BeyondVC

It's not easy to build a service that everyone loves and even harder to build one that gets 3000 new users a day on an installed base of 2 million users.  Once there you may think of yourself in the drivers seat as having built a successful company.  Unfortunately, this is where the need for revenue comes to play.  As a startup you can only raise external funding for so long before you generate your own cash flow to pay for operating expenses.

Given these facts, I was quite saddened to read the blog post today from Todd Agulnick, Co-Founder and CTO of Xmarks, Inc.  In the post which I believe is a must-read for all entrepreneurs, Todd lays out how he started the company, built it, and tried multiple times to create a revenue model from the incredible number of users and data he amassed over a few years.  As Todd states:

We spent the next year turning over every conceivable rock looking for ways to use the data in our corpus that would prove compelling to our users and revenue-generating for us. Some of these ideas, like SearchTabs, saw the light of day; others never made it out of the lab. Our “SearchBoost“, service was an upsell to advertisers: pay us a fee and we’ll add a mark to your ad when it’s displayed to our users, showing the bookmark rank of your site. Our tests showed that we could boost ad click-through rates by 10%. We built it and it put it front of potential advertisers. Many were interested, but ultimately the feedback was negative: our user base was too small to be worth their time and attention.

As evidenced from above, it sounds like Todd and his team tried every conceivable way to build a business out of their awesome product.  If you are an entrepreneur you have to remember that building a consumer Internet business is not easy!  Even though Xmarks  jumped over 3 of 4 huge hurdles -building a great product/service, amassing users, and growing quickly, it was still not enough to build a scalable revenue model.  Does this mean that I expect entrepreneurs to have a sustainable revenue model from Day 1?  Definitely not but on Day 1, I do want to hear about the various ways you may generate revenue in the future.  I also want to point out that advertising will most likely not work for your business unless you can generate a significant amount of traffic, way more than you even think you are going to need today.  And finally like Xmarks, it may not work the way you dreamed it would but please take all of those lessons learned to your next startup as you will be all the wiser with the experience you had.

During the last month I have spent more time looking at Angel investments as I believe it is a great time to start a business.  However, one key question I keep asking myself after meeting with entrepreneur after entrepreneur is whether or not what they have is just a feature of a larger product offering, a standalone product in and of itself, or a business for the long term with multiple products.  Each path provides a unique risk reward perspective for both investors and entrepreneurs.

To be honest with you, many of the companies I have met with seem like features of a broader product offering.  That is not bad in and of itself as focus is key when starting a company and going to market. As a start-up, you always want to be the innovative player with the new easy to use technology.  However, just being the mobile version of what is already existing in the market is a cause for concern as it doesn't take much for a larger competitor to replicate that effort and use its marketing muscle and existing customer base to freeze a start-up out.  Sure, you may get some customers early on as you are the only one, but in the long run you need to think about what broader feature set you will offer to be a true standalone product. 

A product is typically a couple key features tied together to solve a problem for a customer.  This means that you can provide more value to your customer and consequently extract more dollars from your end-user.  The opportunity for many companies that are just features is a quick flip, but the risk is if that doesn't happen the large player may just develop the feature in-house leaving no exit for you.  The more seasoned entrepreneurs know that starting out with a killer feature is just a launching pad to bigger and greater things.  They know it is just a go-to-market strategy that is part of a larger vision and a step towards a broader offering down the line.  These entrepreneurs know that they may never get there, but also understand that without this they have a limited market and return opportunity.  yes, I know start-ups are inherently uncertain and many times it is difficult to even calibrate how big the market is, but don't forget to lay out the broader vision beyond the initial killer feature when building your company.

On the flip side, what I don't advocate is coming out of the gate as a complete and whole product solution.  This brings you right into the crosshairs of large, incumbent players and makes your life much more difficult as you have to sell against a much larger salesforce with significant marketing muscle.  While your goal may be to grow to that kind of solution, start highly focused, features are ok, but have a broader vision to show a path towards building a great company.

I was on a call yesterday with an inspired and talented management team.  As we walked through the deck, one point particularly struck me as I listened to their well-honed pitch.  The company was trying to boil the ocean and do everything for its customers.  While it was great that the team seemed to understand the market and the problem that their customers had, I must say that I started to lose interest by the fifth differentiating feature of the product/service.  One slide really highlighted the problem for me – it showed a feature list of 10 features and then showed 3 different competitors who were either already well established public companies or well funded startups that only offered 30% of what this angel-funded startup would offer.  In my mind I was wondering how an angel funded company could go-to-market against companies with billion dollar market caps or with $30mm of venture funding which were highly successful because they were incredibly focused on a subset of problems that this start-up was trying to solve. I know, I know, I always like entrepreneurs to think big but that must be balanced with how a startup goes to market.

You see, it is always hard for a startup to enter a market with an end-to-end product positioning as most customers expect large companies to cover this territory.  What most customers expect from startups is innovation and breakthrough offerings, not end-to-end solutions.  Going back to the call, my humble suggestion was for the management team to complete their beta test with their handful of customers and figure out which 2 or 3 features were the most compelling and differentiated offerings with respect to their competition and market.  They should then plan their go-to-market strategy with a more focused approach that emphasized a new and innovative offering instead of a "we do it all for you" approach.  In the long run, if successful, the startup could always add another feature or two as they grew their customer base but keeping the message simple early on is imperative to drive a successful product launch.

While 2009 was a tough year, I must say that it was nice to see a number of our portfolio companies have blow out 4th quarters for bookings and growth.  Despite that, I am still taking a cautiously optimistic approach to 2010.  There are still conflicting reports on the growth of the economy and it is unclear whether Q4 was the release of some pent-up demand of if it will be more indicative of sustainable new spending on technology.

Either way, I would like to caution those start-ups out there who are looking to aggressively ramp up their sales based on a great quarter (more on this from a post in 2006 on when to hire a vp of sales).  Yes, it is imperative to keep the momentum building but before you get too aggressive with your growth plans make sure you can answer all of these questions about your go-to-market strategy:

1. Do we have a clear value proposition and know which market we are selling into and who we are selling to in the organization?

2. Do we have the right product and are our customers satisfied? – selling is one thing but if the product has serious issues in production then ramping up sales could put a severe strain on the business moving forward

3. Are our sales repeatable or one-offs which means lots of customization of our product on every deal?

4. Is our quarter based on one or two lucky huge deals or based on a broader swath of customers?  Do we have a continually growing sales pipeline or did we run it dry for a big Q4?

5. Do we have a solid understanding of the full sales cycle from lead generation from marketing to the closing of the sale – it is important to get good metrics here to make sure that marketing is spending wisely and targeting the right areas of the market to build the pipeline.  You need to feel confident that if you spend more on marketing, you will get more leads which will lead to more sales.

6. How can we build a more leveraged sales model through resellers, partners, or OEM relationships – you can't do this without answering #1 above.  If you are solely reliant on direct sales then think long and hard about how to add more leverage to the model

In short, if you can answer these questions and the data and anecdotal evidence from the field points you in the right direction, then by all means ramp up your growth.  If you can't answer all of these questions in a highly positive light, then cautiously ramp your sales.  Too many times I have seen portfolio companies get overexcited about their growth prospects and then realize the product is not ready for primetime or that the pipeline has run dry and subsequently the startup overspends and needs to go through a layoff.  Overhiring and then cutting back can be quite negative for morale and can also be a huge cash drain and distraction for management.  Just remember to take a step back and do some analysis before you bet the company's future based on a good quarter or two.