Five Years Too Late

February 26, 2009

Pitching 101: The Competitive Matrix

Filed under: Pitching — Tags: , — fiveyearstoolate @ 8:21 am
Eric Wiesen

Eric Wiesen

Pitching 101: The Competitive Matrix

In the last installation of Pitching 101 I applauded a company who had applied the best practice of doing research before pitching investors. Today’s chapter is about a practice of which I’m less fond.

As background, it goes without saying that we’re going to want to talk about competition in your space. We’re going to want to have this discussion first because we’re going to need to know whom you’re dealing with as a competitive set, but equally importantly, we need to get a sense of how you think about competition and about your competitors.

To this point, it has somehow become commonplace to include a “Competitive Matrix” slide that looks like this:

competitive-matrix

On the one hand, we get what you’re trying to say – you’re doing something very differentiated and very special. And in a sense, you’re trying to make good on the general investor worldview that if you’re going to compete with incumbents, your offering needs to be not just incrementally superior to them but a significant step forward.

But … come on. We know and you know that in only very rare cases is this slide even remotely accurate. In very rare cases can you legitimately cluster all your competitors, large and small, into the lower-left corner of the competitive matrix slide.

Most investors essentially ignore this slide except for the names of the competitors, about whom they’ll do their own research. At best, it’s a non-factor. But it also looks like you are hiding a scary competitive set of threats through chest-beating hyperbole. And at worst, it signals to investors that you don’t actually understand your competitive challenges. And that’s not something you want to communicate.

My suggestion for best practice is a willingness to have a frank conversation with investors about your competition. Below are some good answers I’ve heard from companies who do this well, answering the competitive question from different angles:

“Yes, XYZ company has raised a lot of money and was a year ahead of us, but they’ve executed poorly, their technology led them down a dead end, and we have won 10 out of 12 customer wins from them in the last six months, which is the real proof that even though they’re the big name, customers are looking for an excuse to leave them”.

“Sure, ABC company is the big name in the space, but they invested tremendous resources in building out a big global platform, and we use cloud services for everything we do. Until and unless they scrap everything they’ve done, we have a major cost structure advantage”.

“It’s true that Google could come around and crush us, but that’s true about almost every B2C web company. We’ve looked at what they’ve done in areas around our space, have talked to people at Google, and we’re comfortable this is not a high-priority area for them. But you’re right, you can never totally control for this.”

Ultimately, if you are really scared to give investors the true answer, and if that true answer is that you’re doing something incrementally better than an entrenched incumbent (or incumbents) or something without a lot of differentiation other than “we’re smarter and will do a better job”, you may be in the wrong business. Investors are going to figure that out whether you tell them upfront or not, but you’re much more likely to get constructive feedback and form a good relationship with investors if you play it straight with regard to competition.

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February 12, 2009

Rolling 8 the Hard Way

Filed under: Startups, venture capital — Tags: , , , , — fiveyearstoolate @ 5:45 pm
Eric Wiesen

Eric Wiesen

Stuart Ellman

Stuart Ellman

Experience in the venture business teaches many lessons. One that is often painfully learned is very easy to see from a distance but hard to see when down in the trenches. There are easy ways to make money and there are hard ways.

At one level this is intuitively obvious, but at another level, it’s clear that a lot of folks (founders and investors alike) don’t necessarily see the world through this lens, and as a result, a lot of businesses get started that are just not really geared to creating excellent investment returns.. At this point, we must make it clear that making money (i.e. generating profits), is not the same as successful deal exits. Many companies come in the door to our firm with clear paths to go from $10mm in revenues to $50mm in revenues and they are much less interesting as investment than some companies that have no revenues and fuzzy plans for profit generation but can solve large problems and will be highly sought after. This may seem confusing, but lets dig a little deeper. It really comes down to markets and competitive positioning..

What’s the easy way to make money? The easy way is the traditional way: solve a problem that lots of people have (or a very big problem that a few people have) and offer them a really good reason to pay you lots of money for what you made or do (we might call this a “value proposition”). Hopefully you’re doing it in a way that isn’t being done by a dozen other companies, and in a way that isn’t easily replicable by others. The easiest business in the world is one where you have something everyone needs and you’re the only one that has it. So if you could manage to situate yourself over the world’s biggest undiscovered oil well, you’d be set – you have something people need and (milkshakes not withstanding) you are very hard to displace. To use an example closer to home, a startup came to us looking for money. They had four people and an idea. The idea was a technically elegant way to create additional money for e-tailers with little downside. They had nothing built and two pilots lined up. They wanted a high valuation and they got many competing term sheets. They also had $0 revenues and it was unclear when they would really start to make money. Why was this deal “the easy way?” Because it was a hard ROI, created money in a sector that needed profits, was reasonably hard to copy, and whatever e-tailers used it had a competitive advantage. Therefore it would either get big very fast or get bought very quickly no matter what the financials looked like.

A friend recently asked, when told about this way of looking at companies, whether Google was an easy model or a hard one. And the truth is – Google was a hard model that turned into an incredibly easy one. If a startup came in the door and said, “we’re going to become the primary destination for search on the web, then sell ads against that search activity”, my guess is they’d have a hard time convincing us (or anyone else) how they would accomplish the first part of that, since changing consumer behavior around search is extremely challenging and expensive. However, if Google came in the door in 2001 and said, “We are already the primary destination for search on the web – now we’re going to sell ads against that search activity”, it would be moderately obvious how easy it would be for them to make money at it. Because the hard part of the model – building a huge stream of consumer activity – had already been accomplished.

So with that backdrop in mind, we’ve been looking at new deals that come in the door explicitly with this question in mind – does the company have an easy model or a hard model? This has particular resonance around B2C companies. While a lot of people in 2009 view the web as synonymous with “software”, B2C web companies that give their service away and monetize with ads (or other behind-the-scenes streams like lead generation) are media businesses, not software businesses. Those that charge for web services are software businesses. So – salesforce.com is a software business while Yahoo Finance is a media business. And startup media businesses are challenging, especially today. The really tough part is how many of them there are. As previously mentioned, there was an explosion of B2C web companies a couple of years ago, along with an explosion of ad networks launching to try to monetize them. This crowding, along with the current collapse in display ad rates, makes a web-based media startup (especially one starting from a dead stop) a very hard way to make money.

Let’s look at another example to compare the startup that sold to e-tailers above. A different startup came in selling a useful but inexpensive enterprise solution. It had $5mm in revenues, a clear pipeline for more sales up to $10mm, a very solid and earnest CEO and management team, solid reference accounts and well known VC backers. This is the “hard way.” Because this is a specific industry with large players that dominate the competitive landscape, the exit possibilities are few. The existing players are large and trade at about 1X revenues. Even if the startup struggles and really succeeds for the next five years, it will not be large enough to remain a standalone company and there will only be two to three potential acquirers who will not have the stock multiples to pay much more than the money being put into the company. And this is if everything goes right.

Without turning this into a portfolio survey for RRE, one thing we’ll note is that many of the companies in our portfolio that are continuing to do well even throughout this difficult economic period are those that have easy models – they make something someone (either businesses or consumers) need (or at least really want) and sell it in a relatively lightweight way. They are also answering unique problems and are changing the competitive paradigm of the industries in which they compete. And this learning will likely inform how we look at new opportunities that come in the door.

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February 5, 2009

Is Capital Efficiency the Enemy of Innovation?

Filed under: venture capital — Tags: , , , , , , — fiveyearstoolate @ 2:17 pm
Eric Wiesen

Eric Wiesen

I’ve been thinking about two themes that have generated a lot of discussion lately. The first is a growing sense that we are in a period of weak innovation; that Silicon Valley (and the rest of the US tech ecosystem) is broken, and that most of what’s being invented today is incremental, with no real innovation taking place. The second is strong focus on capital efficiency within the technology startup world.

At this point, given both the trends in web development and the macro economy, it’s practically a race between the entrepreneur pitching and the investor being pitched as to who will bring up how capital efficient the business is. The large majority of companies we see these days make a point of how capital efficient their models are, and the majority of investors (VCs and angels alike) are quick to dismiss companies that are viewed as capital inefficient.

Let’s step back for a moment and talk about what capital efficient means, and then we can get to the heart of the question. Capital efficient, in its simplest form, means you can accomplish a lot with a small amount of capital. And of course if you stop there, it sounds like an unadulterated good thing. More for less, right? And as a first-order question, I think the answer is yes. Doing more with less is a good thing.

But the second theme contextualizes the first for purposes of our question. We are in a period where much of the technology innovation taking place is in “soft technology”, be it software, web services, technology-enabled services or data businesses. And while it’s certainly an enabling environment that so many of the tools required to create these businesses have become commodity and free, there is an increasing concern that people are simply using free, easy tools to create slightly better versions of things that already exist.

Because how many of the really innovative technology companies throughout history were actually capital efficient? Whether we’re thinking about Edison Electric or Google, Amgen or Intel, Nvidia or Nucor, we often find that companies that really transformed industries with new technology or approaches took a large amount of capital and significant time to achieve it. And while these are clearly cherry-picked data points, I think that even on the web most of the really significant, innovative companies have taken in quite a bit of resources along the way.

I was recently on a panel with a friend of mine who’s an angel investor. And what shocked me was when he said that his group was looking primarily to invest in businesses that could, from a dead start, achieve profitability on significantly less than a million dollars of capital. And while, on its face, this sounds amazing – who wouldn’t want to invest in businesses like that? – another part of me really had to wonder, can you build anything interesting or important if that’s the hurdle you establish at the outset? Would any of the companies who have significantly raised the innovation bar have fit that screen, back then or now?

So I don’t think there’s a clear answer – we at RRE Ventures are clearly going to continue to seek businesses that can accomplish their goals with as little capital as possible, because it’s essentially obvious to do so. But I also agree with the criticism that “Web 2.0” has been at least in part an exercise in excessive capital efficiency, and that people were building incremental products and services with no real innovation in the hope of a quick flip or tuck-in acquisition. In the back of my head, I’m still going to be thinking about opportunities to create something really transformative, even if the road is a little longer and tougher.

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February 2, 2009

Like a Shark

Filed under: Uncategorized — fiveyearstoolate @ 2:09 pm
Stuart Ellman

Stuart Ellman

There is clearly a shakeout happening in the venture capital business. Because of the global financial collapse, a shortage of returns and the lack of an IPO market (two in the last week notwithstanding), new funds have become very hard to raise. But if you ask any venture capitalist, they will say that business is “as usual” and that they are looking for new deals. The dirty secret is that many venture capital firms are only looking at supporting some of their existing companies and will not invest in new deals, but will still take your call, let you stay up all night preparing your presentation and doing your research, and let you schlep up to see them and make your pitch. Why will they waste their time and yours pretending to do diligence on new deals? Because venture capitalists are like sharks in one significant way: if we stop moving, we are dead.

If a venture capital firm were to say that they are not investing in new businesses, they will be quickly forgotten. Word gets around and nobody will show them the new interesting deals, now or in the future. The game of venture capital is all about seeing the best deals. If a firm is the best in an area, whether geographic or vertical, it will see the best deals and entrepreneurs in those areas. As soon as the great deal flow stops (the crappy deal flow will always be there), a good firm may as well shut its doors. No firm wants to cut off the great deal flow. Even if capital is tight right now, there may always be some capital available if a deal is good enough. Also, the markets may loosen up for fund raising from limited partners and you never want to be out of the deal flow when that happens. So, it is in the best of interest of all venture capitalists to say that they are doing new deals even when they are not.

So how does an entrepreneur avoid wasting time with someone who is just looking around or trying to stay in the market, endlessly pitching firms who never say yes or no? One way is to see when a VC firm raised its latest fund and how much capital has been deployed. That can be hard figure out exactly but it is certainly best to find a firm that raised its newest fund within the last three years. The second way is to see if the VC firm has done at least two new deals in the last twelve months. If both those boxes are checked, the firm is probably still doing new deals.

We at RRE last raised a fund in 2007 and have plenty of dry powder. We have been very active on the new deal front and have a number of term sheets out right now. But we run across the same issues when looking for co-investors in deals. Entrepreneurs beware: Make sure the venture capital firms you are pitching are still swimming like sharks and not sinking to the bottom of the sea.

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