BeyondVC

I remember when I first got into this business over 10 years ago and one of my partners told me that the secret to success is about the people, not about the technology.  All too often we are enamored with how cool or sexy a technology is, invest lots of dollars to create that killer product, and sometimes forget that it is all about the people.  We spend lots of time on product development plans, sales plans, and financial models and not enough time preparing and thinking about how to continue to motivate and inspire your team.  When your assets go up and down the elevator everyday you must constantly remind yourself that you need to care for that asset if you ever want to have that killer product.  The end of the year is always a great time to reassess and plan for the next one.  As I spent the week before the holidays on a few compensation committee calls, I thought I would share with you some of my philosophy on compensation and how to take care of that ever precious asset, your employees.

From a philosophical point of view, I view compensation as the combination of salary, bonus (if any), and equity.  For cash starved startups, having management and employees believing in the opportunity and team and being motivated by equity is key to success.  From a cash perspective, you have to pay market to slightly above market rates to attract good people, but I prefer to see the employees with above market equity compensation packages to align interests.  You never want anyone worrying about paying their mortgage but at the same time, given similar backgrounds, I prefer the employee who will take less cash and a higher equity package. 

The next question you may have is what is the definition of market.  On a public company board, for example, I look at other companies that we compete with and other businesses that are in a similar stage of revenue growth and financial numbers.  On a private company board, there are surveys out there that you can get a hold of that outline compensation for different positions based on venture capital raised, geography, stage of company, and revenue.  None of these numbers are scientific but they certainly help you ballpark market compensation.  Of course, any active venture capitalist can look into their existing portfolio of companies to determine what market really is.  Taken together, you must decide if you want to pay market, below market, or above market compensation.  As I mention above, I like to pay above market on equity and at market or slightly above market on cash compensation.  Of course, there are certain cases where you have to be flexible and pay up for the right person.

In terms of bonuses, I am not a huge fan of cash bonuses for companies losing money, especially in the early stages of development.  As a company matures and hires additional executive talent cash bonuses become more important to retain top level executives.  With respect to bonuses, there are no guaranteed bonuses, only performance-based ones.  In addition, I prefer a performance-based bonus over just paying an executive more salary.  As far as bonuses are concerned, it is really important to have clearly defined goals and metrics to measure performance and subsequently pay out cash.  For most of the key management, I like to tie much of the bonus number 70-100% (depending on which function) to overall company numbers like revenue goals, number of new customers signed, and cash balance related numbers.  These metrics should be simple Yes/No metrics – it should be quite clear if someone realized their goal or not.  Of course, these metrics depend on the stage of company and predictability of the future, but overall it is good to see all of management working together as a team, succeeding or failing together on overall company goals versus measuring performance against individual MBOs.  Of course, this means having a clearly defined budget that is put together and agreed to by all stakeholders including management and the board.  This must be put in place by the end of the prior year so you are ready to measure and manage performance for the new year. 

As I look to the new year, it is important to have an option forecast just like any financial forecast.  In order to do so, you should have a general range of options that you will give to each employee based on their level such as staff, manager, director, VP, etc. so that each employee at each level is relatively the same.  The range is to obviously give a little more or less to a certain level employee based on performance and other factors.  From a company perspective, you then look at your hiring needs for the year, put in the number of estimated options for each employee, and you have just created your option forecast for the year.  These compensation bands are important as your employees talk to each other, and whether you like it or not, employees end up knowing how much each person makes and what their equity package is.  In fact, I have seen several instances of VPs asking for salaries and bonuses similar to their peers out of respect.  This is obviously how I do not want to compensate employees as each function adds a different level of value and each VP starts out at a different time in a company’s life.  That being said, it usually becomes an issue at some point in time so it is imperative to have a total compensation range for each level of employee and to avoid paying someone total compensation that is completely out of range and non-market.

This is just a general framework, and there will always be one-off adjustments to be made.  For example, throughout the year I like management to let us know of any "at-risk" employees that may need some adjustment to their overall compensation numbers.  In addition, we also need to know about which employees we should be proactive about and move their compensation to the higher end of a salary range to further incent them.  Finally, I like to know about any key performers or herculean efforts that should be rewarded with some additional performance-based options.  If you can take care of all of these issues in one fell swoop at the end of the year that is best from a governance perspective.  However, depending on the situation, you may have to act swiftly as circumstances can force you to do otherwise.

Finally, and most importantly, there is more to making your people happy beyond the monetary compensation.  As I wrote in an earlier post, A Players like to work with other A Players.  To the extent that you have a strong team and every hire is better than the next, I can guarantee that you will attract some great talent.  A Players like to learn from other A Players and like to know that when their backs are against the wall, they have other team members with the experience and know-how to persevere.  In an employee’s mind, the more A Players means the more likely that the company will succeed and create some real equity value.  In addition, people like to work on exciting projects in a dynamic, lively atmosphere.  There is a big difference working in an environment with team members who are passionate about the product and success of the company versus employees who are happy to go through the motions.

The bottom line is that you have to take care of your number one asset, your team, and start preparing early in the year to make sure that you have the right plan in place to keep your team motivated and excited to work at your company.  This includes managing compensation proactively but also making sure you hire the right people and create a winning, passionate atmosphere in which your team can thrive.

One of our advisors for our fund hosted a New York CIO dinner last night.  It was a gathering of 30-40 of some of New York’s leading technology buyers, mostly from the financial services industry.  As a VC, it was quite interesting to hear about the state of technology spending and what is top of mind for many of these players.  Repeatedly I heard about grid computing, security, and service oriented architectures.  It seems to me that all of the Gartner hype put into these technologies years ago are slowly becoming a reality.  As for startups, not many were mentioned, and most of the technology buyers said your best bet was coming in through a larger partner whether it be a Sun, Cisco, HP, or IBM.  In addition, it was quite clear that this was a small community, and like any small community, they all talk with each other and want to know what technologies their peers are using.  So lesson #1 is while it is always hard to land your first financial services customer, remember not to screw it up because if you do everyone will know.  On the other hand if you deliver on your promises and have a great base of early reference customers, it will pay huge dividends. 

During dinner, one of the CIOs reminded me of the difficulty of startups selling into his organization.  First, when you think of IT budgets, you have to remember that about 60% is spent on people, 20% on hardware, and 20% on software.  In the software bucket, much of this money is spent on software maintenance and relationships with existing vendors.  While the remaining small % of spend leaves room for new license spending, only a fraction of that will be even available for early stage companies.  Lesson #2 is that it is important to understand the culture of each financial institution with respect to their reputation of being an early adopter, fast follower, or mainstream player.  For example, someone from Citi told me that if he were a startup he wouldn’t even bother selling into Citi as it takes an incredibly long time and you could die trying.  Ditto on Bank of New York as their business is about settling the trillions of dollars of cash transactions daily.  Nothing innovative they really need to do here except scale and reliability.  BONY gets no points for taking on sexy technology or more risk.  On the other hand, investment banking and trading heavy financial services companies will take a look at new technology to get a leg up on the competition.

Lesson #3, if you sell into a large financial services player, either be well networked, come in through a partner, enter from the bottom up, or go to revenue generating groups with money and buying power.  On the top down approach it is all about having credibility.  No one wants to be the first, especially if your technology doesn’t work.  On the well networked side, get a reputable CIO to believe in you and your service, get them your board or advisory board, and have them make a few calls their technology friends to open up some doors. With respect to working with partners this can be many times more difficult than landing a large customer.  I would not waste your time with a partner unless you have a number of solid customers and can show the partner how they are going to make money and lots of it.  Finally, entering from the bottom up means staying away from the CIO’s office, offering free downloads, for example, where the actual workers can bring software into the enterprise from the worker-bee level.  This takes time but can be doable.  Finally, if you have the right product and reach the right person in the revenue generating departments, not IT, and show them how they are going to differentiate themselves from the competition and make more money with your product and service, you can avoid being put in the IT bucket all together.  What does this mean for me?  I wouldn’t bet the farm on selling to these guys unless you have a team that knows the space cold, is well networked with peers who have budget authority to get the early customers and traction, and unless you are well prepared for long sales cycles.  It is damn hard to break into the clique, but if you do it can be quite rewarding.

I would even apply this frictionless sales model to the consumer web.  We all know that the Internet is turning every media company upside down about worries of cannabalizing their existing business.  It is clear that CBS gets it as they just announced that March Madness will be delivered free over the Internet.  CBS will monetize it with ads.  CBS is going open and understands this could potentially create new and additive revenue models, not less.  Kudos to Larry Kramer for making this happen.  Larry and I are on a board together and I look for more innovative and forward thinking ideas from Larry as he helps CBS embrace the web, not fear it.  Think about the millions of users who will go watch the March Madness online and check for scores.  Think about all of the cross promotion of new television shows on CBS, the additional ad revenue, and the general brand awareness that CBS will build from this.  On the other hand, I was on the CNN site and saw this.  Why would I pay $3 a month or $25 a year for CNN on the Internet when I can get it for free on the television?  If you are a media company, go the CBS route and figure out how the web will help your business, not kill it.  Be innovative, reduce the barrier to adoption for your customer, and figure out how to monetize your audience.  Add more features, add community so your users can interact with one another, and leverage the web and its interactive, two-way nature.  Don’t just deliver me programming on the web and charge me for it.

As you know, I am enamored by frictionless sales.  Frictionless sales means reducing the pain for customers to adopt and use a service/product and consequently reducing the cost of sales and marketing to get a customer and generate revenue.  As I mention in an earlier post, "The less friction you have in your sales and delivery model, the easier it is to scale. The easier it is to scale the faster and more efficiently you can grow." The lowest friction sale can be a user clicking on a web page and the content owner getting paid for it.  The highest friction sale is spending lots of money on marketing and trade shows and having a large, direct sales force of expensive reps pounding the pavement for months trying to close a large deal with an enterprise customer.  Follow that with a 3 month implementation process to get the customer happy.  There are various grades of friction between these two extreme points like open source business models, software as a service, and reseller/OEM-type models as other forms of packaging and delivering a product/service.  And of course, each of these models requires a different methodology and way of marketing and selling to a customer.  Ultimately what you want is sales leverage where every $1 you spend on sales and marketing equals multiples of that in terms of revenue.  Jonathan Schwartz has a great post on why Sun went open source and why free does not mean less revenue but more revenue.

Opening up the Solaris Enterprise System, and giving it away for free, lowers the barrier to finding those opportunities. Free software creates volumes that lead the demand for deployments – which generate license and support revenues just as they did before the products were free. Free software grows revenue opportunities.

Opening up Solaris and giving it away for free has led to the single largest wave of adoption Solaris has ever seen – some 3.4 million licenses since February this year (most on HP, curiously). It’s been combined with the single largest expansion in its revenue base. I believe the same will apply to the Java Enterprise System, its identity management and business integration suites specifically. Why?

Because no Fortune 2000 customer on earth is going to run the heart of their enterprise with products that don’t have someone’s home number on the other end. And no developer or developing nation, presented with an equivalent or better free and open source product, is going to opt for a proprietary alternative.

Those two points are the market’s reality. And having reviewed them today at length at a customer conference, with some of the largest telecommunications customers on earth, I only heard the strongest agreement. They all, after all, are prolific distributors of free handsets.

Betting against FOSS is like betting against gravity. And free software doesn’t mean no revenue, it means no barriers to revenue. Just ask your carrier.

To further add to his point, just because it is free does not mean it is frictionless.  It has to be easy to install and easy to use.  In addition, free can be time based or feature-based.  What free means is lowering the barrier for a customer to use and love your product.  It means more qualified leads and a shorter sales cycle.  It means a lower cost of doing business-lower sales and marketing and lower implementation cost.  It means a more capital-efficient business.  The great news is that when the more established vendors like Sun jump on this bandwagon and educate their customers, it only further legitimizes this way of doing business for many a startup.

As an early stage VC, I spend a fair amount of time helping entrepreneurs build their management teams.  I have written about what we look for (read the A-Player Domino Effect), the hiring process, and other facets of recruiting talent in previous posts.  One area which I cannot overemphasize is the need for companies to do back channel references on candidates.  We were recently doing a VP of Sales search for a portfolio company and in the intial call with the CEO and myself, we found the VP of Sales to be talented and engaging.  A subsequent face-to-face meeting with the CEO and myself separately over the next week further bolstered our interest in the executive.  After a few more meetings with various members of the mangement team, we decided to begin the standard referencing process where we collected the candidate’ s list of published references and called to get a better understanding of the individual’s strengths and weaknesses.  Of course, the references all came back glowing.  If they did not, I would be a little concerned.  This is where most companies end the due diligence process and begin negotiating a contract. 

However, I cannot overemphasize the importance of getting back channel references (references that were not given by the individual on the official list) to get a real view of the candidate.  You need to look deep into your network and your VC’s network to reach out to investors, executives, peers, and direct reports who worked with the candidate in prior companies to get a complete picture and balanced profile of the recruit.  A wrong hiring decision for an early stage company can be a killer!  All too often startup companies want to run fast and furious and hire that killer executive candidate ASAP without doing the extra work required to determine the right fit. In this particular case, through the back channel references we were able to find a number of inconsistencies about a candidate’s effectiveness at a prior startup, his reasons for leaving, and his overall management skills.  While the references were balanced and fair, they were far from glowing.  In fact, most of the back channel references were consistently mediocre which for me was a vote of no confidence.  Sure, you should always expect to get a couple bad references if you do enough of them on someone, but if you see a consistent pattern of concerns or "areas that need to be managed" emerge from those references, it is time to move to the next candidate.  In fact, let me extend this message and state that doing back channel references should be standard business practice.  Why learn in 3 months that a particular executive, VC firm, or business partner was not a right fit, if you can piece together that information beforehand?  Just a little more work in the diligence process can save you lots of frustration in the long run.

I was in a board meeting yesterday reviewing the sales pipeline for a portfolio company walking through the wins and losses.  As I wrote in an earlier post, it is extremely important (to the extent you can), to get good data on your losses. Many times you learn more from your losses than from your wins.  We like to know who we lost to and why.  We keep a running tab of these losses so we can figure out some key trends, how our competitors are selling against us, and determine what sales tactics we need to employ to reverse the losses.  Interestingly enough, over the last year a trend I have been seeing is the "do nothing" trend from enterprise customers.  We find out that the potential customer has budget, we are selected as the winner, and then they do nothing.  Obviously, the earlier you can identify a potential for spinning your wheels the better off you will be.  Mike Nevens has a great post on SandHill.com outlining this new reality and ways to determine if you are spinning your wheels early in the sales process or methods to make your project one of the 5 out of 30 projects that actually get implemented rather than just approved.

The CIO of one of the largest retail banks in the US recently told me that he has about 60 new projects under evaluation. About half of them will pass technical, functional and investment hurdles. He will then fund 4 to 6 over the next two years.

That means that 25 or so projects that meet all objective criteria will not go forward.

Software vendors and investors need to understand and deal with this reality. 

This is the new reality in selling to enterprises – doing nothing may be a bigger inhibitor to sales growth than your competition!