BeyondVC

It is always helpful to get benchmark data on your competitors and on other companies that have a similar business model.  To that end, I encourage you to sign up for the SIIA Financial Survey to see how you stack up against your competitors. 

We encourage you to invite your software industry portfolio companies to participate in the SIIA Software Industry Financial Survey, conducted with assistance from Deloitte & Touche LLP and its affiliates.

The report from this survey will provide in-depth analyses on nearly 100 financial statement and productivity ratios — detail far beyond that available in annual reports or SEC filings. These include R&D, sales and marketing, legal, revenue per employee and inventory turnover, among others. Results will be shown by sales volume, market segment, ownership, profitability and other measures, allowing you to make appropriate peer comparisons.

I am sure this will be a worthwhile endeavor for you.  When I meet an entrepreneur I always like to ask who they want to be when they grow up and why?  In other words, I like to know what company out there today has a business model that you would like to emulate.  While I do not pin my valuation for an early stage company on the financial model, it is important to have one to understand your costs or cash needs and to understand whether or not you have a viable business model with high gross margins or low gross margins.  For example, if you are another social networking company that walks in my door wanting to be the next MySpace then you better understand that the only way to make that model work financially is to have a huge audience generating tons of page views since the monetization rates on each page view are so low relative to paid search as an example.  If you are  selling infrastructure software and you model out in 3 years that you will be more profitable than every other company out there, I am sure you are missing something as well.

As I mention in an earlier post, companies evolve and need different types of management with different profiles as they grow.  A clear kiss of death that I have seen more often than not is hiring a VP of Sales too early.  Here is the typical scenario – you just signed 3 or 4 customers in a couple of different verticals and you feel that all you need is some bodies on the street to grow your business.  On top of that, you figure that you want to hire the senior guy first so he can bring in his own troops.  Hiring a VP of Sales too early can cost you dearly.  Here are a few reasons why:

1. VPs of Sales need to make their comp.  Typical salaries range from $150-200k plus performance equaling a total package of $300 to $350k.  Most VPs of Sales will try to get you to guarantee the first year or at least the first couple quarters of compensation to offset the risk of working at such an early company.
2. All VPs need people to manage which means your VP of Sales will want to hire a bunch of reps to grow the business.  The experieced enterprise direct sales reps will cost you $80-100k base plus performance of up to $150-175k total comp.  Once again many of the best reps will want to get some guaranteed draw for at least a quarter or two to get started.

What ends up being a situation where you expect to bring on a performance-oriented sales team becomes one which many of your new hires get guaranteed comp for a couple quarters.  The burn rate added to your company almost doubles overnight with these heavyweight sales guys with no leads to go after and no mature product to sell.  In addition, over time the sales team will get frustrated if the product is not ready for primetime and they will be out looking for a new job in a couple of quarters making all of this effort a very expensive experiment.  Hiring a VP of Sales is not a commitment to hire one guy, it is a commitment to bring on a team, one that will not be cheap.  Before you make this commitment, make sure you are ready.  As you can read from an earlier post, when you ramp your sales efforts is critical.

Do more with less and be careful of ramping up sales until you have a repeatable selling model.  In other words do not hire too many sales people and send them on a wild goose chase until you have built the right product, honed the value proposition, identified a few target markets with pain, and can easily replicate the sales process and model from some of your customer wins.

Many of the best companies I have seen have taken the bootstrapped approach where the founders of the company act as the initial sales team to close a few deals, to learn about the customer, and further refine the product.  Yes, this can only last so long as everyday out of the office or with customers means another day not developing the product.  That being said, rather than hire a VP of Sales first, I would encourage you to focus on generating leads and hiring a sales rep or two to follow up on them.  This way you can take a smaller step to refine your sales model and product before going big.  Remember don’t hire a VP of Sales to only have them hunting for dodo birds.

I met with a 10 person company the other day and once I got to Slide 2, I immediately started having questions about the opportunity.  What struck me was a company that had a CEO, COO, and a VP of Marketing and a VP of Sales.  You have probably heard this many times before but I will reemphasize the point – companies have different personnel needs at different stages of development (start-up, first customer sales, rapid growth, maturity).  It is also more costly to bring in the wrong hire then to wait to bring in the right hire.  The entrepreneur was obviously quite proud of his team thinking that he would get over some major objections from investors.  I, on the other hand, saw a startup that had too many chiefs and not enough indians.  I also saw a team that probably did not have enough discipline to ask the tough questions and make difficult decisions.  I mean why does a 10 person company need a CEO and a COO?  As an early stage investor, I would rather have a company with a clean slate that we can build a team around rather than a fully-baked team when we don’t necessarily know if the market is the right one to go after and if the product is the right product.  When I fund an early stage company, I would typically rather have an entrepreneur that has product vision, a development team to execute around that, and the openness to build a team around him as the company grows.  It can be death to have a top-heavy organization from Day 1 because startups change and change frequently during the early days.  Don’t lock yourself in with big salaries, big options, and big egos until you really know what market you are going after, the skills and experience you will need to win that market, and the product is ready for prime-time.  In a future post, I will walk you through one of the biggest and costliest mistakes I have seen early stage companies make – hiring a VP of Sales too early.

When you first release your product to the market, it is extremely important to think long and hard about product pricing. I can’t tell you how many meetings I have had where I have thought that companies were giving too much away for too cheap a price. Or they have given their product or service away for free which can be a great model but they had no plan to monetize in the future. When asked about pricing, I have at times heard a “we want to release it to the market and see what happens.” That can and does work great for testing a product and its features and building a user base, but when you do this, I would also hope that you have a plan for how you will monetize in the future. The allure of undercutting your competition and driving volume is a strong one, but one that can also be quite dangerous to your business. One rule that I have always believed in is that gravity takes over in product pricing. In other words, it is much harder to increase pricing (defy gravity) then it is to reduce the price of your product. The corollary is that it is much easier to reduce pricing then to increase it as customers feel like they are getting a good deal. Over the last twenty years, it is clear that technology buyers expect to get more for the same $ spent last year or to get the same product for less $ this year. This is applicable to consumer as well as enterprise-focused companies.

While I am no means an expert in product pricing, it is important to first analyze the competitive landscape, how your product fits in versus the competition, and then to figure out where you want to play in this market given your strengths and weaknesses. If there are no direct competitors, then look at some potential substitute products that customers are buying and figure out how your pricing looks relative to those companies. Once you get an understanding of the market dynamics, you should figure out how you want to enter the market vis a vis your pricing – do you have the most-feature rich set of services and want to charge the most or charge a similar price for more functionality or do you want to be the high volume-low cost provider. Finally, I would think about your product roadmap and determine if you can get to market aggressively, be different from your competition, and build a model around upselling new features and functionality. More often than not, I see companies not doing enough thinking on product pricing with the idea that they can always change it later on. In addition, many companies seem to err on the side of charging too little, rather than charging a little more with the opportunity to discount and drop or refine pricing down the line if sales do not ramp up as anticipated.

So when you release your product, remember that the laws of gravity take over in product pricing. If you are going to give a product away for free, have a plan to upsell or make money down the line with premium services or other functionality. Also remember that once a customer starts using a product or service that the last thing you ever want to do is take value away from your customer by increasing the price or beginning to charge for a service without adding new features and functionality. How you price your product at market release is not easy to undo in the future.

I recently sat in a presentation which a portfolio company CEO gave for a potential strategic partner.  He first started out with a two minute explanation of the business and then insisted on diving into the demo.  I wasn’t sure if that prospective partner really got it and before we knew it, the CEO said it was much easier to just dive into the demo to explain.  I kind of cringed but did not want to stop him from giving the demo as I was hoping he would get to the big picture.  While everyone was impressed with the demo, it lasted too long and got us focused in the weeds and not the forest.  From that meeting, I was left with a deep understanding of the features and functionality but what was clearly lacking was the vision for the business.  If you can’t explain what you do, its context, and the opportunity in a few sentences and have to give a demo for someone to get it, I would suggest going back to the drawing board and thinking long and hard about how you make sense of what you do verbally.  It would have been great if the CEO started the presentation with a clear and compelling message of the company (not the product) on where the world would be 5 years from now and how his product or service today would grow to meet this vision of the future. 

As one of our marketing consultants, Richard Currier, has always told our portfolio companies, "you market the vision, and sell the product." If you get too locked into talking about a product, then your partner or customer gets stuck into thinking about who else does this and why are you different.  Getting into a feature/fucntion battle in the first meeting is not a great way to start.  Sure enough, our prospective partner started naming several companies asking us how we differed from them.  If you start with a vision first and clearly talk about your view of the market in the future and how your product evolves from where it is today to a roadmap of the future, then it is easier to differentiate your company and bring the discussion to a higher level. 

Trust me, the word vision became almost a dirty word during the market crash as no investor wanted to have another entrepreneur or CEO long on vision and short on execution.  The problem is that the very skills that got us to the market hype (lots of vision, big thinking) were not the skills that enabled many of us to survive the downturn (tactical focus on generating revenue, conservative business plan, and execution).  If I look at the world on a spectrum from focus on all revenue and profits on the one hand and all technology and vision on the other hand, I would like a mix tilted much towards the technology spectrum in the early stages of a company’s growth.  Pre-2000, I would argue that the mix was all tech and vision with no focus on building a business.  Post-2000, many companies were much more on the business spectrum and less on the tech side.  Today, I am asking that entrepreneurs bring back that vision thing and show us the big picture because showing me a point product doesn’t cut it.  In addition, in today’s world it is much harder to get public and many of the acquisitions today are not based on how many customers you have or revenue but based on your technology today and product vision in the future.  I have a number of companies being looked at right now and having a 2 year advantage on a product can mean alot for a strategic partner or acquirer. I am by no means advocating that you build a company to flip, but I am just stressing that vision is not a dirty word, that you need one, and that as long as you carefully balance that with building a real business you will be in great shape.