Family Traditions

One tradition that has developed in our family is that each night before they go to bed, my two oldest kids ask me about the new companies I saw that day and whether they were interesting as investment opportunities.  Apart from occasionally leading to "proud parent" moments when they dissect the business opportunity to a T, I am always struck by how some stories I hear retell easily and how others don't retell well at all.

While it would be easy to chalk this up to the more technology driven stories not making the transition from board room to living room, the common denominator is actually that great entrepreneurs have an ability to deliver a message that is compelling, concise and easy to remember such that it can be retold in a way that others understand it perfectly.  In our evening sessions, this has proved to be true whether the company is focused on consumers, SMBs, enterprises or OEM partners.  

While delivering a compelling, concise and easy to remember pitch such that I can discuss the opportunity with my kids is not terribly important, the gist of the message is.  Every time you make your pitch as an entrepreneur the recipient will retell the story to someone else and if all they get is blank stares, your likelihood of success goes down.  This is true if you are recruiting and your candidate goes home to speak to their spouse or significant other; if you are selling and your prospective customer discusses the opportunity with their boss or colleague; if you are speaking to the press and the writer reviews the story with their editor or tries to summarize in their blog; or if you are raising capital and your prospective investor discusses it with their partners.

What makes a good pitch?  The first key point is a simple vision of what you are trying to do and why this is important.  Far too frequently this gets bogged down in how you are doing something rather than why.  My kids, and anyone else for that matter, don't care that you have the best technical approach in the world.  Instead they want to know what the technology allows you to accomplish.  As an example, our portfolio company Goby launched today what they describe as a "search engine for your free time".  While the company is based on a tremendous amount of technology from very smart people at MIT, note they don't use the term "semantic" or "federated" or "deep web" in their pitch because, again, people care about what you help them to do, not how you can do it.  The second key point to communicate in your message is a sense for target markets and how broadly applicable your solution can be.  It is surprising to me how infrequently entrepreneurs fail to connect their idea with concrete market opportunities.  In the case of Goby, the connection point is that 71 percent of US adults find themselves frustrated with the irrelevant search results returned by traditional search engines and there is nothing more frustrating than spending your free time researching how to spend your free time!  Finally, the third key point in any pitch is how the idea, customer value proposition and market translate into a compelling business opportunity.  This is the point where my kids often surprise me with their insight based on the simple statement, "but Dad, i don't see how that would ever make any money".  At the end of the day, we are building companies and if there is no means to generate significant revenue, there is no company to be built.

Don Dodge recently had a good post on what should be in a short pitch, but the discipline I would encourage is to distill all your messages into a single powerpoint slide or if you are more ambitious, a single twitter message.  Either really forces the communication of what you do, why it is important, who cares about it, and how that will translate into revenue into a few, powerful sentences.  And then, when you are done, try it out on a 13 year old!

Cut day

Bill Gurley recently had an excellent post on the state of
the venture capital industry, with an emphasis on how Limited Partners think
about the asset class.  I generally
agree with his primary thesis that: 1) the industry will be smaller and raise
less capital and 2) this is net healthy for entrepreneurship given that fewer
companies will be funded in what would otherwise be overcrowded sectors.  That said, I am not sure the metaphor he
used – a picture suggesting all the industry needs to do is go on a diet to
lose some weight – is right. 
Instead, I think the more appropriate metaphor is what went two weeks
ago in the NFL: teams cutting players to have appropriate sized rosters.

Here’s how I see it: If venture capital funds typically have
4-year investment period, over the course of that time period most firms would
need to raise a new fund.  As a
result, if we look at the four years from 2005 to 2008, when the industry as a
whole raised $125 billion across 952 funds, we have a rough approximation of
the size of the industry on a run-rate basis prior to the recent economic
turmoil.  During this time, it is
estimated by the NVCA that there were approximately 7,500 practicing venture
capital professionals, or $16-17 million of capital to invest per
professional.  If going forward,
the industry raises more like $15 billion per year, or $60 Billion over four
years, at the same ratio of capital per investment professional, the industry
can support only 3,600.

As a result, much as NFL teams need to cut back to get to 53
players on their roster, venture capital firms will need to cut back investment
personnel to reflect the reality of the current funding environment.  I don’t think this change will happen
over night, nor do I believe the industry will actually get to this level of
professionals (about where the industry was when I first joined in the early
90s), but directionally I think this change needs to, and will, happen (and
already is happening

What does this mean for entrepreneurs?  First, be sure to spend some time
thinking through whether the particular partner you are working with is likely
to be on the team going forward. 
If they have not made an investment in the past couple of years, are working
with a only a small number of portfolio companies, or are focused in an area
(industry, geography or stage) that the firm seems to be de-emphasizing, they
are potentially at risk.  Further,
the firms that are likely to see the greatest cutbacks will be at both ends of
the size spectrum.  The larger
firms that have added significant staff over the last 10 years will likely trim
more than those that have stable sized partnerships and conversely, the smallest
of firms in the industry will be at risk as they just wont have the fee income
to support their organization and accompanying overhead.

Second, the reduced size of the venture capital industry
will result in fewer companies getting funded.  Each one of the venture capital professionals in the industry
today is out trying to make investments, so if there are approximately half the
number of participants, it stands to reason there will be approximately half
the number of companies funded (if all the industry did was diet and have less
capital with the same number of participants, as Gurley’s image implies, one might
incorrectly infer that the same number of companies might get funded just with
less capital each).  While this
certainly raises the bar on the quality of the team, idea and market
opportunity for entrepreneurs, it importantly will result in a significantly
healthier market environment for those companies that do receive capital.  We all have been part of companies that
were pursuing a good idea and market opportunity, only to see a dozen companies
created in that space, with the net result being a bar room brawl in which only
one or two players emerge from the saloon bloody, bruised and vulnerable to
another fight.

So just as cut day in the NFL is not fun, this process in
the venture capital industry will not be easy or painless, but will net result
in stronger teams and a more healthy environment for the industry and
entrepreneurship as a whole.

Cloud Computing Trends and Opportunities

At Flybridge, we
periodically dive deep into areas in which we see significant market growth and
investment opportunity.  Recently, we did so in the whole field of Cloud
Computing and thought it would be interesting to share some of our thoughts.
 I would also like to thank our great summer associate,
Ravi Inukonda, who
worked with me over the last few months on this effort.

If you have been
following trends in enterprise IT as of late, you have been unable to miss
Cloud Computing and all the bad puns that normally accompany such commentary (“
Mostly Sunny for Company Opting for Cloud Computing
” or “Future bright for
cloud computing
” being two such examples).  

While the ideas are
not new – IBM called it Utility Computing back in 2002 – the Cloud Computing
trend really gained steam over the past couple of years.  The momentum is
more than marketing, as the advent of Cloud Computing has really been enabled
by advances in server/CPU architectures, storage and networking subsystems,
open source software adoption and most importantly virtualization, all of which
were perhaps too nascent to truly enable the cloud until recently.  In
addition to the technical advances, the current economic environment has
furthered these trends, as customers look for ways to reduce capital
expenditures and increase the efficiency of their IT operations.  As a
result, we now believe that Cloud Computing is at a tipping point and that it
represents a fundamental architectural shift that will create numerous
opportunities up and down the enterprise IT landscape. Past tipping points
include the shift to client server architectures, enabled by more powerful PCs
and widespread adoption of LANs, and the shift to Internet based three tier
enterprise applications, driven primarily by the adoption of the web.

Given that Cloud
Computing is used so frequently as an adjective, it is worth a quick segue to
define the term and architecture.  Simply put, cloud computing is
infrastructure or applications that are delivered as a massively scalable
service that is elastic in its ability to quickly scale up and down, where the
complexity is abstracted from the end user, that are paid for in some form of a
by the drink utility model.  Taking this down a level, we think about
clouds along two dimensions.

  1. From an
    architectural approach, cloud computing services tend to be Infrastructure as a
    Service, for example Amazon's EC2 compute platform, but also
    including other compute, networking and storage infrastructure; Platforms as a
    Service, for example's platform, that allow
    developers to rapidly build and deploy clound-based applications; or
    Applications as a Service (SaaS), such as Netsuite's ERP and accounting
  2. The other dimension
    is whether these services are offered to customers as public clouds by third
    party organizations, private clouds in an enterprise's own data-centers or as a
    hybrid of the two. 

From Flybridge’s lens as an early stage venture capital
investor, we believe that starting a company focused on public clouds offering
infrastructure as a service is a fool's errand.  In that field, the keys
to success are massive scale, a low cost of capital and operational excellence.
 These capabilities are in abundance at places like Amazon, Google and
Microsoft, but not at start-ups.  Further, we think that general purpose
Platforms as a Service are also difficult for start-ups given the need to drive
developer adoption and the long gestation cycle as the platform is built, users
recruited, applications deployed and ultimately scaled.  The exception to
this rule of thumb will be companies that successfully latch onto existing
developer communities, such as what Engine Yard has done for the Ruby
on Rails community.  Finally, we also believe that many of the horizontal
SaaS application opportunities have been played out.  Whether it is
Salesforce for CRM, NetSuite for ERP or Workday for HR, most if not all of the
obvious markets have credible, large, well-funded companies with market leading
positions offering solutions. 

Does that mean that all the promising
opportunities are already covered or are there big white space opportunities
for new companies?  We think there are a few trends and themes that offer
great promise, each one of which can support numerous successful companies:

  • Enable enterprise data centers to be more cloud like. CIOs of large
    companies that we speak to are generally concerned about control, security and
    delivering a good, reliable service to their end-users.  The first two
    issues lead to a generic concern with seeing any of their mission critical or
    sensitive applications hosted in a public cloud.  That said, the mere
    existence of services such as Amazon's Web Services puts pressure on their
    ability to deliver a good service to their end-users as they fundamentally
    change expectations.  If a user can have a full server OS, storage and
    networking provisioned on AWS in minutes, the current enterprise service level
    of weeks or months to provision the same looks pretty weak.  As a result,
    enterprise CIOs that are responsible for data centers will over time look to
    manage and operate these data centers much in the same way as a public cloud.
     This will, therefore, create opportunities around management,
    provisioning, billing, access control and other technologies that allow a
    private cloud to be effectively operated.  As an aside, there will also be
    an opportunity at the networking layer as the deployment of cloud architectures
    in enterprise IT data centers will create the need for high speed, low latency,
    low power, non-blocking network switches. 
  • Bridge the cloud
    and enterprise boundary.  The advent of public cloud infrastructure
    will create opportunities for companies that bridge the divide and smooth the
    transition between private and public clouds.  While there is a risk that
    the Platform as a Service vendors will view this as their domain, witness
    Amazon's recent VPC announcement there are many services such as backup
    and email archiving that benefit from a combination of on-premise and cloud
    based software that will be outside of the domain of the platform providers.
     The other approach that we see promise with along this front are
    applications and platforms that support cloud-bursting, in other words an
    application that runs most of the time in an enterprise data center but under
    heavy load relies on the public cloud for scalability.  
  • Provide tools
    to better manage cloud environments. Any time there is a fundamental
    architectural shift in the enterprise IT landscape, it has created
    opportunities for new companies to move more quickly into the space than
    incumbent vendors with installed bases to protect and legacy applications to
    support can.  These companies have generally focused on systems
    management, network management, security and the like.  This trend is
    already underway in the cloud market and can been seen in the success of
    companies such as RightScale and New Relic. In addition to
    tools for the management of the cloud, we also believe that new infrastructure
    services, such as horizontally scalable databases written solely for cloud
    applications, will see great adoption as more applications are written from the
    outset to be run in the cloud.
  • Develop SaaS
    applications for vertical markets. While there may not be much whitespace in
    major horizontal application markets, there are many vertical market niches
    that can support the creation of very large companies.  In these markets,
    a start-up can build deep domain knowledge around the problem set and offer its
    applications in a cost-effective manner (often leveraging public clouds for
    their infrastructure), making their solutions easier to adopt, maintain and extend
    as compared to traditional enterprise applications in the same field.  We
    are seeing this with the success of our insurance SaaS company, FirstBest
    , but there are numerous other examples in the healthcare IT,
    bio-medical research, energy and other fields.
  • Create companies
    that are enabled by the Cloud.  One of the aspects of cloud computing
    that excites us the most is that it is a huge enabler of innovation.
     Cloud computing makes it so easy to develop and deploy applications that
    it levels the playing field for start-ups versus large, well capitalized,
    competitors.  As an entrepreneur, I can now buy access to world-class data
    center infrastructure for dollars an hour that would have previously cost me
    millions to purchase and deploy.  As a result, savvy start-up executives
    can look to create companies that would have previously been too capital
    intensive to contemplate.  This is especially true if the computing need
    of such applications, for example software testing (see SOASTA for one such
    provider) or financial modeling are intermittent for any one customer but
    relatively smooth across many such customers.

Given the benefits
of a more flexible, dynamic and efficient IT environment, Cloud Computing,
under this name or new ones to come, will see significant adoption across the
enterprise IT market over the next several years. This will create many
opportunities for savvy entrepreneurs, so if you have ideas or thoughts, please
let us know!

The Rebirth of Enterprise IT

(This post pre-dates my own blog and first appeared on my partner Jeff's Seeing Both Sides.  While it is now dated – the first post was from September of 2007 – many of the thoughts still ring true so I thought I would include it here).

When Nicholas Carr wrote his now-famous Harvard Business Review article over four years ago, “IT Doesn’t Matter”, the most damning claim to our industry was that IT had become a commodity input – irrelevant as a source for strategic advantage. Many pundits, from Larry Ellison on down, began pontificating on the maturation, consolidation and eventual death of the enterprise software business – at least for companies whose names are not IBM, Microsoft, Oracle, SAP or Symantec.

The general thesis goes something like the following: 1) corporate IT departments are looking to reduce, not increase their number of vendors and are therefore not inclined to work with start-ups; 2) customers no longer are pursuing best of breed strategies, but instead want integrated suites to simplify deployment and operations; 3) the sales and marketing costs of large enterprise software solutions are extremely high and drive a need for significant investments that are beyond the capabilities of many early stage companies; 4) the overall rate of growth of the software industry as a whole has slowed and there are few areas for innovation. Common analogies used by these pundits include the maturation and consolidation of the automobile and railroad industries in the early to mid 1900s. Pretty depressing stuff.

In the last six years, many venture capitalists are submitting their own vote on this debate with their feet, as the percent of funding dollars to software companies has declined from 25% of all venture disbursements in 2001 to 19% in the first half of 2007. Anecdotally, when you walk the halls of VCs around Sand Hill Road and Route 128, you hear a similar refrain: “We’re diversifying away from software… we are experimenting with consumer-driven business models… we like Web 2.0/new media plays”.

So where does that leave a talented entrepreneur (or VC, for that matter) with deep experience in this now passé field? While challenges remain, we submit that there remain numerous glimmers of hope in the enterprise software market – and certainly the recent reopening of the IPO market and the more robust M&A environment has brought some of these to light. If you look at some of these recent successes, themes and strategies emerge that entrepreneurs can adopt to drive the creation of successful companies:

  • Innovate to drive efficiency. For many times over the last decade, enterprise software companies positioned themselves as automating certain functional departments of corporations. First it was manufacturing, then financials, supply chain, sales, marketing etc. If this is your view of the enterprise software environment, then by and large Larry Ellison is right – there is little room for new categories and innovation. That said, if you spend time with the average CIO, you will hear a different story. In today’s “post-bubble” environment, CIOs have seen their staff and capital budgets cut back, but the demands on their organizations from business executives have continued to increase as companies seek to have a more flexible and cost-effective IT organization to support their business plans. CIOs have gotten their much sought-after “seat at the table”, but with that seat comes the pressure of accountability to deliver bottom-line results. Compounding this challenge of doing more with less is the sheer magnitude of the accumulated applications and technologies that have been deployed by enterprises over the last 20 years. The number of lines of code, disparate pieces of software, and points of integration has exploded exponentially. As a result, there remains a robust opportunity for focused vendors to drive innovative technology into enterprises to drive efficiency in IT operations. The bar, however, is quite high. If you can’t drive a 5 to 10 times reduction in key metrics, the status quo will prevail. A recent success story is Bladelogic, which went public in July of 2007 and trades at 13 times trailing twelve moths revenue, primarily due to the company’s success in automating data center operations, a key means to drive efficiency in IT operations. Opsware, which HP just agreed to acquire for $1.65 billion, is another example and also demonstrates there is a relatively healthy M&A market, as these innovative companies fill key product gaps for large acquirers, such as IBM, Microsoft, Oracle, HP and EMC, as well as mid-sized public companies such as BMC, CA and Symantec.
  • Wrap your software in commodity hardware. One of the complaints you will often hear from IT departments about working with a new vendor is the challenge of integrating their solution into their already complex environments. The mundane, manual tasks of requisitioning and provisioning the necessary hardware to run, or even pilot, the shiny new piece of software slows the path to adoption. As a result, a number of innovative software companies don’t appear at first blush to be software companies at all. Instead they sell pre-provisioned, plug and run, hardware appliances. Companies that adopt this model are not only able to leverage Moore’s law to drive performance, but also can ship their customers a unit that can be slotted into a rack and up and running in hours, not days. This allows customers to trial the solution and see the benefits immediately, mitigating the long sales cycles that plague many traditional enterprise solutions. Further, the appliance approach tends to lead to easier adoption by channels that are better suited to selling hardware than complex software. This appliance strategy was seen initially in the security software industry, but has since spread to other areas such as storage back up solutions from companies such as Data Domain, which recently went public and currently commands a $1.4 billion market capitalization on trailing twelve months revenue of $76 million.
  • Dominate a niche. Start-ups are often caught in a quandary. To raise money and hire the best people, they need to convince VCs, employees and other supporters of the company of a big vision and the opportunity to capture a billion dollar market. To do so, however, they run the risk of going too broad, too quickly and losing the laser focused approach that allows young start-ups to win against large, incumbent vendors. A better strategy is to instead think about climbing a staircase. You know you want to reach the next floor, but you don’t do that by trying to jump up 13 stairs all at once. Ask yourself, “What can I uniquely do today for a customer that solves a real problem and also provides a link to doing more things for those customers in the future?” In today’s age of rapid development, componentized software and offshore resources, software code is relatively easy and cheap to write, and is no longer the “barrier to entry” and source of competitive advantage it was ten or twenty years ago. Instead, what matters to customers (and potential acquirers) is the deep, domain-specific knowledge instantiated in that software. For an early stage company to build this knowledge, they need to be incredibly focused in a given domain and make sure they have people on their team who understand a customer’s business better than the customer does themselves. Unica, a recently public $80 million in revenue marketing automation company in Boston is a good example of this. When they first got going, they had the best data mining tools for marketing analysts on the planet. Not a huge market, but one that valued innovation and provided a logical steppingstone to campaign management, lead generation, planning and the other marketing tools that the company sells today.
  • Explore SaaS (software-as-a-service). If the key barrier to success for early stage enterprise software companies is excessive sales and marketing costs, adopting a software-as-a-service model may be the right approach. This is more than just selling your software on a subscription versus perpetual license basis. Instead, SaaS is all about making it easy for customers to understand, try and, ultimately, gain value from your software. In 5 minutes and for no up front cost, I can become a user of Within the 30 day trial period, I can self-qualify and decide if it is the right solution for me and worth the on-going subscription cost. Most importantly, I can potentially do this without consuming a single dollar of their sales and marketing spend. None of the airplane trips, four-legged sales calls, custom demos, proofs of concept or lengthy contract negotiations that lead to the 6 to 12 month sales cycle that costs a traditional software firm 75% of their new license revenue in a given quarter.
  • Consider Open Source. Open-Source is not about free software, but rather products that have seen, or have the potential to see, widespread grassroots customer adoption. A passionate end-user community has the benefit of driving a development cycle that quickly surfaces key product requirements and needed bug fixes. Further, the grassroots adoption of the product provides a ready installed base of early adopters who will promote the product across their enterprise, purchase professional services and acquire more feature rich versions of the product. Like SaaS, this is a way to mitigate high sales and marketing costs. When My SQL looks for customers for the enterprise version of their open-source database, they have to look no further than the estimated 11 million active installations of their software or the 750,000 plus people that subscribe to their email newsletter. RedHat’s version of Linux, Jboss’s version of the application server and Sugar CRM are three other well-known open source success stories, but other opportunities abound.

Enterprise software entrepreneurship and investing is certainly not for the faint of heart, but when pursued with some combination of the strategies above, we believe interesting opportunities remain for innovative companies to make their mark in the world and have a positive impact. Contrary to the claims of many, it is still possible to build these companies in a relatively capital efficient manner. Sticking to some of the examples cited above, it is illuminating to note that Bladelogic raised $29 million of venture capital before its IPO, Data Domain $41 million, Unica $11 million, Red Hat $16 million and Jboss (pre-acquisition) $10 million. Only raised a lot of capital – $64 million – although almost 75% of that came in their last round when one would assume there was evidence the model was beginning to work.

In the end, we believe the analogy to the automotive industry is flawed. The manufacture and distribution of cars is fundamentally different from the software industry. In auto industry, there are tremendous benefits of scale, the underlying platform (tires, chassis, internal combustion engine, frame and skin) has remained the same for decades, and there is little room for small players to access end-users. Software, on the other hand, is a digital good and an information business. Innovation is limited only by the creativity of the author. Small teams can be extraordinarily productive – often times more so than larger teams and organizations. The underlying platform and architecture has changed several times in the last 30 years, and there is no physical product to distribute, thus end-users can be accessed much more directly. Is there a benefit to the incumbency and distribution might of IBM, Oracle or EMC? Absolutely. Does that mean there is no place for creativity, innovation and entrepreneurship in this industry? Absolutely not.