Tech, Startups, Capital, Ideas.

One of the biggest challenges for entrepreneurs right now is valuation. Simply put, multiple compression in the public markets combined with frantic missives from investors has translated into vastly reduced valuations in the private markets.

Some companies are raising up rounds. Typically they are in “must have” large markets that are relatively unaffected or even rewarded in this environment. Security and cost-savings are two such examples. Often, they have out-executed since their last round, were already incredibly cash efficient, and have revenues that are doubling or tripling year over year. Or they are a combination of some of the above and hugely strategic. That is, if they win in their market the bet is that they will be incredibly valuable.

But the challenge faced by many CEO’s is growing into their last round valuation. While next year is likely to be better in terms of the willingness of private market investors to invest, valuations are not likely to move much until those investors see liquidity opportunities. And by all accounts, that is going to be a long while in coming.

As one CEO aptly put it in a board meeting this week, investors should not have to tell their management teams to initiate discussions around expenses. Savvy entrepreneurs and CEO’s took the initiative to do this themselves. Productive board discussions followed and that is just good business.

The real challenge and opportunity in this climate is for companies to find innovative ways to grow. That is where investors can be most helpful to their CEO’s and entrepreneurs. Because if cost-cutting is a company’s only accomplishment in the next 12 months, the likelihood of getting funded at an up round — or even getting funded at all — is incredibly low. For those companies with products that are selling, re-deploying some spending in their organization, from product to sales, for example, can be a whole lot more valuable than absolute dollar savings.

As Alan Patricof eloquently stated earlier this month, “Find a way to use this moment to gain your greater share of the market by providing a solution that is needed by others to improve their prospects in the difficult environment ahead.”

Growth is always attractive to investors. In a market filled with fear, uncertainty, and doubt, it’s more important than ever to stay focused on that goal.

Last week I met with the talented CEO of a growing company. His first question: “Are you still investing?”

Yes. We’re open for business.

The irony was that I had specifically stopped off to see him. I clearly had interest. But after watching the public markets and reading all the associated news, he felt compelled to ask. And rightly so, because a lot of investors have stopped investing altogether.

As reported in Private Equity week (September, 2007), MDV is currently investing out of our $580 million ninth fund. The firm has been working with entrepreneurs through thick and thin for nearly 25 years.

When I started my first company, I found it very hard to raise money. The market was grim and I had little startup experience. My two co-founders and I boot-strapped the business. The path was never easy. But we did it.

When I formed my second company in 2002, the market was just as grim. I was fortunate enough to have venture investors who believed in me and were open for business. As you have no doubt read elsewhere, some of the best tech companies were started during recessions.

There is no one-size-fits-all message we are delivering to our portfolio companies. With a diversified portfolio across sectors and within tech itself, no one message would fit them, nor would they want to be treated as numbers rather than as individuals. We’ve sat down with each portfolio company to take a hard look at their operating budgets, sales plans, and market approach.

Many of our entrepreneurs have seen it before. Coming from cash efficient or boot strapped backgrounds, they have been running lean and mean operations all along. Others see the current market as an opportunity to consolidate. They have a product that is selling well and they are going to keep on selling it, some even more aggressively than before.

Some rightly worry that customers will buy less. But some areas are selling better than ever before. Which ones? Those delivering peace of mind, such as security, compliance, or better customer service; cost savings; or incremental revenue.

Many have highly evolved sales models that don’t require customers to buy in big to get started. They have pricing models that align with the customer - no huge up front investment, but rather, pay as you go. Customers of companies like PBWiki and Ironkey, to name just two, are able to get started with a small purchase and then grow their spending as their needs grow. The result is large per customer revenue even with a small initial start.

Tech companies, especially those with SaaS models, are finding innovative ways to increase their runway. They are giving customers a discount for paying a full year up front. They’re incenting their sales forces to close one year deals with up front payments. And they’re charging for incremental usage such as bandwidth, storage, or transactions.

The bottom line is, great companies are still being built. They are doing it lean and mean, and they are doing it with the pain of experience under their belts. These days, there’s clearly no more security working for a large company than in running your own shop. If anything, doing a startup gives you more control.

Great entrepreneurs are continuing to invest their own time and energy, and we’re continuing to invest in great entrepreneurs.

We’re open for business.

You’ve scaled back development plans but are aggressively selling the product you already have. It’s one that’s compelling to customers, offering either increased revenue generation or cost savings. You’ve decided to hire more sales people. But you need to get them fully productive in record time, in a tough market. Here’s an exercise one of our early stage portfolio companies recently did en route to scaling sales, and why you should too.

The Value of Customer Backgrounders
Early in a company’s life, the founders and perhaps one or two BD-ish sales guys are out selling. They’re doing whatever works to close deals - as they should. But the real challenge is how to replicate their approach. Customer backgrounders are the first step.

A Real Life Example
On a recent morning, in the office of the CEO and founder of this particular company, I had the privilege of sitting in on a sales backgrounder meeting. Using a detailed list of questions, everyone who had been involved in selling product to a customer went through and described the sales process. It was incredible how much knowledge was shared and how efficiently. Sure, there’s historical data contained in Salesforce.com, but the nuances of the sale - from the details that differentiate prospects from qualified leads to the unique aspects of the value proposition that mattered to each customer - can only be gotten through open and detailed dialog.

One thing that made the meeting incredibly successful was the very clear time limit. The team probably could have spent an entire day going through their numerous customers, but the clock kept us on track.

Like many of the best management exercises, customer backgrounders serve two purposes at once. First, they let you go back and fully understand how each sale occurred - knowledge that can be gathered, summarized, and put into a form that future hires can use. At the same time, they provide a way for you to transform initial customer wins into case studies and other marketing material that can be leveraged to win future customers.

Often, good startups are in a large overall market, but not in quite the right segment of that market. Either the market shifts or the company does. The best entrepreneurs iterate on customer learning - and leverage a whole lot of luck and good timing - to catapult themselves into really big markets.

Customer backgrounders are a great forcing function to not only make you go back and capture what you’ve learned from selling to your customers, but to hire more sales people and to do it at scale. Moreover, going through the customer backgrounder process educates your entire organization on which customers are likely to produce real, immediate revenue, and which ones will be more trouble than they’re worth.

The Backgrounder Questionnaire

Although there are many forms the backgrounder questionnaire can take, I’ve included the actual key questions used in the discussion I described, below. Of course, you should tune the questions to your own company, target market, and sales approach, and only spend timing answering the relevant questions.

1.      Customer name and location

2.      Brief description of customer’s business

3.      Size of business (in revenues, locations, operations, other relevant metrics)

4.      Solution(s) sold (specific to your product offerings)

5.      Description of current implementation

6.      Potential growth

7.      Success metrics (specific to your business, typically around ROI)

8.      How we got lead

9.      Length of sales cycle

10.  Describe the sales “process”

a.       Number of meetings. demos, downloads, proposals, etc.

11.  Who was on sales team from company and level of involvement

12.  Who was/were the buyer(s). Describe all involved:

a.       IT

b.      Business

c.       Procurement

d.      Executives

13.  Was there an RFP, competitive evaluation, etc.?

14.  Contract - Standard or custom - if custom, provide detail.

15.  Competition

16.  Major buying criteria (from their point of view)

17.  Customer’s business case - if we know what it was

18.  Technology infrastructure (e.g. major related software in use at customer)

19.  Implementation timeframe

20.  Hurdles/Obstacles

a.       IT

b.      Features

c.       Scale

d.      Price, terms

e.       Company viability issues

f.        Integration

21.  References - if applicable, how many did they do and with whom

22.  Status today - are they referencable and do we have metrics we can share?

23.  Futures:  Technical requirements/Features requested by customer

Summary

As you can see, the above list is quite exhaustive. But whether you’re selling a low price product via tele-sales, or a high priced enterprise offering, this is the level of detail you need to have on your customers to gain real insight. Customer backgrounders are highly effective whether you’re just starting out or looking to scale sales after having been in market with a few versions of your product. In an era of ultra constrained resources, customer backgrounders provide the highly disciplined approach necessary to inform your marketing, product, and sales initiatives. If you don’t do everything possible to understand your customers and get to the big market fast, don’t worry - your competitors will!

What’s after Web 2.0? People have been asking that question for a long time and the answer is crystal clear: Revenue 2.0.

What’s changed since Revenue 1.0?

High speed Internet. The Internet and widely available ecommerce resources have made it infinitely easier to reach the consumer. According to the Pew Internet study, some 55% of Americans now have high-speed internet connections at home. At the height of the last dot com bubble in mid 2000, fewer than 5% did. In June of 2000, only 22% of Americans had ever bought a product online. As of September of 2007, about 50% had. Simply put, the location of where the battles are fought has changed, from the desktop to the browser.

Whether it’s the local camera store, the mid size retailer, or WalMart, every business is now online. These merchants need the tools to reach their customers, sell to them, and have an on-going relationship with them that keeps them coming back. Better email marketing, the presentation of more relevant products for the customer to buy, and more automated customer service and selling tools are the kinds of solutions every business is looking for.

Hosted delivery. Hand in hand with high speed Internet has come hosted delivery. In Revenue 1.0, hosted delivery was a thought but buyers were far too wary of vendors to rely on it. Now Salesforce is in practically every organization and businesses are integrating consumer and business Internet services into all levels of the organization. Acceptance of hosted delivery is a reality.

Hosted delivery has also dramatically changed the services model. In Revenue 1.0, on the ground services teams had to be at the customer, and much of their learning was lost. With hosted offerings, on the ground teams are still necessary, from time to time, but because all changes are made across a single hosted product, service learning is captured and reflected to all customers.

Hybrid pricing model. A compelling, hybrid pricing model is emerging to support hosted delivery. The challenge with Software as Service businesses has been the high up front cost and relatively slow payback to companies delivering service (the vendor has to deliver the service up front, but the buyer only pays for it over time).

But now startups and large companies alike are bringing to market a hybrid model that takes the best aspects of the old licensed software model (that is, charging up front) and combines it with the best aspects of the SaaS model (recurring revenue independent of product upgrades). While SaaS companies don’t typically charge for two or three years of use up front, many have started charging up front for minimum usage or a period of service - say the first year.

Open source. Open source has changed the landscape not only in terms of lower cost of initial delivery but also in terms of customer adoption. That a startup can get a beta up and running by leveraging a lot of pre-existing, low-cost building blocks that were unavailable just a few years ago is not news. But what is news is that open source has become a viable, effective sales model. Open source is the Trojan horse way into IT buyers, even in a down economy. IT can try out, pilot, and use products available on the open source model, but delay paying for them until budgets stabilize. And in some cases, IT can continue to spend on services to support and manage existing offerings, without committing to capital expenditures.

Efficient customer acquisition mechanisms. Hosted delivery, open source trials, and key learnings from the consumer world have found their way into the business of Revenue 2.0. Forms of viral user acquisition, pioneered in the Web 2.0 world have become embedded in many business products. Whether it’s a simple link to refer a friend, a full affiliate program, or offerings that are more and more specifically designed from product inception to leverage existing customer bases (once jump started) to upsell and cross-sell, today’s business entrepreneurs are learning from consumer offerings.

In Revenue 1.0, product engineering and product marketing and selling were, in most cases, independent. In Revenue 2.0, marketing, sales, and customer feedback mechanisms are considered up front and built right into the product.

Customer acquisition cost - the cost of the channel - is where startups spend the majority of their venture dollars. These dollars, unlike product investment, cannot be leveraged if a company is trying to sell product consumers or customers simply don’t want to buy. Revenue 2.0 provides opportunity to innovate not just on product itself, but on marketing approach, sales model, and sales efficiency as well.

New consumer monetization approaches. 10 years ago it would have been hard to imagine consumers spending money on things like virtual goods or using their mobile phones as payment mechanisms. In 2007 there were over 2.7 billion mobile phones in use (compared with just 850 million PC’s) and some $1.5 billion spent on virtual items. The reality is that the consumer market is a world-wide one, and consumers now have multiple ways to spend small amounts of money - an especially desirable fact in a down economy.

Entrepreneurs have seen this movie before. Perhaps the biggest difference from Revenue 2.0 is that many of today’s entrepreneurs have seen the boom/bust movie before. Many of today’s founders were at other startups during the crash and have been running lean operations all along. One entrepreneur at a growing company recently emailed me asking what the real motivations were behind some of the recent messages to startups. “We have been doing these exercises all along, but especially for the last 9 months.” The magnitude of the market changes is shocking for many, but the response of entrepreneurs this time is swift, smart, and prudent. They recognize the value of operational experience and capital efficiency.

What hasn’t changed?

What hasn’t changed since Revenue 1.0 is just how difficult it is to build highly compelling offerings consumers and business customers want to use and pay for. While products have become easier to prototype, the fundamental challenge of creating innovative, unique, and pain-solving solutions remains the same.

Opportunities abound to deliver cost savings, produce incremental sales lift, or simply give consumers living in uncertain times a place to find a little refuge with their friends.

Panicky messages from investors not withstanding, many of today’s Revenue 2.0 entrepreneurs have all along made operational and capital efficiency a core competency. Even in a challenging market, they will continue to thrive.

It’s all too easy for investors to hand out pithy messages like “manage what you can control” and “focus on quality.” This is advice they obviously should have been giving their startups all along.

Like the founders of portfolio companies Infusionsoft, hi5, and PBWiki, to name just a few, I learned how to run lean and mean while bootstrapping, before raising venture capital. Many entrepreneurs who haven’t bootstrapped may have learned similar lessons, but there’s no substitute for the learning that comes from bootstrapping.

There’s also no one size fits all set of rules for building a great company. Scarcity of resources creates immediate focus. Focus wins. But capital enables speed and scale. Navigating the difficult path between capital and scarcity is an art that is company and entrepreneur-specific.

With that in mind, I sat down with Clate Mask, CEO of fast-growing Infusionsoft, to find out what he’d learned from bootstrapping. Here’s what he shared with me:

• Focus more on revenue than on product.  It pains me to say it, but the better mousetrap does not sell.  The whole company needs to be aligned to drive revenue (which will offend some non-sales folks, who will wonder if they’re second-class citizens).  Build a zero-based budget.  Be aggressive in sales.  Expand expenses as revenue expands; make it a reward for employees.
• Build the business incrementally.  We all want to build the best product, process, team, etc. TODAY, but that’s not a wise use of capital and you won’t get the ROI you need for quarters or years down the road.  The less capital you have, the more immediately you need ROI-measured in days, not months, quarters or years.  Sounds easy, but I’ve found few people do this.  This skill comes down to understanding WHAT to invest in today and what you need to wait to invest in next week, month, quarter or year.
• Hire slow.  Easy to say, but human nature wants to bring “help” on board as fast as possible to ease the pain.  Get used to the pain.  Only hire when you absolutely have to.  Hire people who are optimistic, energetic and adaptive… and have a high pain tolerance.  Most people in start-up or growth stage hem and haw over a $100k capital expense, but hire a new $100k (per year) employee in a heartbeat.  I love employees, but it’s important to remember they are recurring expenses, so they need to deliver ROI on an ongoing basis.  If they’re not delivering, you’ve gotta let them go.
• FOCUS the strategy and operations.  Know your BHAG, align everything with it, and connect your strategy to your operations.  A great resource to help you do that is www.gazelles.com and Verne Harnish’s book, Mastering the Rockefeller Habits.  This helps you develop the rhythm in your business that comes from annual, quarterly, monthly, weekly and daily meetings that enhance focus and eliminate waste.
• Teach frugality to everyone.  Set the example as the leader.  If you are indulgent, your executive team will be… and so will the rest of the employees.  Understand that a dollar saved multiplies very fast in your hi-growth company.  Make it easy for people to see by teaching them a dollar saved is really $10 saved.

With the help of Stanford GSB student and IBM sales veteran Alex Salazar, we recently conducted a study on SaaS company metrics. The conclusion - that SaaS companies are service companies first and software companies second - may seem obvious now that you’ve read it. But read on to find out how the best startups deliver on customer happiness.

At MDV we have a large portfolio of SaaS companies, from those like Infusion Software targeting the small business market to Proofpoint, which delivers one of the leading anti-spam solutions to large enterprises. Spread across a variety of areas, Fliqz, Genius, PBWiki, Rally Software, Sabrix, and Visible Measures are just a few of the others.

Although many investors agree that bookings, MRR, and churn are important metrics, the numbers presented by different companies for these metrics often don’t match up. Bookings numbers are reported according to contract length, annualized, or sometimes whatever is easiest. Churn measures often lack context - customer churn, seat churn, and percent of revenue churn are all referred to as churn.

Here are the metrics.

Churn. Churn describes what’s leaking out of the bucket each term. It measures the health and satisfaction of customers, and forecasts the reliability of revenues.

On the negative side, churn numbers are confusing because there are an overwhelming number of churn calculations. They often lack context and of course, they’re only a trailing indicator. If churn suddenly increases, you’re already months late on a problem in your market or product. That’s why it’s not sufficient to measure churn.

Customer satisfaction. To determine (and predict) true customer satisfaction and the health of the recurring revenue base, you have to directly survey your customers as well and measure customer satisfaction. Customer satisfaction means surveying customers after support calls, and on a random basis across the entire customer basis, on a regular basis. Although it can help, it’s not sufficient to popup a web-based survey or send an email, because you don’t end up with a random and reflective sample of your customer base.

Bookings. The common wisdom is that bookings numbers are mis-leading (typically because they are annualized). Customers may churn out resulting in lower revenue than expected, or expansion may occur, resulting in numbers that are better than forecast. However, bookings are one leading indicator of MRR and reflect the performance of the sales team in the current month. Bookings can be an early indicator of something going wrong in the business. Ideally bookings should reflect contract length and provide breakouts for new sales, upsells, renewals, and non-recurring revenue.

MRR. Finally MRR, simply put is “how much we did this month.” MRR tells no lies. Unlike Contracted Monthly Recurring Revenue (CMRR), which describes the revenue expected next month, MRR is simple and actual. It reflects new accounts and pricing changes.

What These Metrics Mean To You
What does all this mean for management teams and investors? For investors, it means that it’s critical to ask qualifying questions when presented with bookings, revenue, churn, and customer sat numbers.

Granted, in the early stages of a company’s life it’s all about getting product up and running and customers using beta software. But once past that point, it’s keeping customers happy and healthy that matters. The flip side about SaaS is that while it’s easier for companies to deliver product to market and for potential customers to try out the offerings, it’s also easier for them to switch. Companies should actively think about ways to maintain high switching costs: the more customer data that can be imported into the system faster and that builds up over time, obviously the harder it is for customers to switch. Make your SaaS company a life-long relationship rather than a transaction; great service is critical to maintaining that relationship.

Service Is Today’s Critical IP
For years, software was the core intellectual property (IP) of tech companies. But delivering a best of breed, whole product experience over the Internet is hard. Customers expect 100% up-time and company and product responsiveness on part with consumer Internet offerings. The era of the 18 month release cycle is ancient history. Agile is the name of the game.

In fact, it’s a lot harder to exceed customer expectations with a service than it was with installed software. That’s why today, while the first “S” in SaaS remains an important part of a company’s IP, the second “S” comes first.