First,ten BUT...

Seth Godin's latest post "First, ten" highlights a classic start-up mistake, but for me misses an important step.
He suggests that you find ten people to use your service who "trust you/respect you/need you/listen to you...", that, " if they love it, you win. If they love it, they'll each find you ten more people (or a hundred or a thousand or, perhaps, just three). Repeat."
Seth Godin makes a key point here which we've seen many start-ups, large and small, all miss: if you require that your business grows virally, then all that spend on launch and PR is wasted if you do so when the product is not yet good enough to be viral by itself. That's not to say that PR etc. can't be great when you want to pour some petrol on that fire, but you're better saving up that fuel for when the fire is already spreading by itself.
However, I'd have to suggest some qualifiers. The test is not those "first ten", but whether those first ten start to "spread the virus" by themselves. That might well mean that they need to be considerably more than ten so that you can measure and understand them, but it certainly doesn't have to be ten thousand. Key to that viral spread is the communication from an existing user to a new one, and that's a tough barrier because the user chooses it, not you (how many different ways have you heard Twitter described?). My view is that Seth Godin's definition of the "first ten" might prove a little unrepresentative- they're clearly going to listen, and therefore give you the chance to communicate much more sophisticated and subtle ideas, you can "teach" new things, or even "un-teach" perceived wisdom. You could also get those first ten to think about what the service could mean to their lives and how they might use it, and it will be much more memorable. So I would suggest that the "first ten" test is necessary but not sufficient.
My suggestion, based on our portfolio, would be to aim for a larger group of people, grown gradually, and iterate the product, messaging and experience to the point that you start to see that demand is spreading "all by itself". Then go and get the petrol can!

How "recession-proof" is your business?

The most popular boast now from entrepreneurs seeking funding is that their business is, to some degree, "recession proof". Whilst it will be some time before we know the magnitude and implications of the economic situation, we can attempt to help our portfolio companies understand how vulnerable they may be. Fred Wilson had an excellent post on the strength of his portfolio using something he dubbed The Survival Matrix. I thought I'd extend this a little by putting together a kind of recession-proofness-test that draws in some of the other issues. Please take the precise numbers with a big "pinch of salt": I am not planning on defending any of the weightings or rankings. I'd welcome any debate about what's included, but my purpose is to highlight issues and help give people a feel for where they stand. When I tried this test on a few portfolio companies it certainly showed a wide disparity. At the lowest 45 points and the highest 109 points out of a theoretical maximum of around 220. My view is that companies upto perhaps 50/60 points really need to think hard and urgently about making what might be quite big departures from plan. Whereas around "100 points" perhaps a slightly more considered view makes more sense even if the actions taken are still pretty firm. I can't imagine many VC-backed companies will get anywhere close to 200! I hope this test helps a little for companies to focus on just how much and how urgently their plans need to adapt. I'm doing a presentation around this stuff at our portfolio seminar this morning which I'll post up too. You can find the calculator here.

Choosing an Entry Market Sector

A common issue I see with early-stage companies is over their selection of entry market sector. Obviously, all investors love their portfolio companies to have a huge vision to change large markets in a big way, and on occasion the best way to plan to reach that is to go straight to the big opportunity head-on. However, often that's going to be slow and hard, perhaps credibility is crucial, in which case it's really helpful to find a launch "beach-head" in the lines advocated by "Crossing The Chasm".
So where companies have chosen to use a beach-head, the next question is which one? If you just pick the "largest sector", or the one you're "most familiar with, you face a danger- the best entry sector is not always the obvious one. I think there's a different set of thinking about launch markets, where you highlight a slightly different set of factors as important.

Criterion	Ultimate market	Launch market
Scale	Ideally as large as possible	Manageable, but low priority in selection process
Differentiation of offering against competition	Important	Critical
Focus on customer problems	Can be more general- boxed product is easier to scale	May be helpful to have solution type sales initially
Unit sale	Very large or small is good- scalability is crucial	Ideally ~1 months burn- large enough to be useful, but small enough to avoid lengthy approvals
Mission criticality	Mission critical to the customer provides extra value	Ideally not too critical- hard to buy from a startup
Length of buy cycle	May be long	Short is incredibly helpful
Easy customer identification	Useful	Vital

I bet there are some great suggestions for improvements to this table- please let me know!

Plan B for Fundraising

Guy Kawasaki has an interesting post comparing the merits of bootstrapping vs. early VC backing which is well worth reading. He nicely positions bootstrapping as a Plan B, and certainly makes it appear quite an attractive option. My own take would be:

	Outcome
	Product Sells	Product Doesn't Sell
Venture Backed	You exit and have to share some of the rewards* with the VCs	The company fails and everyone is unhappy.
Bootstrapped	You exit, but probably only after raising some money to give yourself strategic options and thereby boost the price.	The company fails and everyone is unhappy.

(* in our experience ventures that have insufficient capital to have other strategic options get sold for a lower price, so maybe the rewards would not be so different too.) So my advice would be to understand the future for your business and really decide if VC money changes the potential outcome in a good way. If it doesn't then don't take the money just to give yourself a salary along the way!

Enterprise 2.0 - some great posts on the beauty of edge-in adoption

Nic Brisbourne at Esprit has put together a really concise post about the market entry strategy of Enterprise 2.0 companies. I totally agree with his premise and have thought it's one of the most exciting opportunities in the current arena. Maybe I've just missed it, but I'd really like to see a great example of this having worked. Please point me to any great examples, excepting perhaps Salesforce.com, which seems to be used as an exemplar for every enterprise software strategy in the last five years!

Fotango to smother Zimki on Christmas Eve

Canon's subsidiary Fontango had created something really interesting in "Zimki", a platform for building scalable applications- a kind of David vs Goliath approach to the space Amazon EC2 is trying to pursue.
Whilst the management at Fotango were keen to opensource the platform, Canon felt differently, with the result that the project has been pulled. Anyone who can explain how this was a good outcome for Canon I'd love to know!
Gervase Markham points out that by Canon pulling the platform, ironically, they've helped prove one of the main reasons why the platform needed to be opensource to work. Simon Wardley, Fotango's now ex-COO must feel thoroughly justified.

What type of web startup are you?

Rail Mail Sorting Slots
Originally uploaded by Potjie

I had a very thought provoking conversation yesterday with Lee Strafford the former CEO of Plusnet about web companies. One part of the conversation I think might be interesting was around classifying the different types of such companies by the way in which they build competitive barriers:

Class of barrier	Characteristics
Tech Heavy	Some piece of technology is strikingly difficult to do, perhaps requiring realtime communication or tricky client software to make it work. These companies can take a little longer and can raise money earlier in the adoption lifecycle due to the inherent IP. We've got a couple of these in the works, but they're in no hurry to tell the world what they're up to!
Execution orientated	In these cases the company is not doing anything that technically that groundbreaking, but they're getting the business model, user experience, pricing etc. right in a way incumbents with more inertia would struggle to do. Here the key is about speed and quality of execution. I think I'd probably put Yuuguu in this category at the moment...
Critical mass orientated	Lots of web1.0 gravestones here! This is where you have to find ways to get the kind of critical mass of users which means that the service can gain a strong lead. This is more like the Facebook model. To be honest we've only tried this once and we ran out of capital before we reached critical mass. You can't sell these early and the key is probably to find ways to reach that early audience cheaply. I believe that Facebook did this early by getting links with US colleges.

Perhaps it's interesting to think which model fits your company best, and then what that implies for strategy?

Economics of Software-as-a-Service

Talking to a former exec from an IM supplier to SMEs I gleaned some useful insight today. His company had sold a fairly standard type of secure IM to SMEs. To start off with they'd sold the software, installed on the customer's servers, on a rental model, mimicking the "Software-as-a-Service" approach which is now so popular with startups. However, he explained that the company had gained much more sales traction with customer when, after some time, they reverted to a classic upfront software licence and downstream support payment model. Whilst I could understand one or two customers feeling this way I was initially surprised that it was such a transformational change. I was surprised that customers weren't fairly uniformly delighted with being able to link the timing of the cost to the timing of their benefit.
Without knowing the details I can only speculate, but it did strike me that the USP for this provider's product was really about helping them feel secure in an application, IM, where their particular customers were less comfortable (otherwise I'd argue that there are loads of similar alternatives). So to some degree they were selling to maybe the "late majority" rather than "early adopters". Maybe these people in particular could be said to be rather slower to adapt to new models for buying software, but also perhaps to be characterised by a different cost of capital.

Cost of Capital

In economic terms most SME's, but especially early-stage technology companies, have a VERY highcost of capital (I've seen it figured out to be around 80%), whereas the customer's cost of capital- particularly if it is itself stable/mature (i.e. late majority), maybe more like 12-20%. It therefore makes little sense from a purely economic standpoint for an early stage company to use a "rental" type payment model for software provided to a customer who's an established business. Perhaps more simply put, an early-stage company may have to pay precious early-stage venture equity rates for money to fund the working capital element of providing a "rental model".

Summary of differences

I've attempted to put together what I could think were the key selection differences between a "rental" model and an "upfront" model.

"up-front" model	"rental" model
Favourable where vendor has higher cost-of-capital	Favourable where the vendor has lower cost-of-capital
Suits better laggard customers	Suits better early-adopter customers
High investment can make for reluctance to change out	Contractual commitments can keep customers "locked-in"
"Capital" budget can be harder for vendor to access	Contractual details on termination, rate increases etc can be harder to negotiate through purchasing
Upfront revenue particularly helpful where costs of acquiring customers are high	Rental revenues helpful where costs of supporting customers are high

(Please use the comments section below- I'm sure this is far from exhaustive- and I'll add your contributions into this table as best I can.)
You may be surprised to realise how strong the Cost-of-capital effect is in practice. Take the following example:

• Company A sells their system on a rental model for £10,000
• Company B sells the same thing on an upfront plus support basis for £15,000 upfront and £2,500 annual support charge.

The Net Present Value of both of these revenue streams for a early-start company with a 50% cost of capital is actually about the same (my workings are here), whereas I suspect that most of their customers would very much prefer to pay that little bit more for a perpetual licence!
As always your comments are very welcome.

"Applications Engineering" or Platform

Early stage investors like backing "platform" technologies, but everyone knows these are rather rare beasts. On the other hand customers buy solutions to their problems- especially if they're looking at using a cutting edge technology. This can put an early stage technology company in a bind that's particularly frustrating for company and potential investors alike.
Without naming-names, obviously, I've seen quite a few companies who are falling into this gap. A particular example I saw a few years ago, but with huge parallels to a much more recent applicant for funding, was looking at a sensor technology. This company had a technology with a particular set of USPs which took it well beyond the existing sensors. It also had some early customers keen to use their technology. So, the company believed, we should've been keen to pursue the investment. However, the problem was that the early customers had applications which didn't really use the USPs of the sensor. Indeed the main reason that the customers were so enthusiastic was that their inventor was willing to explore doing a relatively small volume sensor with a specification a little different from the off-the-shelf sensors from the big manufacturers. In essence then, although pitching as a "platform" they were addressing early customers who were buying because of the "application engineering" they could obtain from the hungry start-up.
Still, revenue is a good thing, so surely this "application engineering" model should've made the proposition more investable not less? Well, for us at least, it wasn't that simple. The company was tooling up in terms of management, team and core-competencies to match the "applications engineering" model, and that made us at least a little nervous that they'd be able to point the company towards the platform opportunity in a reasonable timescale.
I don't think there's an easy solution to this conundrum- at least I've not come across it yet- but I still believe it is a problem worth recognising when it makes itself known.