Tag Archives: Business

SaaS 101: 7 Simple Lessons From Inside HubSpot

A nice quick and very interesting read for those interested in the Software as a Service (SaaS) business model either as a buyers or investors…


SaaS 101: 7 Simple Lessons From Inside HubSpot

// It’s been a little over 4 years since I officially launched my internet marketing software company, HubSpot.  (The “official” date is June 9th, 2006 — for those that are curious about such things).  So, I’ve had about 4 years on the “inside” of a fast-growing, venture-backed B2B SaaS startup.  Quick stats:  ~2,900 customers, ~170 employees and $33 million in capital raised.  But, this is not an article about HubSpot, it’s an article about things I’ve learned in the process of being a part of one of the fastest growing SaaS startups ever. (I looked at data for a bunch of publicly traded SaaS companies, and the only one that grew revenues faster than HubSpot was Salesforce.com). onstartups saas blackboard

In any case, let’s jump right in.

7 Non-Obvious SaaS Startup Lessons From HubSpot

1.  You are financing your customers. Most SaaS businesses are subscription-based (there’s usually no big upfront payment when you signup a customer).  As a result, sales and marketing costs are front-loaded, but revenue comes in over time.  This can create cash-flow issues.  The higher your sales growth, the larger the gap in cash-flows.  This is why SaaS companies often raise large amounts of capital.

Quick Example: Lets say it costs you about $1,000 to acquire a customer (this covers marketing programs, marketing staff, sales staff, etc.).  If customers pay you $100/month for your product and stay (on average) for 30 months, you make $3,000 per customer over their lifetime.  That’s a 3:1 ratio of life-time-value to acquisition cost.  Not bad.  But, here’s the problem.  If you sign up 100 customers this month, you will have incurred $100,000 in acquisition costs ($1,000 x 100).  You’re going to make $300,000 over the next 30 months on those customers by way of subscriptions.  The problem is that you pay the $100,000 today whereas the $300,000 payback will come over time.  So, from a cash perspective, you’re down $100,000.  If you have the cash to support it, not a big deal.  If you don’t, it’s a VERY BIG DEAL.  Take that same example, and say you grew your new sales by 100% in 6 months (woo hoo!).  Now, you’re depleting your cash at $200,000/month.  Basically, in a subscription business, the faster you are growing, the more cash you’re going to need.

2 Retaining customers is critical. In the old enterprise software days, a common model was to have some sort of upfront license fee — and then some ongoing maintenance revenue (15–20%) which covered things like support and upgrades.  Sure, the recurring revenue was important (because it added up) but much of the mojo was in those big upfront fees.  The holy grail as an enterprise software startup was when you could get these recurring maintenance fees to exceed your operating costs (which meant that in theory, you didn’t have to make a single sale to still keep the lights on).   In the SaaS world, everything is usually some sort of recurring revenue.  This, in the long-term is a mostly good thing.  But, in the short-term, it means you really need to keep those customers that you sell or things are going to get really painful, very quickly.  Looking at our example from #1, if you spent $1,000 to acquire a customer, and they quit in 6 months, you lost $400.  Also, in the installed-software world, your customers were somewhat likely to have invested in getting your product up and running and customizing it to their needs.  As such, switching costs were reasonably high.  In SaaS, things are simple by design — and contracts are shorter.  The net result is that it is easier for customers to leave.

Quick math: Figure out your total acquisition cost (lets say it’s $1,000) and your monthly subscription revenue (let’s say again say it’s $100).  This means that you need a customer to stay at least 10 months in order to “recover” your acquisition cost — otherwise, you’re losing money.

It’s Software — But There Are Hard Costs. In the enterprise-installed software business, you shipped disks/CDs/DVDs (or made the software available to download).  There were very few infrastructure costs.  To deliver software as a service, you need to invest in infrastructure — including people to keep things running.  Services like Amazon’s EC2 help a lot (in terms of having flexible scalability and very low up-front costs), but it still doesn’t obviate the need to have people that will manage the infrastructure.  And, people still cost money.  Oh, and by that way, Amazon’s EC2 is great in terms of low capital expense (i.e. you’re not out of pocket lots of money to buy servers and stuff), but it’s not free.  By the time you get a couple of production instances, a QA instance, some S3 storage, perhaps some software load-balancing, and maybe 50% of someone’s time to manage it all (because any one of those things will degrade/fail), you’re talking about real money.  Too many non-technical founders hand-wave the infrastructure costs because they think “hey we have cloud computing now, we can scale as we need it.”  That’s true, you can scale as you need it, but there are some real dollars just getting the basics up and running.

Quick exercise: Talk to other SaaS companies in your peer group (at your stage), that are willing to share data.  Try and figure out what monthly hosting costs you can expect as you grow (and what percentage that is of revenue).

It Pays To Know Your Funnel. One of the central drivers in the business will be understanding the shape of your marketing/sales funnel.  What channels are driving prospects into your funnel?  What’s the conversion rate of a random web visitor to trial?  Trial to purchase?  Purchase to delighted customer?  The better you know your funnel the better decisions you will make as to where to invest your limited resources.  If you have a “top of the funnel” problem (i.e. your website is only getting 10 visitors a week), then creating the world’s best landing page and trying to optimize your conversions is unlikely to move the dial much.  On the other hand, if only 1 in 10,000 people that visit your website ultimately convert to a lead (or user), growing your web traffic to 100,000 visitors is not going to move the dial either.  Understand your funnel, so you can optimize it.  The bottleneck (and opportunity for improvement) is always somewhere.  Find it, and optimize it — until the bottleneck moves somewhere else.  It’s a lot like optimzing your software product.  Grab the low-hanging fruit first.

Quick tip: Make sure you have a way to generate the data for your funnel as early in your startup’s history as possible.  At a minimum, you need numbers on web visitors, leads/trials generated and customer sign-ups (so you know the percentage conversion at each step).

You Need Knobs and Dials In The Business. One of the great things about the SaaS business is you have lots of aspects of the business you can tweak (examples include pricing, packaging/features and trial duration).  It’s often tempting to tweak and optimize the business too early.  In the early days, the key is to install the knobs and dials and build gauges to measure as much as you can (without driving yourself crazy).  Get really good at efficient experimentation (i.e. I can turn this knob and see it have this effect).  But, be careful that you don’t make too many changes too quickly (because often, there’s a lag-time before the impact of a change shows up).  Also, try not to make several big changes at once — otherwise you won’t know which of the changes actually had the impact.  As you grow, you should be spending a fair amount of your time understanding the metrics in your business and how those metrics are moving over time.

Quick advice: If you do experiment with pricing, try hard to take care of your early customers with some sort of “grandparenting” clause.  It’s good karma.

Visibility and Brakes Let You Go Faster. One of the big benefits of SaaS businesses is that they often operate on a shorter cycle.  You’re dealing in days/weeks/months not in quarters/years.  What this means is that when bad things start to happen (as many experienced during the start of the economic downturn), you’ll notice it sooner.  This is a very good thing.  It’s like driving a fast car.  Good breaks allow you to go faster (because you can slow down if conditions require).  But, great visibility helps too — you can better see what’s happening around you, and what’s coming.  The net result is that the risk of going faster is mitigated.

Quick question: If something really big happened in your industry, do you have internal “alarms” that would go off in your business?  How long would it take for you to find out?

7 User Interface and Experience Counts: If you’re used to selling client-server enterprise software that was installed on premises, there’s a chance that you didn’t think that much about UI and UX. You were focused on other things (like customization, rules engines and remote troubleshooting).  That was mostly OK, because on average, the UI/UX of most of the other applications that were running on user desktops at the enterprise sucked too.  So, when you got compared against the other Windows client-server apps, you didn’t fare too badly.  In the SaaS world, everything is running in a browser.  Now, the applications you are getting compared to are ones where someone likely spent some time thinking about UI/UX.  Including those slick consumer apps.  You’re going to need to step it up.  In this world, design matters much more.  Further, as noted in #2 above, success in SaaS is not just about selling customers, it’s also about retaining them.  If your user experience makes people want to pull their hair out and run out of the room screaming, there’s a decent chance that your cancellation rate is going to be higher than you want.  High cancellation rates kill SaaS startups.

Quick tip: Start recruiting great design and user experience talent now.  They’re in-demand and hard to find, so it might take a while.

—-

So, what do you think?  Are you running a SaaS startup now?  What have you learned?  Would love to hear about your experiences in the comments.

You can follow me on twitter @dharmesh.
//

via SaaS 101: 7 Simple Lessons From Inside HubSpot.

Posted by Dharmesh Shah on Mon, Jul 19, 2010

NASA and Rackspace Open Up the Cloud | CIOZone.com

Very interesting market play. I’m speculating that they are betting on “viral marketing” to propel them into becoming the 800 pound guerrilla in this domain.  If enough geeks and hacks dive-in, we may be looking at the next Tomcat/Apache…

… July -19 – 2010

NASA and Rackspace Open Up the Cloud

Posted by meggebrecht in Rackspace, OpenStack, Nebula, NASA, Lew Moorman, Jim Curry, Cloud Computing, Chris Kemp

Rackspace announced Monday that it is open-sourcing its cloud computing platform, making a bid to bring some sorely needed interoperability to the cloud with the launch of the OpenStack project.

First up is the software behind the company’s cloud storage engine, Rackspace Cloud Files. You can freely download early code at the OpenStack site under the Apache 2.0 license — meaning of course that you can do pretty anything you want with the code. The full release is expected in mid-September, according to the site.

In mid-October, Rackspace will release OpenStack Compute, code based on its Cloud Servers technology and the Nebula platform operated by NASA, which is partnering with Rackspace on the project.

So basically, anyone will be able to download the software behind two massive cloud computing platforms and build their own. And NASA and Rackspace have pledged that their engineers will continue to develop the technology — they kind of have to, considering that both organizations will be powering their clouds using OpenStack. Rackspace also says that it will commit money and manpower to supporting enterprise and service provider adoption of OpenStack….

via CIOZone.com – Professional Network for CIOs and IT Professionals – NASA and Rackspace Open Up the Cloud.

Why VCs Won’t Sign Your NDA

Plain and simple: just don’t do business with people that you don’t trust. Once the genie is out of the bottle…

Why VCs Won’t Sign Your NDA

Written by Audrey Watters / May 10, 2010 7:30 PM / 7 Comments

There are several important documents you’ll want to have ready when you meet with potential investors. Your mission statement. Your founding team’s resume and responsibilities. A business plan.

But most investors agree: they do not want to sign an NDA.

While non-disclosure agreements are designed to protect your ideas, asking potential investors to sign an NDA is generally seen as unnecessary and unwise. Most VCs point to the following reasons for avoiding NDAs:

1. Trust. Potential investors are not your competition, and asking them to sign an NDA is often interpreted as a sign you don’t trust them. As professional integrity is important to VCs, requiring an NDA is generally seen as a violation of business etiquette.

2. Legality. An NDA is a legally binding document, and as such, it’s something people will refuse to sign without having a lawyer review. Most investors are unwilling to accept the risk of litigation should they hear about a similar concept – and it isn’t a stretch to assume that investors are weighing multiple pitches with similar or related concepts. Furthermore, an NDA means the investor is restricted from mentioning you, your idea or your project. And chances are, as an entrepreneur, you do want your investors to talk about you.

3. Ideas. Good ideas are dime-a-dozen. As Andrew Warner argues, “Ideas are worthless. It’s your execution of those ideas that will be valuable. Besides, this idea that you’re so proud of now will probably change completely as you build your company.”

There may be times in which you should require a non-disclosure agreement. As Anil Dash recently wrote on this subject, “Now, I’ve had clients ask for an NDA, which makes perfect sense, and I might ask contractors working for me to do the same. Or some big companies just have a boilerplate NDA that they throw in front of people as a matter of course. But for individual entrepreneurs who just have a good idea and big dreams, it’s easy to be misled into thinking that walking in the door with a fancy legal document makes you look professional or ‘serious’.”

Whether or not you ever consider an NDA, it is advisable in the early stages of forming your business that you share your ideas and plans with people you trust. And if you are approaching someone as a potential investor, it’s important that relationship be build on credibility and integrity, not on a legal document.

via Why VCs Won’t Sign Your NDA.

The Case for Backshoring

Finally, leaders are starting to recognize that offshoring is not “the magic pill”.  One has to look at the total cost of these offshoring efforts; not just labor cost and rent.  As a LEAN practitioner,  the wholesale transfer of just about any and every service or manufacturing effort has never made sense.  Yes, in some cases its the way to go; but, for a long time there it seemed like it was just the fashionable thing to do…it was a mantra…what all the cool kids were doing.   Whenever I would ask why are you doing that, they would at me like I had two heads. I just wanted to know the info so that I could build a model or rule of thumb for future use (the engineer in me is rearing its head).  Well, we’ll see were this goes; maybe there is hope.

The Case for Backshoring

Which manufacturing operations should return to the United States?

For years, the NCR Corporation simply followed the pack. Like many other large U.S. manufacturing companies, in the past couple of decades the maker of automated teller machines (ATMs) relied heavily on outsourcing to trim factory costs. By hiring Singapore’s Flextronics International Ltd. to make much of its equipment in cheaper offshore locations in the Asia/Pacific region and South America, NCR could slash hundreds of millions of dollars in plant expenses and be reasonably certain that its ATMs met quality standards.

But recently, NCR has rejected this strategy — at least to a degree. In 2009, the company decided to reclaim responsibility for making one of its most sophisticated lines of ATMs from Flextronics in Brazil and instead manufacture the machines in Columbus, Ga., not far from the NCR innovation center, where its new technology is on display. The reason: The company was concerned that outsourcing distanced its designers, engineers, IT experts, and customers from the manufacturing of the equipment, creating a set of silos that potentially hindered the company’s ability to turn out new models with new features fast enough to satisfy its client banks. “I think you’ll see more of this occurring,” says Peter Dorsman, NCR’s senior vice president in charge of global operations, who says he has been contacted by dozens of U.S. companies studying whether they should make similar moves. “You’ll see a lot more people returning manufacturing to America.”

NCR’s change in direction has raised the possibility that U.S. manufacturers are getting serious about “backshoring” some of the production they shifted overseas in the wholesale offshoring movement that started in earnest in the 1990s. General Electric Company Chief Executive Jeff Immelt recently attracted attention for remarks he gave to a West Point leadership conference calling for U.S. companies to make more products at home. Demonstrating Immelt’s commitment, GE announced in the summer of 2009 that it would build two new plants in the U.S. — a factory in Schenectady, N.Y., to make high-density batteries and a facility in Louisville, Ky., to produce hybrid electric water heaters currently made in China. Dow Chemical Company CEO Andrew Liveris similarly has appealed for a renewed focus on manufacturing in the United States.

Backshoring is primarily an American phenomenon, because U.S. manufacturers have been much more aggressive about outsourcing than their Asian or European counterparts. Japanese companies experimented with outsourcing high-end items to factories in Southeast Asia and China, but quickly changed course after growing concerned about the loss of intellectual property and about disrupting the link between research and manufacturing. As a result, Japanese companies generally farm out only the manufacturing of commodity products.

Cynics might conclude that pronouncements about the need for manufacturing in the U.S. are simply aimed at currying favor with the Obama administration, which is worried enough about the issue that it named former investment banker Ron Bloom as manufacturing czar. Moreover, although cases such as NCR and GE are noteworthy, many U.S. jobs are still going offshore. For example, the Whirlpool Corporation recently announced the closing of an appliance factory in Evansville, Ind., amid plans to move less-skilled jobs to Mexico. And in the financial-services and information technology sectors, there is no letup in sight in the rush toward India. IBM, for example, has more than 90,000 employees in its Indian outsourcing operations.

But the logic behind backshoring is compelling enough that it cannot be easily dismissed as a mere short-term aberration. Higher transportation costs as well as rising wages and raw materials prices in China, inevitable by-products of the huge gains that the developing country’s GDP has made despite the global recession, have frightened some U.S. companies away from Asia. An apt illustration: Wright Engineered Plastics Inc., a Santa Rosa, Calif.–based maker of injection molds, has expanded its West Coast plants and decreased its use of Asian facilities because many of its key customers have shifted their own manufacturing operations back to the U.S. in light of prohibitive increases in the prices for raw plastic in China.

Moreover, some companies are amplifying materials and logistics savings from backshoring by modernizing their U.S. plants to outpace Chinese facilities. Such is the case with Diagnostic Devices Inc., a maker of blood glucose monitoring systems. In August 2009, the privately held company based in Charlotte, N.C., announced that it was moving the manufacturing of its Prodigy line of audible glucose monitors to North Carolina, ending a five-year agreement with a contract manufacturer in China under which Diagnostic Devices sent components overseas and then had the finished devices shipped back to the United States. By automating its U.S. factory with robots and other high-tech hardware and software, and by taking advantage of lower shipping fees for a mostly local customer base, Diagnostic Devices reduced its production budget by 40 percent. And there is an added bonus, according to a company spokesman: “We will also have far more control over and protection of our intellectual property, which you don’t have in China.”

NCR’s decision to backshore goes well beyond dollars and cents — and, in fact, may provide the most convincing rationale for the gains that backshoring can produce. The ATMs being made in Columbus now are NCR’s most sophisticated, capable of scanning checks and cash and eliminating the need for the customer to fill out a deposit slip. This feature has provided a welcome revenue lift for NCR — bringing in as much as US$50 million a year, significant for a company with $5 billion in annual sales. But these machines likely never would have been developed had large customers like JPMorgan Chase and Bank of America not persistently prodded NCR to move in that direction. That type of potentially profitable interaction between NCR and its customers is difficult, and launching desirable new products is slowed considerably, NCR’s Dorsman says, when the manufacturing facilities are offshore. “We take our cue from our customers,” says Dorsman. “They are heavily involved in the development process. And with this new approach we’re taking, we can get innovative products to the market faster, no question.”

NCR also found that having Flextronics manufacture high-end ATMs in Brazil — and relying on the vendor’s third-party suppliers, many of which NCR was unfamiliar with — left important internal constituencies in the dark, further slowing and complicating new product launches. Hardware and software engineers, sourcing executives, manufacturing and operations staff, and customer service managers all had trouble applying their expertise throughout the many remote handoffs between separate organizations.

Despite backshoring’s growing appeal, it’s hard to call it a trend yet. Indeed, most Western CEOs remain convinced that offshoring and outsourcing are still the least expensive approach for manufacturing products — and notwithstanding recent anecdotal evidence to the contrary, their position is rigid. For example, Boeing CEO James McNerney Jr. still clings to a radically outsourced supplier model for the company’s wildly ambitious 787 Dreamliner aircraft even though the plane is more than two years late and is facing numerous customer cancellations because of supplier glitches in distant factories. Of course, CEOs are also attracted to offshore destinations because the manufacturing tax breaks offered by governments in many developing countries are more generous than those granted by the United States.

Author Profile:

via The Case for Backshoring.

But what may be at stake in the schism between offshoring and backshoring is a company’s long-term ability to innovate. The making of commoditized staples like shoes, clothing, and consumer electronics will mostly remain in Asia. Backshoring will be more prevalent at the high end of the technology spectrum, in industries such as telecommunications and health care that are sensitive to quality and fast product cycles or in cases in which companies feel they can profit from getting immediate and ongoing feedback from U.S. customers. Those aspects of manufacturing, many experts believe, are where the best opportunities for earnings growth lie. “That’s where we can be competitive,” says Ron Hira, associate professor of public policy at Rochester Institute of Technology and coauthor of the 2005 book Outsourcing America: The True Cost of Shipping Jobs Overseas and What Can Be Done About It (with Anil Hira; AMACOM).

China grew >10% in 2009; about to surpass Japan

While getting gas (petrol for our international readers) this morning, I heard on NPR (National Public Radio) that China released it’s numbers this morning. Their economy grew by over 10%! There was a discussion about whether China would beat-out Japan in 2010 to be the #2 economy in the world; the US being #1. Well, I have to say: not bad for a bunch of communists. Oh, did we all forget? One consistent thing that I hear about China is that things happen gradually. So I’m wondering when their form of government will catch-up to their economy.

Now you may ask yourself: how did the Chinese do that in 2009—the year of pain and intense pucker-factor? Well, their Government pumped $1.44 Trillion (with a capital “T”) into their banks which in turn pushed it into the hands of the consumer and small business. Hey, didn’t we do that in the US? Why yes; yes we did. Except that the US banks horded the cash and kept a tight lid on credit. So, small businesses (which really fuel the economy and have the greatest affect on unemployment) still can’t get any credit, which means that they have diminished working capital and are stuck in survival mode. Also, this morning on the TV I saw a snippet with my idol Warren Buffet . He said that the current US “Stimulus Package” was like “taking 1/2 a Viagara” and that now we need to do the rest. Man, I love this guy!

In the interest of full disclosure; I have owned Berkshire-Hathaway for over 15 years.

Banks Hording Cash as of July 2009

Angel Investors – The Good, Bad and Very Ugly | Dr. Earl R. Smith II

Here is another blog about start-ups, PE/VC, and entrepreneurship that I thoroughly enjoy. I would like to share it with you. Dr Smith has a wealth of info and his reader’s comments are also very useful.  Please go to his site and read the comments.

Angel Investors – The Good, Bad and Very Ugly

Posted by Dr. Earl R. Smith II

DrSmith@Dr-Smith.com

www.Dr-Smith.com

There is a tendency among entrepreneurs to chase money wherever they find it. The pressure to find the financial resources so necessary to build a business can be over-mastering. Most of the time the partnerships which form between founders and angel investors are productive but, in a few cases, I have seen it turn very destructive. Companies that should have realized success have been held back by investor partnerships that have severely limited their potential or, in some cases, doomed them to failure.

Look Beyond the Checkbook

It may be hard to be discriminating when you are in the heat of the ‘money hunt’ but the sins of omission you commit while chasing investors can return ten-fold to destroy any chance of success. The problem become acute because of the incredible range of circumstances, experience and interests that angel investors bring to the table. Their having money to invest in not enough. You need to understand their basic motivations and what is driving them to act as an angel investor. You also need to understand that all investment money is not the same. Some money will help you succeed while other investments will be a poisoned pill that will reduce your chances of building the business you envision. Here are some ‘sacred cows’ that you need to slaughter:

  • Angel investors are in it for a return on their investment: Well, how can you argue with that? You would assume that the primary driver is always a return on investment. But, as you will read further on, that is not always the case. I know angel investors who are simply bored and looking for something to do and others who are frustrated CEO-wannabees. For some investors, it is all about a return but for others the return is secondary. You need to sort these two groups out. Do not listen just to what they say; it is what they do that is important.
  • They have money they; must be smart: This is another fallacy. Some of the dumbest and most self-destructive people I have ever met are wealthy. I have found only a weak correlation between wealth and intelligence and a slimmer one between wealth and wisdom. Many a destructive hubris has been built on a fat bank account. Investors have an important role in start-ups but pretense, omnipotence or omniscience can warp an investor’s understanding of that role. Smart investors play their part in a highly professional and constructive manner. Seek them out; they are most likely the winners you want to associate with.
  • They have been successful in business so they will know how we can be: Past success is not always a good indicator of wisdom going forward. In fact, great success can be counter-productive when they decide to work with start-up companies. I know one investor who continually regales his CEOs with stories of how he ran his company. Of course, the company was running over one hundred million annually when these stories took place. The CEOs, wanting to emulate his success, take steps that are entirely premature. The result is wasted resources and a dysfunctional corporate culture. Past business success is not a good indicator of professional performance as an investor. Remember, you are seeking an investor, not a shadow CEO.
  • They will become my close personal friends and advisers: Not a good idea; the correct focus of investors should produce a tension in the relationship with management. If you want a friend, buy a dog.

The Bad and the Very Ugly

The problem with writing about angel investors is that they come in an amazing variety. I have met lots of them and there is always something different about each. The ease of entry into the field may have something to do with it. The only real entry requirement is wealth beyond current needs. That’s all it takes to become an angel investor. There are no educational requirements, courses to take or certifications to merit. Only a bank account and a decision to ‘invest’ are required to hang out a shingle and open up for business. Watch out for the following:

  • The Shadow CEO: I have met investors who purposefully pick weak or inexperienced CEOs to work with. Their real agenda is to run your company from the back seat. These investors are very intrusive and will push you to make decisions and commit resources that will put your company at risk. They are mostly successful entrepreneurs who have built and sold a business. In the process, they have lost touch with the necessary energy levels and passion that is essential to building a start-up into a going business. Mostly they remember the later stages of their company and the extended staff they had. Then they turn the CEO into a kind of executive assistant and attempt to run the company by proxy. Most of the companies in the portfolio of this type of investor remain very small. They generally have very complex Excel spreadsheet projections and poor records in meeting them. Stay away from the Shadow CEO; they are very dangerous investors.
  • The Crazy, Rich Uncle: This is probably the most dangerous type of angel investor because they are so easy on the management team. They are mostly retired and living comfortably. Their mission in life is to ‘give back to the younger generation’. A clear indication of this type is the total lack of performance metrics and a weak statement of expectations. They can be very seductive to entrepreneurs but there is a dark side. Without stiff set of performance metrics, the company can develop a culture of permissiveness. That will feel good until the money runs out. A key indicator of this type is the feeling that the amounts of money involved are, at least initially, not sufficient to cause them concern. The expenditure patterns are not carefully monitored and discussions do not turn serious until the money is spent and the wolves are at the door. As an entrepreneur, you need to seek out investors who will be hard on you; insisting on strict performance metrics and precise definitions of roles. Take the easy way out and you will be in for a ride to nowhere with a crazy, rich uncle. Sure you will enjoy the ride but, in the end, you will be let off the bus in the middle of nowhere with a tarnished reputation for failure.
  • The Gaggle: Remember the old saying about a camel being a horse designed by a committee? These gaggles are fond of that kind of engagement. The investments that they make are very often selected in a very casual way and supervised fairly loosely. The problem comes as the group itself is very loosely organized. Different participants might have significantly different understandings of what it mean to be an investor and what that status entitles them to. The can range from complete indifference to total immersion in the management of the company. This situation can result in lots of pulling and pushing of the management team without an overarching strategic vision. Investments should be made based on clear and concise understandings codified in a detailed investment agreement.
  • The Bottom Feeders: You will meet some investors who are really only interested in your intellectual property. They ‘drag the bottom’ of the entrepreneurial community looking for weak teams with good ideas. Mostly they insist that their funding be used to develop the technology rather than developing revenues. Once the money runs out, they regretfully inform management that they are closing the company down and talking the intellectual property as compensation for their investment.
  • The Lead Broker: I have seen these lead brokers promote themselves into central roles in companies without putting much of any of their own money on the line. The net result is that the bulk of the investor group gets involved without much direct knowledge of the business or the management team. In one case, such a broker put together an investment in excess of one million dollars without making any investment of his own. He still managed a seat on the board and a dominate role in the management of the company. Be particularly careful of the broker who can invest but does not. This situation can turn nasty if expectations are not met. Finger pointing and recriminations can come to dominate the relationships among the investors. This could seriously damage chances of follow-on investments by the group.

The Good

Good angel investors always take a highly professional approach to the process and their portfolio companies. They generally focus in industries that they are familiar with. It is a good idea to avoid angel investors whose portfolio companies do not fit a close pattern. The best angel investors will often forgo the option of claiming a board seat and, instead, insist that an independent board member with professional experience be appointed. Beware of investors who seem to see investment in your company as an opportunity to enhance their reputation by sitting on yet another board. Here are some positive things to look for:

  • Success Breeds Success: There are angel investors who have the knack to help their portfolio companies thrive; while others seem to doom them to failure or stagnation. I know of one angel who specializes in little deals and has a well developed ability to keep them that way. Other investors seem to have the opposite skill. Their companies grow and prosper. It is a good idea to do some diligence on the track record of the investor. Go with the successful ones even if the deal terms are less generous.
  • The Investment Agreement: There ought to be a detailed investment agreement agreed to before any funds are transferred. This agreement should be very specific when it comes to the roles and responsibilities of each party. The best agreements provide for an earn-in by management based on performance. It also sets the ground rules for further investment. Good angel investors will require this as a matter of course. The worst ones will simply require a term sheet and then write a check. Remember that the absence of planning is the road to failure. Think of the investment agreement as a strategic plan for the relationship.
  • Strategic Agreement on Roles and Responsibilities: Good angel investors will insist that the roles and responsibilities for each party be very well understood from the very beginning. These roles will be codified in the investment agreement and specify the actions that each party will be able to take under a range of possible outcomes. Although such an agreement can complicate initial negotiations, it will help greatly when performance does not meet expectations and realignment become necessary.
  • Use of Proceeds: I have seen investors write rather large checks without insisting that there be an agreed upon use of proceeds. You can imagine what happened then. Entrepreneurs initially like the freedom to simply take the money and spend it as they see fit. But, more often than not, this leads to waste and spending on things that do not connect directly to the success of the company. One company, upon receiving funds in this way, spent a lot of the money on new laptops and cell phones with expensive service plans. They replaced very serviceable units. Another CEO kept paying his salary, even through results fell far below projections, and failed to pay suppliers. The result was a law suit that is almost certain to shut down the company. It is good business practice for the angel investors to insist on a detailed use of proceeds and for control over the spending of their money.
  • Insistence on Performance Metrics: As a CEO you should be insisting on performance metrics for every member of your team. That is just good management. Your investors should take the same approach. It may seem initially easier to deal with angel investors who are very lax about this, but it is far from best practices. I am not just talking about Excel spreadsheet metrics. They have to be much more detailed than that. Good performance metrics detail the responsibilities of each member of the management team and the way their performance will be measured. Everybody from the CEO to the receptionist should have a job description with metrics attached. And the metrics should be sufficiently detailed to drive evaluations based on performance. Performance should be the driver in determining both compensation and earned-in interest in the company. Performance metrics are a sign of a professional and productive organization. Start-ups with that culture have a much higher chance of success.
  • Focus on Governance Issues and Oversight: “Who’s minding the store?” If the answer to that question is “nobody but us entrepreneurs”, consider that a red flag. In the short-term, it may feel good to be free from oversight but, in the long-term, you are guaranteed to make more mistakes and waste more opportunities. The board of directors has a very important role to fill in any corporate structure and it is not just making sure that the investors get to a liquidity event as soon as possible. Good governance means overseeing the strategic planning process, dealing with issues of succession, audit and compensation, and providing for the protections and expansion of shareholder value. This fiduciary relationship with the shareholders is an important part of the corporate structure. Without it, management is under no effective supervision and the investment looks more like a roll of the dice than an investment.

Keep This In Mind

An angel investment creates a relationship that will help determine how successful you are going to be. Your skill in crafting that relationship is a test of how dedicated you are to the success of your company and team. If you take the easy way out, your chances of success will drop significantly. If you opt for the limp relationship with an inattentive investor, your prospects will suffer. Angel investors, the good ones, bring much more than money to the table. The good ones have helped their companies succeed and will help you do the same.

© Dr. Earl R. Smith II

via http://www.dr-smith.info/angel-investors-%E2%80%93-the-good-bad-and-very-ugly

PE Fundraising Hits Brakes

PE Fundraising Hits Brakes

Podcast: Listen to this article.

on 07 January 2010, 13:55

by Red Herring Staff

Private equity fundraising declined precipitously in 2009, according to a report, its worst year since 2004.

Industry researcher Preqin on Thursday reported that 482 funds worldwide raised $246 billion in 2009, down 61 percent from the $636 billion raised in 2008.

“Although investors are in a much clearer position now than at the start of 2009, the chances of a return to the fundraising levels seen in 2007 and 2008 are very slim, Preqin representative Tim Friedman said in a statement.

Particularly dismal, fourth-quarter 2009 saw only $35 billion raised, the lowest level since third-quarter 2003.

The biggest category of funding went to buyouts, raising $102 billion by 84 funds in 2009. The largest regional deployment went to North America, where 228 funds focused there raised $145 billion. That compares with 136 Europe-focused funds that raised $74 billion and 118 Asia and other world regions raising $27 billion.

LPs have seen lower investment returns and have less money to commit to funds, according to the Preqin report, and that isn’t expected to change anytime soon unless the exit market improves.

via PE Fundraising Hits Brakes.