Month: June 2007

Entrepreneurship

What kind of customer do you have?

Posted on by Ed Sim

I was in two board meetings recently, and I was shocked at myself when I seemingly gave contradictory advice to two companies.  On the one hand, I told the first company to do whatever it takes to land that big account for the quarter, and on the other hand, I told the second company to push harder for a higher price or to walk away.  Shouldn’t you always do whatever it takes to land a customer and continue building the pipeline?  Yes, in theory, but at the same time you have to understand what kind of customer you have: is it a good customer or a bad customer.  While there is no perfect definition for these two types of customers, let me give it a try.  In the first portfolio company’s case, the good customer we were going after was going to be a marquee win and great reference for future prospects down the line, would help us validate our technology and team in a head-to-head competition vs. the big incumbent, and finally would be a repeatable sale where we could take and package our software to many other prospects.  In that case, we told the company to be aggressive in order to land that customer, including giving it away for free for a short period of time to get that first big win.  The great news is that we landed that marquee customer and did not have to go the free route.  Ideally a good customer is also one that is profitable.  In this case, even though the first marquee win may not have been profitable in year 1, we were able to see future profitability down the line from expansion opportunities in the existing account and from that customer serving as a great reference and industry leader in helping us close other deals.

A bad customer is clearly the complete opposite of a good customer – one that requires too much one-off customization, is not a marquee account or potentially a great reference for future sales prospects, and ultimately an account that does not lead to repeatable sales.  In addition, bad customers for the most part will be highly unprofitable as you will probably spend way too much time on the account trying to make it referenceable.  So in the second portfolio company’s case, given that we had a bad customer, I told them that we should go back to them to charge more to at least make some money from the current deal or walk away.  Ideally, if it is a bad customer, you may just want to walk away altogether to go find that good customer which will lead you to many more great opportunities.  Starting your company with a handful of bad customers can kill your business so be ruthless with your time and carefully assess what kind of customer you are about to close.

Web/Tech

LinkedIn and Facebook on collision course?

Posted on by Ed Sim

I signed up for LinkedIn in mid-2003, and since then I have not been very active on the service other than accepting invites as they came to my inbox.  Over the last couple of weeks, I have noticed a significant increase in the number of requests from friends and colleagues and interestingly most of them are not from the technology industry.  It is clear to me with over 10mm users worldwide that LinkedIn has crossed the proverbial chasm.  The company has clearly done a great job creating a strong revenue model around social networking and leveraging the technology industry to get started, but as I see more and more mainstream users join the service I wonder how big it can get and how it will play against the other players in the space.  LinkedIn has repeatedly stated that it believes people will have two profiles, one professional that is maintained on LinkedIn and one personal which is maintained on MySpace or Facebook.  I don’t doubt that at this time, but I must admit that while Facebook has mostly been about friends and personal relationships, I have been surprised at the number of professional and business contacts wanting to add me as a friend on Facebook ever since it opened up its platform.   It will be interesting to see how these two services grow, how the boundary between friend and professional contact continues to blur for the professional, and whether Facebook makes a concerted effort to enter into LinkedIn’s turf.  For example, why couldn’t I maintain one profile on Facebook and only share the professional information with those in that network and the personal with those in another?  Expanding that thought, wouldn’t it be great if there was a metaservice where you only maintained one user profile and you could check off which details were fed into which different social networks.  I would love to hear your thoughts on the subject.

EntrepreneurshipVenture Capital

Don't forget to look at venture debt when raising a new round

Posted on by Ed Sim

We all know the story – it is incredibly cheaper to start a web-based business versus 5 years ago with the rise of open source software and commodity servers.  However, while getting started with thousands of users is cheap, scaling to significant numbers will require some dollars.  The good news for you and for venture investors is that your buck can go alot further today versus yesterday not only because of the commoditization of infrastructure but also because the venture debt market is alive and kicking.  In the last six months, we have augmented some of our existing venture financing with venture debt as the market has become quite competitive which means pricing and terms are getting more attractive for  all of us.  In addition, while most associate venture debt with investments in companies with core technology, more and more venture debt firms  are back and willing to offer capital to earlier stage web-based companies with  no  financial covenants and MAC (material adverse change) clauses.   Of course the more flexibility you have with respect to uses of cash means that pricing will go up.  All I can say is when evaluating your company’s cash needs and potential runway, looking at the venture debt market is not a bad idea.

There is also another market metric that is driving a renewed interest in web-based companies for these lenders- they are getting funded by VCs (venture debt lenders mostly like to do deals with strong financial sponsors which increases their likelihood of getting paid back) and these startups are better able to manage their burn rates reducing risk and offering lots of upside.  Sure, while some of these venture debt firms recognize that web-based businesses may not have as much hard and true intellectual property, the fact that they are more capital efficient and can scale more rapidly means they can also generate pretty nice returns from the warrant portion of their deal.  Getting in earlier also allows these venture debt firms to buy more of the company from a warrant perspective than getting in on later rounds.  The trick for entrepreneurs is to look at bringing on debt concurrent or soon after your close of equity financing. 

Why can raising venture debt be great?  It is quite simple –  the dollars are relatively cheap compared to an equity financing  and extending your runway to hit more critical milestones means a potentially better valuation for your company down the road.  And of course if you exit before raising another round, there are more dollars available for the equity holders.  A typical structure for an early stage deal could be an equity raise of $3-5mm with another $1-2.5mm of debt.  From a pricing and terms perspective, you should look for capital which is flexible in terms of use for true  growth capital (growing your business) with no financial covenants or MAC (material adverse change clauses) which can put more risk into the debt equation.   Of course, the more flexibility you have, the higher the interest rate will be relative to other types of loans. Most venture debt deals will have an interest only portion for a short period of time before amortization (monthly payments of principal and interest kick in).  Typically you will see terms of 30-36 months where your lender will get paid his full portion of the loan and interest by that time frame.  In addition, lenders will ask for warrants equal to a percentage of the dollar amount raised (for example, depending on the deal, a 5% coverage for $1mm could be equal to $50k of equity to be purchased at the current share price).

All is not rosy as there are some potential and hazardous downsides to this model.  If you burn through your cash and can’t make the monthly principal and interest payments, your lender can take over your company as their debt is usually secured against your company and intellectual property.  Trust me, a number of companies got burned with this during the Internet boom when their businesses were based on wildly inflated revenue projections and unilimited capital resources.  Just when you needed another month or two to sign that strategic deal, the venture debt guys would come in and pull the rug from under you.  Granted it is not that bad as your lenders are your partners and will negotiate with you, but at the end of the day, if they see their ability to get paid in significant jeopardy, they will do what they have to do to recoup as much value as possible.  For some investors and entrepreneurs, this risk may not be worth the dollars.  For others who are confident in their execution and ability to raise another round, there is no better way to stretch your dollars in the company and create more value with minimal dilution.  So the next time you hear the word "debt," don’t be scared and keep an open mind as you may be able to stretch your resources further and achieve some additional critical milestones driving increased value in your business.  The interest in web-based businesses is there and the competitive market means that pricing and terms are pretty attractive now.