Startable - Healy Jones’ & Prasad Thammineni’s Blog

I help organize events for the New England Venture Network, and we recently met with Dan’l Lewin of Microsoft. Dan’l is a Corporate Vice President for Strategic and Emerging Business Development and is responsible for Microsoft Corp.’s global relationships with startups and venture capitalists. He had some interesting things to say…

Microsoft intends to keep a healthy startup acquisition pace

Over the past several years MSFT has acquired approximately 20 companies per year, and this strategy willlikely continue in the current environment. Dan’l reminded us, as venture capitalists, that our startups were worth something to Microsoft based on their IP and the employees who created that IP. Microsoft does not really need any help with distribution, sales people or customer lists, so he seemed to imply that his ideal time to make a purchase is when the startup has proved its validity with some customers but before it has built out its large own, internal sales team and distribution partners. It sounded like acquisitions in the sub $200 million range were much easier for MSFT division heads to complete than larger purchases, in particular if these fit neatly into that division’s stated strategic goals. Again, no change to Microsoft’s current strategy. But good to hear that they will keep buying companies in this bad economic situation.

Microsoft is trying to keep its software relevant to startups

I got the pretty clear feeling that MSFT feels serious pressure from open source. To combat this they have a cool new program called BizSpark. Basically, they are willing to give away a lot of very valuable Microsoft software to startups that are less than 3 years old and that have less than $1 million in revenue. It’s not a bad idea, as I do know that a number of developers enjoy .NET. Curious to hear people’s impressions of this program.

Atlas Venture, the fund that I work for, has announced the raise of our 8th fund. This is a real accomplishment, given the horrid state of the financial markets. And, it means that we are still making investments. Wahoo! 

Here is a great link to “50 Essential Strategies For Creating A Successful Web 2.0 Product” by Dion Hinchcliffe. I’m about half way through the list, but some of the points are pretty thought provoking. Dion is trying to be quite comprehensive, so he has the standard “release early and often” advice, but also has more nuanced suggestions such as “Search is the new navigation, make it easy to use in your application” and “The link is the fundamental unit of thought on the Web, therefore richly link-enable your applications.”

This is a solid read on Web 2.0 strategy/design execution. I’d recommend that even experienced web executives take a look at the list. Even if you already know everything he mentions it is still a well written refresher on what makes the online environment so special.

Interesting link today in PE Hub on the drop off in venture capital funding in Q4 2008. The post attempting to prove that well known funds like KP and Sequoia have slowed done their investment pace in Q4. I would think it’s pretty obvious all VCs backed down in Q4 - just like everyone else, VCs were reeling from the tempest in the financial markets and trying to understand how that would affect their portfolio companies and favorite industry spaces. I think more interesting are the spreadsheets linked at the bottom of the page. If I’m parsing the data correctly, then Q4 venture capital investments were off pretty substantially, both in terms of number of companies backed and total dollars invested.

• Q4 2007: $8.085 billion invested in 1,051 companies.
• Q4 2008: $5.403 billion invested in 818 companies. 

Drop from Q4 2007 to Q4 2008 was approximately 40% for both metrics. That’s a big drop, although not as big as the 60%+ drop from 2000 to 2001. (full year and Q4 drop were both just over 60%)

Here is the breakdown by stage (I’ve considered startup/seed + early as “Early stage” and expansion + later stage as “Later stage.”)

• Q4 2007: Early stage: $2.012 billion invested in 387 companies.
• Q4 2008: Early stage: $1.564 billion invested in 326 companies.
• Q4 2007: Late stage: $6.073 billion invested in 664 companies.
• Q4 2008: Late stage: $3.839 billion invested in 492 companies.

Drop from Q4 2007 to Q4 2008 for early stage was -22% in $ and - 16% in # of companies invested in.

Drop over the same time period for late stage was -37% and -26%, respectively.

Yikes.

It’s getting hard to raise new capital, and even harder to raise follow on capital? I think that makes sense if you consider my previous post on VC funds cutting off lower ranking portfolio companies from the follow on financing teat more quickly. 

*Note: I got all of this data from the “National data spreadsheets, including sector-by-sector investing” spreadsheet at the bottom of the PE Hub post - I hope I’m using the best data.

Dow Jones’ Venturewire, a news service for VCs, today published an article titled “Darwinism Sets In At Claremont Creek.” This article described a venture capital firm dealing with the recent economic downturn, and how they are allocating their reserves to existing portfolio companies out of their older fund. The key take away from the article is that the fund will continue to fund their best investments but will stop backing their less-promising startups. In other words, some of their companies are not going to get additional funding from them.

That’s pretty bad news for some of their portfolio companies. The article talks a bit about how this is happening across the venture universe, and I believe that the journalist used the Claremont Creek fund as an example because they were very forthright on explaining their efforts/methods/thought process. Hats off to the investors at Claremont for being so honest about this. Startup CEOs can learn a lot from this example.

So that you understand a bit better what is going on here, we can go with the math presented in this article. Claremont Creek’s older fund was raised in 2005 and was $130 million in size. It has made $44 million in investments into 16 portfolio companies. (They are not making investments into new companies out of this fund; instead, new investments are made out of a new fund, a $175 million fund, that was recently raised.)

The older fund should have reserved the remaining $86 million ($130 million - $44 million already invested) for these 16 companies. That’s about $5.4 million for each company. I’m willing to bet they did a robust job projecting the cash needs for these 16 portfolio companies, so let’s pretend that each portfolio company “needed” that $5.4 million to get to an exit/become profitable or whatever.

But now we have the evil economic downturn. Read the rest of this entry »

It is hard to want to be aggressive in a scary market. I was reminded of this during a recent internal meeting where we gathered our partners and discussed our portfolio companies. A number of technology companies continue to grow very well despite the nasty economic environment. These companies are typically doing something quite unique, with a clear value proposition to their customers. I’m not talking about marginally improved solutions over existing solutions. Instead, these companies are real game changers, offering something that is a break with how their customers solved the problem in the past. As a venture investor, you want to encourage these startups to hit the gas and grow aggressively through this tough economy.

How does a venture investor encourage a CEO to continue to think big in a rough market? Should a venture capitalist push a CEO who has a startup that is performing well to go for the brass ring in this environment, even if it greatly increases the risk profile of the business? Does “slow but steady” win the race in difficult times or does the team that bets it all end up winning?

I guess that there isn’t a grand theory to apply to every single startup. Each company should be take in a case by case basis. But it is important for entrepreneurs with venture backing to realize that your VC may be highly inclined to take that bet and push you to get aggressive despite the environment. This is just the nature of the beast, and you need to be aware of it. I’m not really able to offer great advice on how you deal with it, but below are a couple of ideas I’ve heard recently on when to be aggressive and when to be more careful with cash burn.

Aggressive falls into several buckets.

One is sales. In a nasty market environment, how big do you grow your sales team? I have a woefully under formed opinion here, so welcome any advice. What I am hearing from the partnership is that the “right” level of aggressiveness in your sales hiring/expenses (from a VC’s perspective) is based on the health of your end market and the ROI of your current sales team. You should think about growing the sales team, even if this burns cash in the near term, if: 1) customers will have the cash and resources to buy your solution, and if they are really getting positive returns from it 2) your current sales people continue to be ROI positive and closing new opportunities or growing the bookings pipeline with legitimate potential deals then you probably want to keep hiring.

Around R&D spend, I think the real question to ask is one that I heard from a board member of one of our portfolio companies. This board member was CEO of a company that recently sold company for $1 billion+, and has offered some excellent advice from his board position in the past. His take was: “who is chasing you right now?” If there is someone in the rear view mirror nipping at your heels then this is the time to be aggressive. However, if the market conditions has taken the wind out of your competitors sales, then you can be smart on how you spend your development money and conserve cash. I thought this was really good advice.

General infrastructure or processes. This may be the time to under build. I realize that you may end up getting bitten in the butt if your startup isn’t yet totally scalable when the turn around happens, but if you can get by now with less and avoid building in advance of demand then you may be better positioned to weather this storm. I know Prasad has some opinions on this point.

Obviously my generalizations above don’t apply to every company. They were more just reactions to things I’ve heard recently. I welcome any comments!

This isn’t quite a VC Pitch Tip, but it is a tip for technology entrepreneur raising venture capital. As a founder of a technology company, when you bring on venture don’t forget to make sure you have a board seat. Assume you are going to get one until you get the term sheet - then make sure the founders will have someone representing them!

When I talk with an unfunded startup about their burn rate I am often quite impressed with their intelligent frugality and capital efficiency. These tech startup founders usually assume they will be continue to be extremely capital efficient post venture financing, and for the most part they are correct. However, these entrepreneurs sometimes do not take into account the additional costs of doing business with a venture capital firm. There is some legitimate additional overhead required to keep your venture capital partner happy, and some of it is not cheap. Keep these items in mind when you think about your cash flows post venture investment:

Audit/tax work

Most VCs will require some sort of audit from a known auditor. These can get quite pricey. Hopefully the VC has enough pull with the auditor to get you a reduced price in your first few years of working with them. Most real auditors will do this, and I’ve heard from some audit partners that they don’t actually make money on auditing startups in the first few years. Regardless, this is still an expensive proposition. Tax wise, you will need to do what is called a 409 report if you are granting options to employees. The trick is that the commons stock options that you grant are probably worth less than the implied company valuation that you get from the VC. This is a good thing, as it lowers the tax burden for the employees who are getting the options. Unfortunately these things are not as cheap as you’d like. You can easily end up spending over $40k a year on these items. Most of these costs will spike around year end, April tax season and when you are raising additional capital.

CFO/Controller

Most of our really early stage companies have part time CFOs. You probably don’t need a full time CFO or controller if you are a real startup, but you do need someone who knows what they are doing manning the finance wheel. Once you start sending out invoices you’ll want a person who can call up and gently remind customers to pay you. It is also quite natural for a venture firm to want a trusted person managing the cash balances of the business, and these part time CFOs can greatly ease the work burden of the startup’s CEO. They also help in the financial preparation work for your monthly board of directors meetings. I’ve been very impressed with the work ethic and output of the outsourced CFOs I’ve worked with at our portfolio companies. Their cost should be less than the cost of a controller. Once your business grows to the point where your part time CFO is costing you, on an hourly basis, as much as a full time controller would cost it is probably time to hire a controller. The cost for a part time CFO can really vary depending on the amount that you are using them, and will spike at the same times of year as your audit costs jump. You should expect to spend anywhere from $30k to $75+k on this service per year.

Legal Read the rest of this entry »

Julien Wallen had an interesting comment on my recent blog post on new year’s resolutions - in particular my resolution to attend more technology conferences in 2009. He quite astutely questioned if technology conferences had a positive ROI, “But I’m somewhat cautious about conferences. My experience is that either you need to prepare really really well to make best use of the time or the ROI is really questionable - that is with a startup budget not a VC one ;-)” So, I’d like to see if I can get a discussion going around this, and thought I’d offer up a venture capitalist’s opinion on technology conferences so that entrepreneurs could get a bit of a feel for if and how technology conferences might fit into their venture financing strategy. (read Julien’s blog post response on the ROI of tech conferences here)

Are technology conferences worth the cost?

Is there a positive ROI for a VC to attend a technology conference? 

Of course the answer is that It Depends!

Wow, what a cop-out answer!

As a venture capitalist, I attend conferences for one of three reasons (I reserve the right to increase the number of reasons if more become apparent.)

1. Meet new startups - conferences can be a very good place to meet new startups and find new potential investments.
2. Fill in an investment thesis - industry specific conferences can be great places for a venture capitalist to refine an investment thesis and learn more about the competitive landscape in an industry, get a feel for customer needs, the next generation of technology, best practices, etc.
3. Support an existing portfolio company - a good venture capitalist makes introductions that help portfolio companies succeed. Conferences can be great places for a VC to facilitate in person meeting between portfolio company executives and critical players in that company’s ecosystem. (In my short, not particularly illustrious career as a VC one of my shining moments was at a conference where I introduced a portfolio company CEO to several players, one of whom ended up becoming a large customer of the company and another of whom is now a serious channel partner for the business. The CEO compensated me with a cookie at a board meeting - a very tasty cookie.)

How does a venture capitalist make the conference worth the cost?

Preparation! In a prefect world, my conference schedule would be almost as scheduled as a day in the office, with back to back meetings with entrepreneurs and key players. Of course, one of the advantages of a conference is the ability to “wander” around and “bump into” people/companies that have been difficult for me to reach - and having a game plan in advance on who and which people/startups I want to “randomly” meet is pretty critical.

As an entrepreneur, how should technology conferences fit into my venture financing strategy? Read the rest of this entry »

This is the time of the year to make resolutions… so here are a couple as they relate to my venture capital career in 2009:

Meet more senior executives

Last year, one of the most helpful things I did was to introduce several startups to experienced executives in their industry. In a couple of instances these experienced executives ended up providing very valuable advice to the startup founders, and some are in discussions to join the startup teams as board members, advisors or potentially as employees. I continue to be amazed at how open experienced yet entrepreneurial executives are to spending time with, making introductions to potential customers for and generally helping startup. Additionally, the right experienced executive joining a startup’s team can really make a company “fundable.” This year I will make it a goal to meet more of these entrepreneurially minded experienced executives and get them introduced to the best startups I can find. Read the rest of this entry »