missing its product release date so let's hire more engineers.  And what happens is that more money gets poured in and that only exacerbates the problem as management never really spends the time to dig deep to understand what the underlying issue is and to fix it at the source rather than layer on more resources.  In other words, an entrepreneur only hastens his downward spiral by spending more money on an inefficient business strategy.

This to me can kill a company before it even gets off of the ground.  Expectations are too high too early, companies will ramp up too quickly, and any misstep is seen as a failure.  Secondly, companies that have too much capital usually try to do too many things and lack focus.  It sounds like Joost was building a client, negotiating with media partners, and building out its own ad serving technology and had its own ad sales staff.  It sure sounds like a big operation. 

Another point to add is that companies founded and led by rockstar entrepreneurs are not enough to drive success.  Rock star founders and CEOs will definitely open a ton of doors and drive lots of media attention, but the company still has to execute.  In addition you want your rock star driving much of the execution rather than hiring a huge staff with layers of bureaucracy.  Many of these famous entrepreneurs will typically have their hands in a number of different projects at once.  Finally, having been successful before, you really need to assess how hungry these rock stars are for success.  Hunger and passion do play a huge role in driving company DNA and creating a winner.  I have had just as much success funding entrepreneurs who have had modest wins but were still seeking the big exit.  Bottom line is that Joost had a ton of promise but may have been better served by raising much less money at the start and staying highly focused on the task at hand with a much leaner operation.

I want it NOW, I want it REAL TIME

I was recently asked by a friend if he should get his son the new Nintendo DSi.  This would be an upgrade from the current DS and also add the photo capability.  As I thought about my own son's usage of the device, I said no.  Once my son got an IPod Touch for music and now games, he never looked back.  While he loves the music, the real reason is because of the App Store and ability to instantly download any game for free instantaneously.  While the DSi does have a Wi-Fi connection, the IPod Touch is just so easy and frictionless.  And as evidenced by the rise of the Internet and the ability to download movies, music, and games instantaneously, it got me thinking more and more about the fact that we live in the "Now" or "Real Time" Generation.  Yes, it has been happening for awhile but we finally have the broadband speeds and ubiquitous connectivity that we craved for the last 10 years.  We also have better pricing and better products to be able to download those movies and games anywhere and on any device.  In addition, you can just see the rise of Twitter as another example of this new culture of real time.  People no longer want to wait for anything any more – if you have something to say, say it on Twitter or Facebook.  Products and friends are just a click away.

Sure, we can clearly see the impact of the Now Generation on consumers and new web applications.  A substitue product or application is just a click away.  If you don't like the user interface, if the product loads too slowly, or if the registration process is too burdensome, you can do another Google search and instantly find a substitute.  But what does it mean for the enterprise, for the corporate IT professional and startups selling into these companies.  I have always believed that the old way of selling enterprise software products with expensive sales forces and complicated installations is dying.  Buyers no longer want you to push software that they may or may not need.  They are empowered and can easily do their own Google search and download open source software or fill out a short registration form to trial a web-based app.  They, like my own son and his friends, are increasingly seeking instant gratification.  They are not just consumers but prosumers who are pulling new products into their departments and potentially into their enterprise.  I wrote about this instant gratification in 2006 and it is happening faster than ever.  The kids who were in college 5 years ago are the very same ones in the IT department tasked with coding new products.  They are used to doing more for themselves, doing their own research, and being able to trial new applications in real time.  If you are an entrepreneur selling into an enterprise and don't see this trend now, you will be toast in the future.

Occam's Razor and the current state of venture

I have made many posts in the past about focus and doing more with less, and as I continued on this path it reminded me of Occam's Razor, the idea that the simplest explanation to any problem is the best explanation.  Of course Occam's Razor can get more complex but over the years it has been associated with the idea that "less is more."  And when I apply this philosophy to the current state of venture, I can see many applications of this theory.

From a VC fund perspective, there has been much discussion about how venture funds have become too large to deliver outsized returns.  First with the lack of an IPO market it is much harder to generate $1.5b for investors on a $500mm fund then it is to deliver $300mm on a $100mm fund.  Secondly having too large a pool forces VCs to invest much larger amounts of capital into companies pushing up valuations and also exit hurdles for success.  Finally, as I have written in the past, I have learned firsthand the problem of giving companies too much money too early.  It can lead to a growth at all costs mentality, a lack of focus which means chasing too many opportunities at once, and a lax attitude on how to generate revenue. Enter Occam's Razor as it seems that the new trend is for smaller groups of GPs to form smaller funds to be able to invest in earlier stage companies.  With the new operating model of capital efficiency, a little amount of money can go a long way and help VCs generate excellent returns at much lower valuations.  Having a smaller fund allows VCs to write smaller checks and take advantage of the current market.

From an entrepreneur's perspective, Occam's Razor can be applied to many different avenues. As we all know, a great entrepreneur must be able to effectively allocate his scarce resources of time and money to fulfill a market need.  The longer it takes to develop a product that the market wants means that it will cost more money and that it also opens the door for a competitor to step in before you.  If you look at the current Internet and SAAS market, the idea of "release early and release often" certainly fulfills the Occam vision.  Rather than spend cycles creating the perfect product with every bell and whistle, many nimble startups have focused on a more reductionist theory of releasing an often simpler product quickly with the idea of getting market feedback for the next iteration. 

Occam's Razor also applies to how an entrepreneur should operate his business.  Don't pursue too many markets at once, focus on what is delivering the most return for the dollars invested, and hire people and scale your business when you absolutely have a repeatable revenue model.  I have been burned like many others by aggressively building out a sales team too early without a repeatable sales model.  In addition, from a sales and marketing perspective, we have seen a movement to more of a frictionless sales model where there is less hands-on interaction with customers selling and delivering a product.  This would include customers being able to go online and sign up for free trials or download software versus having an expensive direct sales force sell million dollar licenses and one month of professional services to install a product.  Finally and most importantly, the idea of less is more certainly applies to raising capital. With the rise of open source software and cloud computing, companies can now get started with less dollars and scale more cheaply and efficiently than before.  As all entrepreneurs know, raising less capital means retaining more ownership.

In summary, it is becoming increasingly clear that Occam's Razor and the idea of less is more will continue to spread as the cost of technology continues to decrease, as entrepreneurs get even more efficient in building businesses, and as a non-existent IPO market and the factors above lead more VCs to create smaller more nimble funds to capitalize on the new market realities.

Inspirational video for entrepreneurs

Jonathan Kay from Grasshopper sent me a great video on entrepreneurship.  First I love the inspirational message.  Secondly, I like the use of a viral video to cleverly promote his virtual PBX numbers for entrepreneurs.  Take a look and hopefully it will brighten up your day.

What I love about the message is that entrepreneurship is not about making money but about pursuing a passion and doing your part to make great products to make the world a better place.  OK-it may sound a little hokey but I remember during the bubble how entrepreneurs would come in talking about how much money they would make for everyone but have no passion for their product.  And guess what, many of these monetary focused entrepreneurs were the first ones to quit when the world got tough.  Without a bigger sense of purpose, it is hard to be an entrepreneur and stick through the inevitable tough times that will come your way.

Pioneers get arrows in their backs

Pioneers get arrows in their backs – I have experienced it firsthand from an active investor's viewpoint and written about it in the past.  Being early in a market is great but being too early can be deadly.  Just like the settlers in the westward migration, entrepreneurs who are too early will get arrows in their back.  It doesn't matter if you have a rock star CEO (Bill Coleman who founded BEA) and $100mm of funding from some great investors.  If you are too early and have to spend lots of money educating a market and get engaged in long protracted sales cycles and pilots, you are not going to be able to spend your way to success.

That is what it seems like is happening to Cassat Software. Forbes has an article about Cassat nearing the end.  On the surface it seems like the company was built for the right place at the right time helping enterprises save tons of money and run their internal data center like a cloud.  However the first funding went in 6 years ago and has totaled around $100mm since then.  Here is a quote from their founder and CEO:

For many years, Coleman acted as something of a prophet for cheap computing via the cloud, but he also thought it would mean a sharp drop in pricing with which the big companies would not be able to compete.

"The big guys copied my story," says Coleman. Cassatt, he adds, was upended by a slowing economy and by customers skittish about closing big orders or changing existing ways.

"What frustrates me is my own naivete," Coleman told Forbes. "I thought I could give companies something radical that had a proven return on investment, and they would be willing to change all their companies' computer policies and procedures to get that. Right now, it's hard to get people to get beyond proof-of-concept tests or a data center energy analysis."

He will be right eventually but will not have a lot to show for it.  A couple points to make – raising too much money too early can be harmful as it puts huge expectations on a company before it has proven itself and selling million dollar plus licenses into enterprises has gone the way of the dinosaur as only the biggest companies can afford to do this and it is extremely expensive to do.  Remember some of my old posts about frictionless sales and leveraging the web for sales/marketing and inside sales?  Having just participated as an angel in the recent Eucalyptus funding led by Benchmark, we are hoping to avoid this fate leveraging free download model which has generated over 14 thousand users, many of whom are corporate customers.  In addition, we have signed partnerships and are bundled in the Sun cloud computing initiative and the new Ubuntu enterprise Linux release.  Got to love leveraging partners and downloads to drive sales leads and sales.

Growing your business in a recession

I read a great article by James Surowiecki in the New Yorker the other day titled "Hanging Tough."  In the piece, James gives a historical perspective on companies that thrived and grew during previous recessions by increasing spending on on advertising and R&D.  While I am not advocating that companies go out and blow their cash on ads and spending on far-out development projects, I do want my readers to understand that it is possible to gain market share during difficult times.

One way to read these studies is simply that recessions make the strong stronger and the weak weaker, since the strong can afford to keep investing while the weak have to devote all their energies to staying afloat. But although deep pockets help in a downturn, recessions nonetheless create more opportunity for challengers, not less. When everyone is advertising, for instance, it’s hard to separate yourself from the pack; when ads are scarcer, the returns on investment seem to rise. That may be why during the 1990-91 recession, according to a Bain & Company study, twice as many companies leaped from the bottom of their industries to the top as did so in the years before and after.

A personal example that sticks with me is of former portfolio company GoToMyPC which is now Citrix Online.  We had our huge exponential growth years from 2000-2004 during a difficult time in the technology markets.  And yes, we did increase our spending on ads and at one point in time became one of the largest advertisers on the web.  However, what we did was negotiate for pay for performance contracts where we would only pay if we signed up new customers.  While not a novel idea today, it was quite novel back in the day.  Subsequently we were able to turn a fixed cost that could have been a huge cash drain on the business into a variable cost.  In addition, our ads had tremendous impact because every other competitor was not advertising and our brand became quite recognizable.  Were it not for our creative and aggressive approach to acquiring customers, I would argue that while we would have been ultimately successful it certainly would have taken a lot longer.  So reread the article and think about ways that you can creatively grow your business by turning a fixed cost into a variable cost based on revenue growth and you may find a way to efficiently grow while managing your precious cash.  Remember in times like these, everyone is willing to negotiate and what may have been a hard deal to come by 2 months ago may be possible today.

Cover the basics before you raise capital

No matter how many times I told my friend that he needed to get a deck together for a potential capital raise and model out some thoughts on market sizing and financials, I ran into resistance.  It was not because he didn't think it was important or that it mattered.  It was because he was understaffed and going 60 miles per hour trying to get a product released.  I can understand that pain but at the same time, if you want to raise capital from anyone, you need to have the basics covered.

Fast forward 6 weeks from that last conversation, and we ended up having a meeting with a "friendly" VC to receive some market feedback on where his company stood and what needed to get done to raise capital.  And sure enough, it didn't take long for my friend to be questioned on the revenue model, potential market size and opportunity, and how long the cash would last.  Of course, he did have some strong answers but they were not what the VC was looking for – it was not quantitative enough.  We all know that coming up with market sizing and revenue forecasts for a startup is as accurate as the weatherman predicting the weather.  That being said, VCs want to understand the logic behind the numbers as much as the numbers themselves. 

Overall the meeting went as I suspected it would – a VC who was very interested in the product but also highlighting the fact that the revenue model was not clear.  The kiss of death for me on the revenue side was when the entrepreneur said that he would monetize the company like Facebook and Twitter.  Hmmm?  We all know that Facebook and Twitter are unbelievable web phenomenons and suck up incredible user attention.  And yes I am sure that Twitter will find a way to monetize the stream of data flowing through the system and I am sure that Facebook has tremendous value.  That being said accumulating users and worrying about revenue years from now is yesterday's news.  Unless you have tremendous scale when you show up at a VC's door, then don't bank on ad revenue as your only revenue source.  We have seen the market numbers-overall online ad revenue declining but search revenue increasing.  In addition we all know that social apps on the consumer side have incredibly low CPMs and that you need massive numbers to turn into a business.  So if you want to get funded, you better have a clear answer on how you will make money and either be implementing that model today or in the short-term.  What VCs are looking for is a revenue model today that makes sense – this can include premium subscription revenue, analytic revenue, and even lead generation revenue, but don't ptich massive scale and advertising as your go-to revenue souce 24 months from funding.  You will be shown the door quite quickly.

Hybrid clouds are coming

Amazon has taken off with its cloud compute infrastructure but there still have been some limitations from an enterprise perspective.  Mainly, some enterprises are concerned about keeping their data private, about reliability, and storage costs over time.  Any enterprise looking at potentially leveraging the cloud would love to have a hybrid solution which allows them to manage their own internal cloud and then burst over to a public cloud for either automated failover, extra storage, or to port an application over after using an internal platform for development.  Sun seems to get it as evidenced by their announcement today to offer their own cloud computing platform.  Key here is that it will be interoperable with Amazon S3 and its platform.

"Sun anticipates that the cloud scene will feature many clouds, both public and private, that are interoperable and driven by different application types. Applications eyed for deployment on Sun Cloud include Web 2.0 applications, social networking systems, gaming applications, and anything that needs the scale of the Web, said Tucker. Departmental applications are envisioned as well.

"What we're introducing in New York here is we're talking about our public cloud," for developers, Tucker said. Sun has seen a lot of interest in cloud computing from enterprises, he said. "It’s getting very rapid uptake at least in the large enterprises today," said Tucker.

What is interesting is that their is a little known startup with great open source technology called Eucalyptus which is helping drive some of this initiative. Eucalyptus will be the software that will allow the Sun cloud to interoperate with other platforms and services.  With this open source platform, companies can now deploy apps on their own cloud and use Amazon or other cloud services for high availabilty or extra storage without vendor lockin.  Congratulations to Rich Wolski and team as they have made tremendous strides during the last 6 months.  I was just with them in New York yesterday and believe they are on to something big.

Targeted television advertising is finally here

I have written a few post about the future of television advertising (10/2004, 11/2006, and 12/2006).  Yes the web has taken over and yes video on the web is advancing rapidly but that does not mean that the $60b spent on television advertising will disappear overnight.  What is needed for the industry is a way to make television commercials more relevant, targeted, and dynamic.  In other words, some of the best practices and technology from Internet advertising should be brought to television advertising.  Throughout the years Visible World (full disclosure: my fund has an investment in the company and my partner is on the board) has been working on making this a reality.  Today, there is a great article on the front page of the New York Times business section discussing Cablevision's launch of targeted commercials.  Visible World is the company that is helping Cablevision do this.  We still have a long way to go but it is great to see forward thinking companies trying to redefine television advertising instead of giving up and letting the web take over.

"Beginning with 500,000 homes in Brooklyn, the Bronx and some New Jersey areas, Cablevision will use its targeting technology to route ads to specific households based on data about income, ethnicity, gender or whether the homeowner has children or pets.

The technology requires no hardware or installation in a subscriber’s home, so viewers may not realize they are seeing ads different from a neighbor’s. But during the same show, a 50-something male may see an ad for, say, high-end speakers from Best Buy, while his neighbors with children may see one for a Best Buy video game.

“We have, as an industry, been talking about this since the beginning of time,” said Matt Seiler, the global chief executive of the media firm Universal McCann, a part of the Interpublic Group. “Now we’ve got it in 500,000 households. This is real.”

Taking advantage of the horrible environment

My expectations for 2009 are that things will get worse before they get better.  On the portfolio company side, I would rather have my companies growing at a lesser rate getting closer to breakeven than growing too aggressively and burning lots of cash.  Once your house is in order (see some earlier posts I made on this topic), I do see opportunities to take advantage of this environment.

As we all know, in a distressed environment prices come down.  So while now may not be the best time to sell your business as multiples and valuations have come down significantly, it could be a great time to pick up technology to expand your product line. In a world where everything is cheaper, those who are strong enough to make moves can find some great opportunities.  One of my portfolio companies, netForensics just did that as it picked up High Tower Software in an asset purchase.  What this does is allow the company to offer its customers the ability to manage the entire security compliance lifecycle – from log management to a complete security operations center – for all sized organizations, from the smallest departmental installation to the largest enterprise.  In other words, this filled a huge gap in our product line and on our product roadmap and allows us to deliver these capabilities ASAP. 

So in a world where everything is cheaper, you may be able to pick up some great assets at great prices as long as you have your house in order.  Rather than being a distraction, this fit right into our product roadmap and accelerated our product strategy.  One other way to take advantage of this environment is by hiring great people.  There is lots of talent in the market, and it is clear that expectations for total compensation have come down over the last year.  Be on the lookout for these A players so you can continue building your business and be prepared for when the tides turn.