A Good Man In A Storm

Combing through yesterday’s WSJ I came across a piece on the phenomenon of the ‘Bullwhip Effect’ and how it was beginning to be observed in the broader US economy. While this phenomenon is usually discussed in terms of manufacturing and distribution channels, an analog to the Bullwhip Effect is also apparent in markets where young, high growth companies are typically concentrated. Demand kicks up and market sentiment improves which sends companies scurrying to bring back laid-off workers or to engage anew in hiring if such plans were put on hold.

While I have long been an advocate for being methodical in building out young start-up teams — especially small, fragile teams where each additional hire can dramatically affect a company’s culture and DNA — I find too many emerging growth companies make critical mistakes in hiring that can have long-ranging consequences. Here are just a few:

1. Jesus Christ is not currently available. Being picky is one thing, but there is sometimes an arrogance that seeps into a hiring process that is both counter-productive and bad for broader public relations. All companies would love to be able to identify the best candidates that represent an ideal match for the company and that have the potential to become future leaders of the enterprise in the years ahead. The truth is that no hiring process is ever really capable of that level of granularity and foresight. As such, the general rule (for most start-ups) should really be to find the best person available for a given role with respect to the current needs at the company and hope that that individual can grow into a long-term future at the company as he or she demonstrates value to the enterprise. Assessing fit on the basis of a handful of artificial and scripted meetings is hardly optimal. No matter how rigorous the process, no one can really assess the fitness of a candidate for a given role until that candidate is performing that job, at that company, and working with that set of peers, superiors and subordinates at day-to-day challenges in the fast-moving environments in which most start-up companies operate.

For years I have heard stories from long-suffering colleagues about withering multi-month processes over positions that were hardly the most influential at the companies in question. Making a hiring process a Bataan Death March for candidates may feed egos at the company and reinforce some internal sense of superiority among managers there about how exclusive and discriminating the company could be, but chances are that taking that long to fill a critical role is exacting a significant cost on the company in terms of lost opportunities. The next time you find yourself interviewing for your company, say, a Sr VP of Alliances candidate on his or her 11th interview in month five, consider for a moment your most direct competitor and the hypothetical impact of that competitor having found a Sr. VP of Alliances three months earlier and that person being on the job during that time pursuing all the market and alliance opportunities that your company would be pursuing had it brought someone aboard months ago.

2. Hire cooks, not chefs. Celebrity chefs are great but it’s the line cooks that really keep restaurants humming. Food writer Anthony Bourdain had a great line about the difference between cooks and chefs. His point, if I recall, was that people who considered themselves cooks, and were not ashamed to use the term to describe themselves, were better hires. Cooking is a craft, not an art form. Those who consider it an art form often require constant stroking and handholding and don’t think it’s important to show up for work on time. The analogy for start-ups teams is to do your best to avoid prima donnas by finding versatile, hungry managers who would not think it  “beneath them” to incorporate tasks into their workload that might be lower than their job titles might suggest. A natural salesperson loves to sell. A great Corp Dev, BD or Alliances person lives to do deals. If a senior sales person accustomed to managing large enterprise sales accounts is not open to helping a junior colleague with closing a small sales opportunity, that should tell you something. Great hires strive at every opportunity to add value, especially in the early days of a new role. Even in more established, successful start-ups there remains a culture and mentality of everyone grabbing an oar and helping however they can. Getting stuck on formalities or on what it says on the business card should be a red flag.

3. Hire fast, but fire faster. Many VCs and HR execs may take issue with me here, but I am a big believer that when it comes to fast growing start-up companies in an economy pulling out of a deep recession, the right move is often to (1) set a tight spec and a fair but rigorous hiring process and stick to it; (2) hire quickly and deploy that candidate as quickly as practicable; and, (3) if the candidate turns out to clearly be a bad hire — every company has them — remove the problem quickly through transfer or termination, bring on a better candidate, and move on.

4. Fewer constituents, fewer hands, a tighter process. Nothing both complicates hiring and aggravates job candidates more than a hiring process that lurches forward without direction, that has too many constituents that demand that they touch and sign off on all candidates, and that has a spec that undergoes constant evolution. Clearly decide what the spec is early on and decide who will be vetting candidates. Decide, also, how long each step in the funnel will be and who shall have ultimate authority to waive candidates through to subsequent steps. Finally, be disciplined about setting an end date to when new candidates are added to the top of the funnel. It’s bad form to bring in new candidates when others are already nearing the end of a multi-month process. Not closing off the process to new candidates brings about the tendency of companies wanting to see everyone and of putting off hiring decisions on the off-chance that the perfect candidate is just around the corner but has yet to emerge. Too often, companies that fall victim to this trap ultimately never find the candidate everyone can agree upon, no one is ever hired, a long-suffering junior staffer ends up having to pick up the slack, headhunters get frustrated and stop referring candidates, and the company misses out on accelerating its business because the need is never filled.

Caution: Bad Partnership Ahead?

Some time ago our friends at PEHub ran a post from contributing blogger Georges van Hoegaerden on the subject of how best to spot inferior venture capitalists. As one would expect, the intended audience was entrepreneurs seeking venture funding. Broadly speaking, there were some good points.

To be sure, the venture community is guilty of many failings when it comes to interacting with entrepreneurs and there are plenty of opportunities for improvement — particularly in the areas of communication around timelines, assessing the level of interest in the entrepreneur’s company, and the funding process itself. I wanted to focus this post, however, on areas where entrepreneurs unwittingly damage their prospects for a capital raise. I consider these tendencies ‘warning signs’ in that once they are exhibited they usually foretell problems to come in other areas of the VC/entrepreneur relationship and many venture investors simply nip such interactions in the bud than continue to invest the time to properly vett the opportunity.

I suspect that every venture capitalist that has been at this game a while has compiled his or her own list of warning signs to look for when first engaging with an entrepreneur. While it may appear somewhat unfair for an entrepreneur to be dismissed unceremoniously early in a funding process for being guilty of one or a couple of these infractions, venture investors are human, pressured for time and bandwidth, and will lean upon their own pattern recognition to avoid problematic relationships.

1. Demanding that investors sign non-disclosure agreements without merit. I covered this subject at length in a piece, A (final?) word on NDAs, a couple years ago so there’s no sense rehashing it here. The usual VC pushback on NDAs is that (1) they expose them to liability should their firm later decide to fund a competitor (or a company that might reasonably be considered a competitor) and that (2) there is often an adverse selection problem inherent in the request itself. In short, if your idea is that easy to steal/replicate/jeopardize simply by your telling me about it, I am probably not interested anyway. Finally, and perhaps most tellingly from my perspective, in the hundreds of times I been asked to sign an NDA before seeing an Executive Summary I can recall only a handful of those occasions when an NDA might have been warranted. It’s a red flag when an entrepreneur does not understand the opportunity well enough to determine whether there is something truly proprietary that could warrant having an NDA. It tells me that the team does not really know what is important and that it might have an inflated view of the value of what they have built or are trying to do.

2. When the level of paranoia becomes an obstacle to communication and information sharing. In a continuation of point #1 above, unfounded paranoia on the part of the founding team is another red flag that comes up early and often. Intel’s Andy Grove famously titled his book ‘Only The Paranoid Survive’ . Many venture investors consider it important that their portfolio companies constantly be in a healthy state of paranoia. However, the key word here is healthy. Start-up teams need to be constantly focused on incumbents and their competitors and need to think many steps ahead lest they miss out on opportunities that might allow a competitor to steal a key customer, outflank them on a partnership deal, or make another move that could doom the company. Where things get problematic is when a founding team turns that paranoia inward and begins to hoard information, distrust its partners, block employees from speaking with investors or other stakeholders, and take other irrational actions.

If early in the fundraising process a entrepeneur appears vague or less than forthcoming about sharing key information, we will usually lose interest in the opportunity. While I don’t suggest that entrepreneurs blizzard VCs with every document in their files, it is usually better to overshare and let the VCs determine what information is most important in their diligence process than to make the VCs feel they need to pull teeth to get basic questions answered and documents provided.

3. Not understanding the fundamentals of the venture business or the firms being approached. First-time entrepreneurs would do well to spend a little time understanding the venture business before formulating a fundraising plan. I am struck by how many teams that approach us have little to no basic understanding of how the VC business works and how deals get funded. Additionally, it’s critical to do some research on the firms being approached.

4. Getting stuck on valuation at the expense of everything else. Valuation is important, no question, but I think it still takes up far too much time and attention during the funding process and subsequent negotiations. When investments are successful, no one ever remembers (or usually cares) about what the valuation of the first round was. For a company to succeed all team members and stakeholders must be aligned. That alignment comes from a reasonable valuation that is set properly and balances out the inherent risks in the opportunity to the investors, founders and employees. Entrepreneurs that turn down a term sheet hoping they will find another investor that will provide that same capital at a higher valuation are rarely rewarded for taking that risk. Similarly, a good and responsible venture firm that hopes to be around for a while would be foolish to structure a financing so Draconian that it has the effect of demoralizing the team and earlier stakeholders and hampering future fundraising prospects.

Smart, experienced entrepreneurs focus on finding the best partners, not necessarily the cheapest money. If an entrepreneur starts laying out lofty valuation demands early in the process when we are still far from a term sheet, it usually has the effect of throwing cold water on the relationship. Wait until the hook is set; then lay out a cogent argument for why you think the company is worth what you insist it is worth. You might not get that valuation, but you will have a better chance at finding the right partner and the proper amount of capital needed to accelerate the business.

The Care and Feeding of Early Customers

In a recent post, Paying Customers – What a Concept!, I proposed that many early stage companies were having to accelerate their products more than was planned on the initial roadmap in order to achieve two critical goals: (1) demonstrate that customers would actually pay for the product or service; and (2) get revenue in the door as quickly as possible to stanch monthly cash burn.

Our portfolio company, Athleon, referenced in the original post has since gone live with its all-pay platform and, thankfully, management and the board have been delighted with the response from users thus far. Granted, it’s early days but in the weeks ahead a fuller picture will emerge of how many beta customers converted to paying customers, what our overall churn numbers were, and — most importantly — what we have learned from the campaign and how best to leverage the experience into best practices for the company going forward.

I wanted to focus this post on the unique characteristics of early customers and some of the strategies that can be employed for the proper care and feeding of these critical players in a young company’s development. Over the years I have heard some in the start-up community opine that a customer is a customer, that everyone’s money is green, and that a company should not give preferential treatment to one subset of customers over another, or at the expense of another. There is some logic to this, I admit. Ideally, a great product of service is  desireable across a broad segment of customers and should not require special gimmicks or premiums to appeal to that broad demographic. The slippery slope argument would follow that each premium or discount cheapens the brand and its product and results in customers becoming institutionalized to freebies and other enticements in order to stay customers. An oft-cited example of this is the 1980s airline fare wars where the big carriers became enmeshed in a disastrous race to the bottom by heavily discounting their most popular domestic routes. Once cooler heads prevailed and the airlines decided to end their Pyrrhic game of chicken they were forced to spend the next decade re-educating consumers to wean them off the artificially low pricing on the affected routes. Passengers had gotten so institutionalized to the notion of a $199 R/T New York-LA ticket that they thought anything above that price was gouging. The airlines, of course, were losing a fortune on the $199 fares.

1. Handholding is not only OK, it’s encouraged. I propose that early customers are different. They are voting with their pocketbooks on a company that is usually not particularly stable with a product that is probably somewhat undercooked. These are the pioneer customers. In addition to being able to enjoy their much-needed cash to fuel the start-up’s business, a company management can learn a lot from them. Furthermore, they are almost by definition a small (but hopefully growing) group, so maintaining contact with them and interfacing with them is typically manageable in the early going. Pestering them is not recommended, but reaching out on a regular basis is advisable if done sensibly. Early customers can often provide invaluable feedback on new features, new products, policy changes, and the like — before rolling them out. Finally, deputize at least one person on your team to manage calls and inquiries from early customers in the first few weeks after launch. There will likely be some required handholding to get betas to convert. There will also likely be some irate beta customers that just need to vent. Sometimes they can be turned around and can become a paying customer after all; sometimes not. If not, then the exchanges can often defuse the unhappy betas sufficiently enough that the risk that he or she might pollute the well can be minimized.

2. Use premiums judiciously.  I find that valuable customers rarely angle for freebies to give you their business. They want your product, but perhaps they have not been sufficiently sold on its merits and why they need to pay for it. A free book, t-shirt or DVD is not the answer. Unfortunately, that seems to be the knee-jerk reaction from too many start-up teams as a way to ‘bribe’ betas into converting. Premiums like those can work, but they are rarely an elegant response and rarely result in “quality” revenue. Sell the product or service properly and there should be no need for gimmicks. If a beta who wouldn’t convert suddenly does once you throw in a free bobble head, you probably have a lousy (and one-time) customer.

3. Keep the pricing simple. Ideally, I like a really straightforward pricing model. Consumers tend to prefer it as do VCs. That said, I know there are instances where the business model is sufficiently complex that it is just not feasible. With early stage companies, often you are most concerned with getting customers to pay something — anything! — to validate the product and, by extension, the company. As such, don’t get hung up on structuring some overly sophisticated MBA-type pricing mechanism that seeks to perfectly price discriminate and revenue maximize every customer. That’s being too clever by half. The leap from non-paying beta customer converting to paying customer is challenging enough before complicating it with multiple pricing plans. There will be plenty of time for tweaking pricing plans as data rolls in.

4. Offers to early customers should never get worse; only better. One common mistake start-up teams make with pricing strategies is that they often roll out subsequent pricing plans that inadvertently penalize their earliest customers. As mentioned in #1 above, early customers took the greatest risk on the company at a time when few would and they should never be jettisoned or forced into more expensive plans due to some management errors or experience effects. They should also be granted all future premiums being rolled out to new customers. Management will certainly learn things about customer behavior and ideal pricing strategies as time goes on, but nothing ruffles the feather of a charter customer more than seeing a very attractive pricing premium being offered “for new customers only.” If it’s good enough to offer new customers, it’s just as good to offer charter customers if it’s the company’s intention that they remain customers for long.

10 Tech Trends for ’10

As the calendar flips to a new year and decade, the temptation to opine on trends for the year ahead becomes almost a parlor game for those in the technology sphere. Predictions in this industry are inherently broad. Oftentimes, so many things must work in tandem for a prediction to play out in the time allotted that one must give prognosticators partial credit if even some notion of what was predicted reasonably pans out. With that caveat, I offer the following — not so much as predictions for the year ahead but as a collection of things I will be watching closely over the next twelve months.

1. Green shoots, but no Chef’s Salad. Saying 2010 will be a better year for technology companies and their investors than 2009 is hardly a bolt from the blue. Fortunately, there is now compelling evidence that the IT backlog is loosening up and businesses are investing again in their IT infrastructure which should provide a nice collateral uptick for devices, software, services, and support. In this new, frugal world, a disproportionate share of the spoils will go to companies offering scalable solutions, often in the cloud, that are cost-conscious, flexible for their customers, and customizable on the fly.

2. Physical Media dies..a little more. Been passing a lot of empty storefronts that were once a Blockbuster Video or Virgin Megastore? It will only be getting worse in 2010. Not a believer yet? Pick up a newspaper. No, wait, on second thought that’s not so easy any longer either. This also applies to new technologies replacing our old ways of consuming media. Amazon’s Kindle is a runaway hit and Apple’s Tablet is enjoying buzz not seen since the debut of the iPhone. These might prove to be the first real wave of consumer devices (after so many flops) to finally live up to the promise of shifting media consumption and media spend from the brick-and-mortar to digital world.

3. Strongest IPO market in (almost) a decade. The moribund exit environment appears to be improving, albeit not as quickly as most in the venture community would like. While M&A continues to dominate as the traditional exit path of least resistance, IPOs are becoming more numerous as well. Prepare to see 2-3 high-profile tech companies go public in 2010 which will have a positive effect on overall tech valuations and provide much-needed coattails to other public technology companies in waiting. Possible 2010 IPO candidates? Facebook, Zynga, LinkedIn, Silver Spring Networks and a handful of smaller cleantech and game companies. If only a few of those marquee names actually consummate public offerings, 2010 could be the biggest year for tech IPOs since the Google offering of 2004.

4. Entrepreneurs Rule Supreme. In a December 2007 post, I offered the notion that entrepreneurs were becoming increasingly relevant again. This came after several years of professional CEOs regularly being brought in by frustrated investors to replace ostensibly prodigal 20-something founders that investors felt were ill-suited for those ascetic post-bubble years. While ‘gray hairs’ and competence will never go out of fashion, the unique qualities of a compelling, charismatic founder who can envision and develop products that can change the world cannot easily be overstated. The Marc Benioffs, Mark Zuckerbergs and Sergey Brin/Larry Pages of the world are often the builders of companies that most directly shape our world and create the greatest value for investors. If Facebook ends 2010 as a multi-billion dollar market cap publicly traded company, helmed by its 24-year old founding CEO, it can only bode well for young, visionary entrepreneurs everywhere and for venture firms willing to take a chance on first-time CEOs with potentially game-changing ideas.

5. Changing of the VC guard escalates. Talk has swirled for years now about a winnowing of venture firms, to little effect. 2010 may change things. Now that ’99 and ’00 vintage funds have wound down (or will shortly) there is a bit of a case of the emperor’s new clothes. LPs can now see in the harsh glare of red ink on white paper how poor many investments in some storied venture firms fared over the past decade. The old saw that ‘no one ever lost money buying IBM’ was also a prevalent view among some LPs who, overly focused on brand,  generationally backed storied firms almost out of habit. This trend is on the wane as limited partners get more serious about sharpening their pencils and closely evaluating what firms they want to be investors in over the new decade. The ivy league venture firms ten years from now will not likely resemble those considered ivy league firms today. Limited partners that take a chance on younger venture firms doing riskier, earlier deals may well be rewarded when the ball drops on 2020.

6. Vertical Social Networks catch fire. Some argue that ICQ and Friendster begat Facebook and Twitter, and that Facebook and Twitter have sired companies like Athleon, Gowalla and Foursquare. Sure, Social Networking has gone wireless but it has also gone vertical, and usage is exploding. Users are demanding the rich content, ubiquity and connectivity of social networking platforms but they are also demanding richer tools more focused on their specific needs, like coaches who use Athleon to communicate with their team’s players, parents, and sponsors as well as using the platform’s suite of applications like playbooks, stats trackers, game film storage, and the like.

7. EnergyTech has its moment. Sure, biofuels and hybrid engines may be more intriguing (and capital intensive) but the “energytech” sphere of cleantech, such as the smart grid arena and Demand Response companies like eRadio, is where many of the first exits in the broad cleantech space are likely to come. Watch investment into the space increase substantially in 2010 with participation from unlikely sources.

8. Early stage VC returns to form. Building companies from the ground up is sexy again. Perhaps it was the bloom coming off the buyout rose in 2008, but many investors are realizing that clever financial engineering and interest rate arbitrage plays do not generally build great companies of lasting value. Limited partners who shunned early stage venture firms after the dot-com bubble are returning in force and looking to again be part of the creation of the next generation of great technology leaders. It’s hard to buy your way into that party after the fact; one needs to be there at the beginning to truly realize substantial returns. Just ask Ron Conway.

9. Alternative fund models gain momentum. I’ve spoken of Pledge Funds and Search funds and a variety of other venture/private equity hybrid structures that have gained prominence in recent years. The ’08 financial collapse has only raised their profile. As LPs pressure private equity and venture fund GPs on everything from clawbacks to management fees, more GPs are going off the reservation and debuting new funds with LP-friendly terms and structures. Some are a bit hyped, but many have some real merit and can address specific needs of certain LP groups.

10. RIP the 2 & 20 Fee Model. As a follow-up to #9 above, the traditional 2% management fee/20% carry structure that has supported the venture industry for decades is now under attack and is not likely to survive unscathed or unaltered. True, there have been previous attempts at LP mutinies that have come to naught, but this time LPs seem better organized and more aligned than ever before. They also now confront an industry somewhat chastened by a tough decade and willing to re-appraise prior assumptions about how to work with long term investors than was the case during the dot com haze when we rang in the year 2000. Oh, what a difference a decade makes.