Dave makes two points. The first point is that most venture capitalists are hypocrites. They expect entrepreneurs to build large, global companies while they as venture capitalists have never personally held an operational role nor built and scaled a large, global successful company.

I think it is this issue that tends to cause a lot of friction between entrepreneurs and venture capitalists and it is this point I am going to focus on here.

Whether they admit it publically, most entrepreneurs look at vc’s as a necessary evil – the vc’s have the money entrepreneurs need to launch their business and in order to get it, entrepreneurs are obliged to put up with someone who is going to meddle with their business – or even take it away from them.

A classic example of how this “meddling” manifests itself is when the company is hiring its executive team. As part of this process, most venture capitalists want to meet with and interview the candidates – many of these same venture capitalists have never held an operational role or maybe they have held an operational role but they were only an individual contributor.

We vc’s expect the VPs of our portfolio companies to have years of experience and to demonstrate significant expertise in their field. Yet, we don’t apply the same criteria for ourselves. Do we really think we have learned enough about an executive operational position sitting in board meetings to actually “interview” candidates – as if we have the domain expertise to hold and perform their job?

Should we meet the candidates and sell them on why we invested in the company and why they should join? Yes, absolutely! Interview them for their operational expertise? Sorry, but for most of us, I would say we aren’t qualified and if we had any sense we would willingly turn that job over to other people who are experts in that role; people who we trust to do the interview on our behalf.

When I first decided to flip from the operating side to the investing side, I thought that my operating background would give me an advantage as an investor.

After all, I had run engineering, products, marketing, sales, alliances and finance functions in companies that ranged from pre revenue to $2B+. And, over the course of my operational career I had been an individual contributor, manager, director and senior executive working for some of the most successful entreprenuers and companies in Silicon Valley – Apple, Oracle and Siebel.

However, I have found that while my prior operational  experience has been useful at various times and some entrepreneurs have even “valued” my input, I have also made the mistake of making some of our best portfolio CEOs angry with me by “offering” unwanted, unwelcome and/or irrelevant advice – what I have come to call practicing ”drive by” management.

If a venture capitalist is to be of much operational value to an entrepreneur, I think we should have personally held or managed a variety of different operating roles – engineering, products, marketing, sales – in a variety of different stage companies. We need to have been an individual contributor, a manager and a senior executive to really understand what it took to make those companies successful.

Each phase/stage of a company requires a different set of skills.

If the only operational roles we have held were in large established companies, we have no personal experience with what those companies faced when there were only a few people in them. If we were an individual contributor inside a start up that became a big success, we may not have been privy to many of the issues the senior executive team faced in the early days.

If we have years of experience on the operating side in a variety of roles, we need to be willing to adapt and throw everything we know out the window because the things we experienced “way back then” are different than the things that are going on now (e.g. social media, mobile, etc.). Different time and different place. We have to be open to and want to continuously learn.

Finally, even if you have all of these “requisite” operational skills and background, the one thing I have found consistent across start ups is that the best teams really don’t want your operational advice – or at least they only want it when they ask for it — not when you may think they need it. They have their own point of view on what needs to get done and, quite frankly, they are in a much better position than their investors to understand the issues in front of them.

I personally know many venture capitalists who have made fantastic investments in superb entrepreneurs yet have never held an operational role. And, the fact they haven’t held operational positions doesn’t mean they aren’t highly sought after by enterpreneurs.

These investors have built great “personal brands” due to their uncanny ability to spot companies and teams that become winners- if an entrepreneur can can get them to invest in their company it carries social status among their peers. Everyone wants to be associated with great brands, personal or otherwise. Not all the great investors may have operational expertise but they seem to find a way to identify those who do – or can learn – and they then apply a light touch when it comes to the actual management of the company.

I agree with Dave McClure, as an industry, the venture capital community should strive to do better. I think we should have more investors who started out on the operational side and built large, global and successful companies — at least we will then have the credibility and experience to provide guidance – when asked.

However, once we’ve made an investment, I have come to learn that it is important we are prepared to get out of the way and let the team we bet on call the shots – this has been one of the more difficult elements of my transformation. After all, great operational executives lead…they don’t follow…at least not for long.

I think I meet Dave’s test for operational expertise but even with all that background, I know I am definitely still learning how to be a good venture capitalist.

The premise behind MyLikes is simple: we are more likely to trust the recommendations of our friends, colleagues and advisors more than we trust consumer ads and the opinions of people we don’t know (with the exception of Hollywood celebrities and sports stars because, of course, we all know they are completely believable, role models for our children and extremely well educated – sarcasm intended).

Here is some data that supports this thesis (source: Lies, Damned Lies and Statistics):

1.  83% of consumers globally are likely to visit a website are likely to visit a website recommended by a friend on Facebook, and more than half say comments posted on retailers’ Facebook and Twitter pages, whether positive or negative, also influence their opinions (2011 Global Consumer Shopping Habits Survey – Channel Advisor)
2. Consumer opinions posted online (70%) are more trusted than information on TV (62%), newspapers (61%) and online banner ads (33%) (Nielsen)
3. In Europe over 50 percent of respondents aged 16 – 64 with access to the Internet, use social networks to assist with shopping decisions and of those that would be likely to follow a retailer on a social network, 35 percent stated they use social media platforms to read reviews or rank products and services (IBM)
4. “Customers who engage with companies over social media spend 20 percent to 40 percent more money with those companies than other customers.” (Bain & Co)
5. A study in South Korea (a mature social media market) found that social impacts sales among moderate and heavy users.  Recommendations shared among moderate social media users increased brand sales by 5%.
6. However, heavy social media users also listen to negative chatter.  Brands talked about negatively experienced a 14% sales drop among this grow (Harvard Business School)
7. The heaviest Facebook users are also the biggest spenders online - the top 20% of users spend $67 per quarter, compared to $27 for non Facebook users (Comscore)
8. According to a Kantar Media study in the US, 35% of social media users say Twitter has influenced their purchasing decisions (Twitter links also result in more clicks than Facebook)
9. Even concentrating on smaller social networks can be commercially beneficial.  Radio Shack in the US found that customers checking into their stores on Foursquare spend 3.5x more than those that don’t
10. Super fans and advocates on your social channels are 50% more likely to create content that influences a purchase (ComBlu)
11. The picture is the same if you look at individual industries.   In the ‘quick serve industry’, consumers exposed to social media have a 7x greater likelihood of ‘higher spend’ (WPP / Ogilvy)
12. Meanwhile, 60% of consumers say they factor other travellers’ online reviews into their plans when booking a vacation / holiday (eyefortravel / Simpliflying)

What I like about the concept of MyLikes is they allow you – anyone – who has created a group of followers/friends through FB, Twitter, etc. to promote certain brands and content you trust to your personal community. In exchange, you get paid for making these promotions. Since it is easy to see what is “sponsored” content you aren’t duping your family, friends, colleagues and they, hopefully, see interesting content and/or products they might have missed if you didn’t share it with them.

I feel this has a beneficial effect for advertisers/brands in that there is typically implied trust between people who know each other; it is not likely we are going to spam each other and we are not likely to promote something we don’t believe in ourselves. I think it is this fact that makes the sponsored content received through this exchange that much more valuable to advertisers/brands.

To learn more, I wanted to try MyLikes for myself  - just to better understand how the process worked. It was a breeze to set up my MyLikes account and to link it to my PayPal account (you get paid when the sponsored content you send out via Twiiter/FB, etc. is clicked on so you need a place where MyLikes makes the payment.)

During the process, MyLikes asked me what types of conversations I typically engage in. In my case, it’s all about business issues and technology. But, if you are primarily interested in things like fashion, entertainment, celebrities, etc.  they can capture that.

Once I completed the sign up process, I was presented with a list of sponsored ads and the amount I would be paid if I sent them out to my network.

I realized that as I was going through the various sponsored ads, I immediately rejected anything I thought wasn’t relevant to the community of people I engage with.  For example, while interesting, I wasn’t about to send out the Sports Illustrated swim suit sponsored ad since this is inappropriate for my brand and for the professional community I interact with. For others, this content might be ok.

I did have a few things that I would suggest MyLikes consider changing over time:

• I would prefer that MyLikes only present me with content I would find highly relevant for my community. Right now, I need to scroll through a serialized list of sponsored ads that aren’t limited just to the areas I would find relevant.
• I would like to see them add the ability for me to rate each ad as to whether or not they are relevant to my community and to use this to filter which ads I am presented with.
• Having to go to MyLikes and select sponsored content feels non-intuitive to me. Instead, I would prefer to find content anywhere that I want to post to my social networks and at the moment of posting be prompted if I want to make it a sponsored post and select the advertiser from a small list of sponsors with whom I trust or new ones who want to compete for access to my network.

The real power of MyLikes’ approach, I feel, is the fact I am self-policing. No one needs to tell me what is appropriate or inappropriate for the community of people I engage with. If I were 15 years old with a bunch of friends, my idea of what is and isn’t appropriate would be a lot different.

This self-policing fact means that the “value” of the content I selectively choose to share with my community should be a lot higher with advertisers than ads generated through the popular ad networks. In other words, CPM rates for MyLikes should be a lot higher because publishers of the sponsored ads are filtering the ads for relevance.

There are other start ups that have been built around a “digital word of mouth” premise (e.g. Zuberance, Amplifinity, etc.). They, however, are primarily focused on providing tools/services for the brands and/or their agencies  to manage their communities. MyLikes, on the other hand, is focused on disintermediating the brands/agencies and putting power into the hands of consumers to decide what brands and what messaging is important.

Just as traditional brokerage firms were disintermediated by new firms such as Schwab and eTrade, there may be an opportunity to disintermediate the traditional advertising firms with these new approaches. We are only in the beginning stages of this transformation. It will be interesting to see where this ends up.

In the meantime, I posted my first MyLikes sponsored ad today. Now, all I have to do is wait for the big bucks to roll in!

I look forward to any feedback you might have. 

Background

A problem that seems to plague relatively large, successful companies is that their ability to innovate and bring new products to market tends to be inversely related to their success and growth. That is, the bigger they get the less innovative they become. There are two primary reasons for this perplexing phenomenon.

The first is that existing customers place increasingly significant demands upon the company’s product resources to provide bug fixes and deliver enhancements to current product lines. Over time, maintenance and product revenues from existing customers dwarf new customer revenue so companies must invest the majority of their resources to secure these revenue sources, leaving few resources for new product initiatives. Second, the public markets expect companies to generate increasingly better operating results – improved revenues and margins each and every quarter.  Investing in new product initiatives result in little short term revenue increases. The problem is compounded by the fact these new product investments immediately impact the expense side of a public company’s balance sheet. This can lead to poor margins and a depressed stock price which in turn can jeopardize a senior management team’s employment tenure with the company.

An advantage a successful company would seemingly have is access to cash to fund new product initiatives. However, while many of these companies do throw off a substantial amount of cash each quarter the quandary they face is that they are unable to use that cash to finance new development initiatives without negatively affecting their quarterly income statement. Interestingly, if they allow their cash balances to grow large enough, shareholders begin to demand the company increase its overall returns through quarterly dividends. Therefore, other than providing a safety blanket buffer for liquidity, cash offers virtually no medium-long term competitive advantage for a public software company.

Some companies have adopted the strategy of using their cash and/or stock to innovate and grow through acquisition; the in-quarter investment expense correspondingly offset by an equal increase in total assets. The downside is that this can take a substantial amount of cash and/or requires very liquid stock. Therefore, this approach is generally limited to a very few large companies such as IBM, Microsoft, Oracle and SAP.  Additionally, these companies are reliant upon finding companies that are willing to sell, they must pay a premium to the market value for the company, the technology they acquire must be architecturally consistent with their current products to gain immediate benefit, and more importantly they must entice existing key personnel to stay. None of these are necessarily showstoppers but each of them introduces complexity and expense and requires a significant investment of executive and employees’ time.

These problems, and others, can result in product innovation stagnation over time and lead to competitive vulnerability for established companies that must serve customers and investors simultaneously.

Proposed Solution: Spin In

A potential solution to this dilemma is the use of a “spin in”. While several definitions of “spin in” exist, for our purposes I am defining a “spin in” as a company formed with the explicit endorsement and investment – including personnel, cash and IP – by the parent company and outside investors. The express purpose of the “spin in” is to build strategic products and/or go after new markets with the ultimate objective that the parent company will acquire the “spin in” at some point in the future.

The concept is relatively straightforward and has been tried, tested and proven most successfully by Cisco but it has also been used by companies in other industries as well as by the federal government. However, this approach has not typically been employed by software companies. One of the reasons it has not been used in the software industry is due to the Not Invented Here (NIH) syndrome many software companies possess. The attitude is typically “we can do it better, faster, and cheaper ourselves.”

However, the facts tend to conflict with the attitude; as companies grow, few really new products are started, completed and brought to market. The primary reason is that each year when the products organization and executive team sit down to consider all the proposed projects for the following year, there is a very finite budget to distribute. A line is drawn and all the projects that fall below the line go unfunded. The projects that are usually funded are those that are the current mainstay of the company; the ones that are most likely to generate short-term product and maintenance revenue.

The dilemma is that those projects that fall below the funding line could very well be the innovation the company needs to compete and secure future revenue streams. In addition, many of those proposed, unfunded projects are the brainchild of some of the most talented personnel in the company. When those projects don’t make the cut, the product team associated with those projects can become extremely frustrated and ultimately threaten to, and often do, leave the company to pursue “their dream”. This can put a significant brain drain on the company and set the company up for disaster in future years.    

A “spin in” is one approach to solving these problems. The framework of the “spin in” structure I am proposing is different from Cisco’s approach and is an attempt on my part to address the issues of each of the constituents involved: parent company, outside investors and “spin in” management/employees.

Product Selection

The key to selecting the specific project/product as a candidate for a “spin in” is to ensure the product is considered to be strategic to the success of the parent company and that the market opportunity is large enough to support an independent company. A product idea that is just a feature of a larger product suite is not a suitable “spin in” candidate. Think of it this way, if it won’t pass a venture capital firm’s due diligence as a sizeable, standalone firm, it isn’t a viable candidate as a “spin in”.   

Financial Structure

There are several important elements required to make a “spin in” a viable financial structure for the parent company, the investors and the employees. Below is the basic framework of that structure.

Ownership

In order to keep the “spin in” company’s financials off the parent company’s books and to prevent it from diluting the parent company’s earnings, the parent company must own less than 20% of the “spin in”. While this is a minority position and could theoretically cause the parent company to lose control, the preferences of that ownership can provide the parent company with the terms it needs to make it feel secure in its downstream rights while other terms can be set to ensure other investors are equally protected.

Many of the initial key employees will more than likely come from within the parent company giving them the opportunity to pursue their interests while continuing to contribute to the ultimate success of the parent company. To attract a world-class management team and employees, the “spin in” will need to allocate a minimum of 20% of its valuation for employee stock.

Therefore, simple math suggests that outside investors will own 60% of the “spin in” at its onset and may need to provide up to 100% of the forecasted cash requirements. The parent company can contribute any one or all of the following: IP, key employees, marketing programs, a ready-made distribution channel, and cash to account for its percentage ownership position.

Collar

The primary difference between the “spin in” proposed here and the ones that Cisco has created is the use of a financial “collar”. The terms of the collar will give the parent company the “first right of refusal” to purchase the company at a pre-determined amount for a pre-determined period of time thereby protecting the parent company from having to buy the “spin in” in the open market at a potentially high valuation.

On the other end, the collar will provide the outside investors with a low-end threshold they can rely upon to sell the “spin in” back to the parent company by a certain point in time, thereby giving them a guaranteed return and shielding the outside investors from potentially losing their entire capital investment.

And, finally, it will provide the management team with the incentives to drive a range of increased valuation outcomes tied directly to revenue and expense objectives.

Lower Bound

The outside investors will hold a ‘put’ option valued at some multiple of total capital invested that can be executed not before 5 years but no later than 8 years after the initial set up of the company and requires a simple majority vote based upon ownership percentage of the outside investors. This approach incents outside investors because they are guaranteed to make at least some positive multiple of their investment in at most 8 years – this is a good, albeit not great, multiple and IRR for a venture fund.

Upper Bound

The parent company will hold a ‘call’ option that contains terms with a “first right to purchase” at the greater of some multiple of trailing twelve month revenues or a multiple of total capital invested, not before 5 years and no more than 8 years after the initial set up of the company. The parent company is therefore protected for a range of 3 years with a first right of refusal to buy the company at a price that is potentially less than the price it would have to buy a  successful company in the open market. And, while the investors could certainly force the parent company to buy the “spin in” even if the technology/business isn’t successful, this is a premium the parent company pays to gain the substantial leverage a “spin in” can provide.

The terms of the collar could state that the company cannot be bought or sold in the first 5 years without the management team’s majority approval. If the call option is exercised by the parent company, the employees of the “spin in” will be paid their percentage ownership based upon the valuation of the “spin in”. If the put option is exercised, the parent company will pay the management team 50% of their ownership percentage using a multiple of total capital in from the outside investors as the “spin in” valuation. As a result, the management team is rewarded by driving the valuation as high as possible, as fast as possible and incenting the parent company to exercise their call option. The management team will be held to an approved spending plan controlled by the board of directors so that the company cannot put the outside investors and parent company at uncontrolled spend risk.

For years 5 through 8, either the investors can sell the company to the parent company or the parent company can buy the company at the pre-determined values. After year 8, the company will gain the right to control its own destiny in the open market because the collar will have expired.

Examples

Let’s take a look at how this might work under several potential scenarios.

TBQ is a public software company with annual revenues of $1B, CAGR of 25%, 25% margins and a current market cap of $5B. The company realizes it needs a new suite of application development tools for their new open-fission architecture. However, after a thorough analysis, the engineering and products organization has a plan that requires 100 product managers, QA personnel and engineers working full time on this for the next 3 years, best case, in order to bring these tools to market at a minimum cost of $75M. They determine that with fully-burdened costs for each HC of $250K/year and 100 HC that it will cost $25M/year.

The senior executive team evaluates the proposal and realizes they do not have the current resources to build these tools and the additional expense will put pressure on the company’s operating results. The company decides to establish a “spin in” to build these tools.

The “spin in”, called Acme Software, is set up with an initial capital investment of $20M from 4 outside investors who collectively own 60%. The parent company invests $1M in cash, some IP and a few key senior personnel for 20% ownership. The employee pool is set up at 20%. This sets the post money valuation at $33.3M. For this exercise, we will assume the put option is 3x paid in capital and the call option is set at 8x revenues.

Scenario 1

Due to the aggressive performance of the management team, assistance by the parent company and the much lower overhead of Acme Software at $150K/year/employee vs. $250K/year/employee, Acme is able to develop V1.0 of Fission-Ware Development Environment in 2 years, not 3 at a total cost of $20M, not $75M and they generate $5M in revenues in year 3, $10M in year 4 (and went profitable) and $15M in year 5.

Year 5 is the first year the outside investors can exercise their right to sell the “spin in” to the parent company. They have the right to sell Acme to TBQ for $60M – 3x the total capital they invested. On the other hand, TBQ has the right to buy the company for $120M or 8x twelve months trailing revenues. Clearly, under these conditions, the outside investors would not want to exercise their put but TBQ might want to exercise their call option to prevent potentially having to pay significantly higher for Acme by year 8. Since the parent company elected to exercise their call option, according to the terms, the employees pocket 20% of the $120M or $24M.

Scenario 2

Unfortunately, the management team is unable to deliver V1.0 of Fission-Ware Development Environment until the third year. They are forced to raise another round of $20M comprised of $5M from TBQ and $15M from outside investors for total capital in from outside investors at the end of the second year of $35M. In year 3, Acme generates $1M in revenue, $3M in year 4 and $5M in year 5.

Under this scenario, in year 5 the outside investors may be inclined to exercise their put option – requires simple majority vote by the outside investors based upon ownership percentage – which would generate $105M for them. The call option would give the right to TBQ to buy the company for $40M (8 *$5M) except for the fact that the term of the put option gives the outside investors preferential rights. Under the put option, the employees are penalized and paid based upon the formula 50% * 20% of $105M or $10.5M and are paid this amount by the parent company.

Under Scenario 2, the total paid by TBQ to the outside investors and Acme employees is $115.5M which is nearly what TBQ paid under Scenario 1 where the management team executed well. As a result, the financial incentives are structured around the collar such that they reward the management team – and the parent company – for achieving success.

The interesting point is that with either the over-performing or the under-performing scenario, TBQ gets their product earlier than originally forecasted by the internal team and for less overall expense. This result is a win for every party involved.

Summary

The potential benefits of a “spin in” approach for large, public software companies are numerous.

1. Strategic projects that might not be funded because they are below the line are able to get funded.
2. The cost of development is carried off the parent company’s balance sheet until such point the product is in the market and generating revenue so it is potentially non-dilutive to corporate earnings.
3. The parent company is able to effectively retain key personnel by enabling them to exercise their entrepreneurial spirit.
4. The “spin in” company retains some of the parent company ‘DNA’ so cultural issues that affect most acquisitions are minimized. 
5. The products that are developed can be managed such that they are architecturally consistent with the parent company’s products so there is little overhead integrating the “spin in” products.
6. The new company is not constrained by the parent company’s branding and marketing budgets and policies.

There are numerous issues not addressed in this basic analysis that must address specific issues around stock class preferences, governance and compliance issues, parent company controls and employee incentives, etc. However, these are issues that have been well documented by some of the better law firms that helped Cisco and others create their “spin ins” and can easily be incorporated.

Hitchhiker: You heard of this thing, the 8-Minute Abs?
Ted: Yeah, sure, 8-Minute Abs. Yeah, the excercise video.
Hitchhiker: Yeah, this is going to blow that right out of the water. Listen to this: 7… Minute… Abs.
Ted: Right. Yes. OK, all right. I see where you’re going.
Hitchhiker: Think about it. You walk into a video store, you see 8-Minute Abs sittin’ there, there’s 7-Minute Abs right beside it. Which one are you gonna pick, man?
Ted: I would go for the 7.
Hitchhiker: Bingo, man, bingo. 7-Minute Abs. And we guarantee just as good a workout as the 8-minute folk.
Ted: You guarantee it? That’s – how do you do that?
Hitchhiker: If you’re not happy with the first 7 minutes, we’re gonna send you the extra minute free. You see? That’s it. That’s our motto. That’s where we’re comin’ from. That’s from “A” to “B”.
Ted: That’s right. That’s – that’s good. That’s good. Unless, of course, somebody comes up with 6-Minute Abs. Then you’re in trouble, huh?
[Hitchhiker convulses]
Hitchhiker: No! No, no, not 6! I said 7. Nobody’s comin’ up with 6. Who works out in 6 minutes? You won’t even get your heart goin, not even a mouse on a wheel.
Ted: That – good point.
Hitchhiker: 7′s the key number here. Think about it. 7-Elevens. 7 dwarves. 7, man, that’s the number. 7 chipmunks twirlin’ on a branch, eatin’ lots of sunflowers on my uncle’s ranch. You know that old children’s tale from the sea. It’s like you’re dreamin’ about Gorgonzola cheese when it’s clearly Brie time, baby. Step into my office.
Ted: Why?
Hitchhiker: ‘Cause you’re f&*%n’ fired!

The scene is hysterically funny – at least to me! But it might be one of those things you have to see/hear live to appreciate.

Anyway, lately I feel like I’ve been hearing the equivalent of “7 Minute Abs” business ideas. That is, the business premise is to take a successful idea with an existing brand and an existing installed base- make a relatively small refinement –  and expect to build a complete company around it – unseating the incumbents, etc.

So, what am I talking about? Someone comes in with an idea for a new CRM application but it has a mobile twist. Someone else comes in with an idea for a real estate website – but with a lot more social capabilities. Another comes in with an idea to connect homeowners with handymen (handypeople?) but it’s a mobile app v a web app.

In fairness, these aren’t bad ideas and unlike “6 minute abs” they are almost always an improvement over the original. However, in my opinion, most of the incumbents could easily replicate the new idea - with little chance of IP infringement – if it takes off.

I think it’s important that if you are going to go after an existing market with an installed base, make sure that your business model/product idea has demonstrable and radical differentiation — something where the value proposition is easy to describe and simple to convey.

In other words, make sure you’re not “dreamin’ about Gorgonzola cheese when it’s clearly Brie time”.

Just sayin’……

It was published based on data from 650+ web start-ups. The authors are Berkeley & Stanford professors including Steve Blank.

The goal of the report as the authors describe it is “…to lay the foundation for a new framework for assessing startups more effectively by measuring the thresholds and milestones of development that Internet startups move through.”

After analyzing the results of their survey, the data suggested that successful Internet startups tend to follow similar paths of development. The authors then factored those paths into stages.

In the study, the authors identify 3 primary types of Internet startups with various subclasses and each of these are segmented by how they execute customer development and acquisition. As the report states, “Each type has varying behavior regarding factors like time, skill and money.”

 The full report, if you want to read it in its entirety – and I encourage you to do so – is here:

Startup Genome Report

If you don’t have the time or the inclination, the 14 key findings in the report are as follows:

1.  Founders that learn are more successful: Startups that have helpful mentors, track metrics effectively, and learn from startup thought leaders raise 7x more money and have 3.5x better user growth.

2. Startups that pivot once or twice times raise 2.5x more money, have 3.6x better user growth, and are 52% less likely to scale prematurely than startups that pivot more than 2 times or not at all.

3. Many investors invest 2-3x more capital than necessary in startups that haven’t reached problem solution fit yet. They also over-invest in solo founders and founding teams without technical cofounders despite indicators that show that these teams have a much lower probability of success.

4. Investors who provide hands-on help have little or no effect on the company’s operational performance. But the right mentors significantly influence a company’s performance and ability to raise money. (However, this does not mean that investors don’t have a significant effect on valuations and M&A)

5. Solo founders take 3.6x longer to reach scale stage compared to a founding team of 2 and they are 2.3x less likely to pivot.

6. Business-heavy founding teams are 6.2x more likely to successfully scale with sales driven startups than with product centric startups.

7. Technical-heavy founding teams are 3.3x more likely to successfully scale with product-centric startups with no network effects than with product-centric startups that have network effects.

8. Balanced teams with one technical founder and one business founder raise 30% more money, have 2.9x more user growth and are 19% less likely to scale prematurely than technical or business-heavy founding teams.

9. Most successful founders are driven by impact rather than experience or money.

10. Founders overestimate the value of IP before product market fit by 255%.

11. Startups need 2-3 times longer to validate their market than most founders expect. This underestimation creates the pressure to scale prematurely.

12. Startups that haven’t raised money over-estimate their market size by 100x and often misinterpret their market as new.

13. Premature scaling is the most common reason for startups to perform worse. They tend to lose the battle early on by getting ahead of themselves.

14. B2C vs. B2B is not a meaningful segmentation of Internet startups anymore because the Internet has changed the rules of business. We found 4 different major groups of startups that all have very different behavior regarding customer acquisition, time, product, market and team.

Valuations and deal sizes for “hot start ups” are reaching lofty heights.

Just off the press is an article from Dan Primack, a journalist for Fortune magazine. In his article titled, “Venture capital shows sign of bubble” he writes the following:

Venture capitalists invested $5.87 billion in 736 U.S.-based companies during the first quarter of 2011, according to a new MoneyTree Report released by PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters. That works out to $7.98 million per deal, which is 18% larger than the average deal size during the prior quarter. It also is 21.6% higher than the average deal size in Q1 2010, and a whopping 47% larger than the average deal size in Q1 2009. Moreover, the average early-stage, expansion-stage and later-stage deal was larger in Q1 2011 than was the comparable deal in 2010. That’s important, because it indicates that this isn’t just reflective of VCs putting more of their eggs into less-risky, later-stage deals.

He goes on to cite the following statistics:

Overall, software companies continued to lead all industry sectors with $1.1 billion raised for 187 companies last quarter. This was followed by industrial/energy with $1.03 billion for 75 companies and biotech with $784 million for 85 companies. The quarter’s largest deal was a $201 million round for BrightSource Energy, an Oakland, Calif.-based thermal power plant developer, that raised $201 million. The rest of the top five was Plastic Logic ($200 million), Fisker Automotive ($111 million), Tabula ($108 million) and SoloPower ($78 million). Per usual, Silicon Valley led the nation with $2.49 billion invested in 212 companies. New England placed second with $639 million for 90 companies, and New York Metro snared $580 million for 69 companies.

So, the question currently being bandied about the proverbial watercooler is are we or are we not in a bubble? If we are in a bubble, are we in 1998 or 2000 (referring to the relative beginning and end of the last formally recognized bubble) and if we are in a bubble will this one end like the last one or will the ending be somehow different this time.

From my own perspective at InterWest, we are seeing more deals than ever in 2011. The weeks are literally jammed with back to back meetings with great entrepreneurs with great ideas. And, the deals that are getting done, for companies in a hot sector (e.g. consumer internet) and/or with a proven team are being fought for and won at valuations that may be hard for the entrepreneurs to live up to — and for the venture firms to generate a great return if anything goes wrong and the company takes longer and more capital to reach its goals.

That said, one observation made by Keval Desai, an early member of Google and VP at Digg, is that:

•  There are 7B people on the planet.
• 2/3rds of them don’t have Internet yet
• 95% without smartphones
• Facebook only has 10% share
• There is an entire new generation that is using mobile tablets, as infants, that will learn, socialize and play completely differently than anyone born prior to them.

In addition, the rapid rise of the mobile/cloud computing market is also driving a complete transformation and overhaul of back end systems thereby creating opportunity throughout the technology markets.

Given all this, it could be entirely possible that we see many years of growth in many, many different technology areas without the big bubble pop we saw last time. Companies started today that see early traction and growth - and revenue – have a good shot at not suffering the fate of the Bubble 1.0 companies like “pets.com” but instead could survive to become the new large incumbents that help to reshape the world in which we work and play.

Of course, this doesn’t factor in exogenous issues such as instability in the Middle East, natural disasters, etc. which could act as a countervailing dampener.

So, while hot start up valuations may appear to be “bubbly”, we may look back and feel they were actually fairly valued. The next few years should be pretty interesting…but hopefully “interesting” in a good way.

The report states, “13 public SaaS companies tracked by Pacific Crest Securities have increased in value 40% since the beginning of 2008. During that same period, the S&P index has yet to return to its pre-recession value.”

It goes on to say, “…not all public SaaS companies have performed equally well. To be a standout in this space, growth needs to be greater than 25% per annum, and the market opportunity needs to be significant (e.g. CRM, ERP, HCM, etc).”

They claim that growth dominates over profitability for a couple of reasons. The first is that the SaaS market is still immature with only a third of the entire software market spend. The second is that these companies have been able to demonstrate significant profitability after sales and marketing spend is cut back.

I’m not sure I necessarily buy into this last statement because I’ve yet to see any high growth SaaS companies that have cut back on their sales and marketing spend in favor of profitability. In fact, I remember a few years ago speaking with Phill Robinson, the then-current CMO of Salesforce. His comment to me was that he had not reached a point of diminishing return from his investments in Google Adwords – and Salesforce has continued to invest heavily in sales and marketing – mostly “brand” marketing v demand marketing surprisingly.

Here is the chart that SaaS Capital showed with the relative performance of each of the 13 public SaaS companies.

So, it’s true for public SaaS companies but does high growth spell high valuations for private SaaS companies?

The answer is a resounding “yes”. In fact, even more so. For fast growing private SaaS companies, valuations have recently been over the top. In the public markets, the high multiple ranges but is about 10x-12x annual revenues.

In the private markets, a high growth SaaS company with “only” a 12x multiple could be a great deal for an investor. One of the companies I looked at last year had less than $5M in revenue but the pre-money valuation of the round when it was completed was in the mid $100M range – all because its YoY growth rate and its pipeline had grown so fast and it was in a very large and addressable market.

In contrast, a low growth SaaS company is in a precarious position. The authors of the SaaS Capital report cite a private SaaS company they have been working with that generated $11M in revenues and is profitable but only growing somewhere north of 10% per annum. The company was unable to find any interested strategic investors and is hoping to get a financial buyer to pay 1.5x revenue this year. If they do, I think they should consider themselves fortunate.

So, if you want a successful outcome for your SaaS business, by defnition it needs to generate high growth. To do that, you need the capital to invest in sales and marketing. And, as I have written about in previous blogs, in a high volume SaaS model, lead generation not sales capacity, fuels growth. This is one reason why I believe we haven’t seen any leading SaaS companies emerge that haven’t been venture backed at some point to fuel growth.

So, by definition, if you’re a SaaS company it’s incumbent upon you to find marketing personnel who are experts at lead generation. I know this is one of the critical hires in each one of my SaaS portfolio companies and it is becoming increasingly more difficult to attract this highly sought after talent.

Given the importance of lead generation for the SaaS model and company valuations, I suspect over the next few years, that marketers with proven lead generation skills in the SaaS market may see base + variable compensation on the same level as sales personnel.

According to the article, from $33M in 2009, GroupOn’s revenue virtually exploded in 2010 to $750M. From an employee base of 120 in 30 cities in 2009, the company now has 4,000 employees across 565 cities. Holy cow!

As I read the article, it reminded me of the significant challenges companies must deal with when faced   with explosive growth.  We were faced with a similar challenge at Siebel Systems in 1998 as we  had doubled from 1997 and we were preparing to double revenue the following year (from $418M to $800M). As it turned out, we doubled in 1998 ($813M) and we doubled again in 1999 to $1.7B.

While this is a high quality problem to have, the fact is this type of growth places enormous stress on executives, managers and employees. And, it is a problem that few executives/managers have personally had any experience with.

One of the issues we faced at Siebel was not only with external hiring, but also ensuring that our executives/managers could scale with the business. For example, people who may have been great first line managers were becoming second and/or third line managers in the course of a single year. Not everyone had that experience nor was everyone capable of making that type of transition.

To his credit, Tom Siebel realized that in order to “keep the wheels from coming off” (his words), we needed to put in place a hiring program that would ensure that employee 5,000 was as capable as employee 100. Additionally, we needed to ensure that managers who whose organizations were exploding internally, weren’t collapsing under the weight of new/different responsibilities.

We knew it was an impossible challenge to make perfect external hires and transition every manager from one level to the next. Therefore, we needed to put in place a process that ensured when we made a mistake and hired the wrong person or we identified that a manager was failing that we had a mechanism to quickly identify and rectify the situation.

We needed  a plan to hire several thousand people in a single year. This meant that people who we had hired within the past year would likely be responsible for hiring additional people within the year. These would be people who themselves had limited experience with our “Core Values” and/or our operating principles.

The opportunity to do this wrong and hire a lot of people who would be detrimental to our business was extremely high. This would cost us a lot up front and even more downstream with our customers, partners and shareholders.

To address the the critical challenge of talent acquisition, we put in place a recruiting and training function across the company. Working with HR, each senior executive was assigned a dedicated recruiter who helped to draft the job roles/specifications that aligned with employees who were currently viewed as successsful in their role within their groups.

We held “Super Saturdays”, where we would bring in dozens of candidates and have them interview with current employees and managers in an intense day long process. By the end of the day, we accumulated all the comments on each candidate from each interviewer and assessed whether or not we wanted to make an offer. For those candidates who made it through the process, HR generated an offer letter and the hiring manager met with the candidate at the end of the day and personally made the offer. It was  a long and exhausting day but we were able to make many great hires within a single day without impacting the business during normal business hours.

Then, in each group certain managers who had tenure with the companyand the organization, were tasked with creating a training curriculum that helped to train new employees. For example, in the Alliance organization, we took the dozens of recent MBAs we had recruited earlier in the year and put them through an indepth program where they were trained on how Siebel created and managed its alliances.

We operated a “boot camp” where newly-minted alliance managers learned the general policies of  Siebel Systems (e.g. Core Values) along with organization-specific issues such as the structure of the Siebel Alliance Program, how to write an alliance business plan, and how to work with other functions within Siebel Systems. At the end of the month long training each manager was tested and certified.

Similar training was performed in Product Management, Sales, Engineering, etc.

Consequently, new employees were able to quickly assimilate into the company and understand our Core Values, our policies, learn who were the key people in different functions across the company, how to work across the organization and how to work within their own organization.

In addition, we knew that not every employee – new or otherwise – was going to work out and as important as it was to bring on great people, it was equally important to be able to identify and remove people who were unable to contribute as we needed. To address this very real issue, we created an objective process.

Every employee at Siebel had a set of quantifiable and written objectives which were captured in an internal system we developed. Today, there are products like Rypple that will help companies capture and track their objectives/commitments. As a result of this process, every six months we stacked ranked every employee across the organization and we eliminated the bottom 5-10% performers.

I don’t claim this was a perfect process by any stretch – I don’t believe everyone liked/agreed with this approach or that mistakes weren’t made from time to time where we terminated or kept the wrong employee – but overall this program helped to quickly identify and resolve employee situations that weren’t working out.

Between these two programs, we were able to “keep the wheels on” even in our hyper growth days.

I think these ideas can even apply to companies that only need to make a few hires. Many times interviews take a back seat to the business and are stretched out far longer than necessary. From what I have seen, most start up companies are poorly prepared to execute quickly in this area. Interviews can be disjointed with candidates left wondering who they need to interview with next or where they stand. Offer letters take days/weeks.  

For high tech companies, people are our most precious asset. So, just as it is critical to have a world class development process, having an outstanding hiring process is critical to success.

For those key hires that could make/break a company and who are likely to be highly desirable by your competitors, putting in place a world class hiring process so they join your team vs. someone else’s could be the difference between your company becoming the market leader or an also ran.

So…ask yourself “how good is our hiring process?” Even if you aren’t in hyper growth, are the wheels coming off?

When I originally started this blog, I did it as an experiment; I didn’t give a lot of thought about the long-term breadth of topics I wanted to cover beyond “Software as a Service” nor the blog’s overall positioning. I thought that if it garnered a few followers I would circle back and consider its “look and feel” and branding.

Well, after 2 years since starting there are now nearly 2,000 people who read this blog each month, so I consider it to be a successful experiment – especially given the fact I’m not some Hollywood celebrity such as Ashton Kucher who apparently has a ton of interesting and intelligent things to say/tweet. Consequently, I felt it was time to finally “circle back” and put some serious thought into branding/positioning/etc.

The first thing about my blog I wanted to change was the title, “SaaS and All Things Software”. I wanted to do this for several reasons. Over the past few years, SaaS has evolved into something a lot bigger – “Cloud Computing”. Cloud Computing includes DaaS, PaaS and IaaS as well as SaaS and I am involved in companies and technologies in all these areas and others. Second, I have many other comments I’d like to make that go beyond “SaaS and All Things Software” and I’d like the blog’s title/message to be broad enough to encompass those observations.

I chose the title, “Rolling Thunder” for two reasons. The first is that it ties into “Cloud Computing”; Thunder. Clouds. Duh. The second reason is that Rolling Thunder is a PR term meaning “continuous communications”. I thought that it fit nicely with the intent of the blog. So, that’s the rationale behind the name.

Based upon the recommendation from one of my partners at InterWest,  I decided to try and use crowdsourcing to come up with a new design. So, I signed up with Crowdspring. Crowdspring is one among a number of websites that features 10′s of thousands of designers (called “creatives”) who look for interesting projects (e.g. websites, blogs, stationery, logos, wedding themes, etc.) that are posted by ”non-creatives” (my term) like me.

After signing up, I created a project, described what I was looking for in a new blog design, and pointed the “creatives” to my existing blog for ideas. In the initial set up, I had to come up with an award amount for my design – it has to be at least $200. In this case, I chose $500 to make sure my project received enough attention.

In total, I recieved about 40 different designs to consider. I ended up selecting one design style from all the other entries. However, that was simply a design. I still had to have it converted into an actual WordPress Theme. This wasn’t within the designers skill sets so I took the design to the web programming firm we use (HyperArts) and had go through a few more design iterations as well as having them convert the design into an active WordPress theme.

Although the Crowdspring approach didn’t give me a “blog ready” result, had I gone the traditional route, I would have spent several thousand dollars in design fees and would have been restricted to just a single firm’s imagination and skills. With crowdsourcing, I had access to many designers and felt I received a lot of creative ideas that influenced the final design outcome.

I relied upon Crowdspring to handle all the financial details, etc. It made it relatively simple and straightforward. None of this would have been possible a few short years ago. Pretty amazing stuff. My only negative comment is that most of the designs submittted are simply repurposed stock art so you aren’t really getting anything “custom” — at least not for the $500 award I offered. But, you do get some creative uses/adaptations of stock art and for my purposes this worked fine.

With that, welcome to my “new and improved” blog. I look forward to interacting with all of you in 2011 and beyond on topics that include SaaS but will branch out to general observations on a variety of things I find interesting…and, hopefully, so will you.

I try to attend Dreamforce each year because a) Marc is entertaining, b) there is always something interesting that he announces and c) it’s usually pretty relevant to the companies and markets I invest in. This year, as expected, he announced several new offerings; one  that I thought was an especially shrewd move is  Free Chatter (good idea since SuccessFactors is gunning to own the enteprise collaboration market with its CubeTree  acquisition earlier this year. I think Lars Daalgard, CEO of SuccessFactors, is one of the few current high tech CEOs who can go toe to toe with Marc for showmanship!).

Another major new offering according to Marc, to be delivered in 2011, is Database.com. This is a new SaaS-based noSQL database offering that developers can use to create a variety of new applications. It supports a multitude of programming languages which is a departure from Salesforce’s more proprietary approach in the past. 

During his explanation of Database.com, it dawned on me that what I was hearing was Marc essentially endorsing and bringing to market a client/server computing offering – client/server 2.0, if you will. This is the very person who eschewed and spurned the client/server computing architecture in favor of “internet/web-based computing” a mere decade ago. 

Think about it. One of the fastest growing areas for application development is for mobile computing on top of Android, iOS, and, dare I say it, Windows Phone 7. Each of these applications are downloaded to a client device and communicate through an API/protocol to a backend server/filesystem. That, my friends, is by definition client/server computing.

Yes, it’s a different time/space and it’s a different architecture that helps obviate many of the issues associated with client/server 1.0. But, nevertheless, it is client/server computing. I found this to be extremely ironic. I wonder if anyone else was thinking the same thing?

The overall show was impressive and my portfolio companies are all very happy with the amount of customer interaction they had in the Expo. Just one  small complaint; Marc, in case you’re out there reading this — don’t you guys think you ought to retire the “No Software” positioning. It served its purposes in its day but I think everyone has figured out that Salesforce is all about software — and now, apparently, client/server computing.