Startups Buying Startups…

Lots of news lately about startups buying startups: Strands acquires Expensr,  Zyb bought Immity, BuzzLogic acquires ActiveWeave, yada, yada.

Why do it?  Why would a startup want to be acquired by another startup?  Where’s the liquidity in that?  Why would a startup want to acquire a startup?  Isn’t that eye off ball?

Increasingly, one hears about these transactions, and the VC’s are quite interested in talking too.  And why not?  Startups are companies too, and they can use acquisitions to gain most of the same advantages big companies gain through buying other companies.  Let’s look at just a few of the reasons it might make sense:

Liquidity

Let’s dispatch this issue up front.  Immediate Liquidity is usually not on the agenda for a startup acquiring another start up, but it may be greatly accelerated and it may beat the alternative.  If a struggling startup is having a hard time getting to the next stage, it may be easier to merge with a stronger startup than to keep going it alone.  This is particularly true in this age when many companies are building products that are more like features or modules of a larger suite.  If their market is hot, they can make it all the way to buiding their own larger suite.  If it isn’t, or if they’re too late to the party, they may have to join someone else’s game.

From the acquiree’s perspective, it’s all about it being better to have a smaller slice of a much bigger pie.

Talent and Technology

When I was working for Borland back in its heyday, this was the number one reason we acquired so many little startups.  Our ideal profile was to identify a team of brilliant technologists who had built a wonderful product but just couldn’t manage to develop the sales and marketing chops needed to hit it big.

Finding great talent was hard, and building out a great product even harder.  Acquiring a little startup that had already gotten critical acclaim from customers was a way to shortcut the need to start from nothing. 

Often such acquisitions make it possible to tackle new markets that weren’t in the original plans, or they may simply make it possible to accelerate the plan of record by not having to build everything from scratch.

Market Share / Critical Mass

This is another motivation for acquisitions that I’ve seen taking shape.  Momentum is everything, and if a couple of strategic applications can rapidly pyramid the momentum, it’s well worth it. 

Filling Out the Story

Very often customers are telling the larger firm they’re missing an important piece of the puzzle, and some smaller entity may already have the piece in hand.  It takes a lot of work to build out a big vision and all of its pieces.  If a smaller firm is available that answers a question your customers are asking that you can’t currently answer, why not do a deal so you can give it to them?

Expect More Startups Acquiring Startups

Expect to see more startups acquiring startups, it makes sense for many of the same reasons bigger transactions have made sense.  The real issue will be getting all the parties aligned on the transaction.  The critical issue in every acquisition is valuation.  Nobody wants to acquire a company that everyone agrees is worthless.  But, will the acquirer have an over-inflated sense of its own worth relative to the acquiree?  Can the respective Boards of the two companies grasp the vision for synergy and figure out how to do a deal that makes sense for everyone?

That’s the real challenge, and those who are good at it will have a powerful new tool to grow startups faster at their disposal.

Umair, Dude, Uh, What? (On Fixing VC)

Umair Haque responds to the conversation surrounding his original posting on fixing venture capital.  It’s a good post.  Umair wants to stick to his guns, so it’s a refutation post rather than a deepending of the conversation.  Let’s take a look at what he’s saying, because I think he’s weakened his case more than he’s helped it.  Recall that his original thesis is that the reason VC is in trouble is that there aren’t enough Googles, and that the reason for that is people simply are selling out too soon.  They lack commitment.

First, RE Paul Graham’s response that Google wanted to sell out but didn’t get a high enough offer, Haque says Graham has missed the “strategic richness” of the story.  He admits Google shopped Page Rank for offers in the millions range, but then suggests they changed their minds and stuck to their guns as proven by their refusal to take offers in the $3B-5B range in 2002.

I’m don’t see how Haque really refutes Graham’s point with that.  I guess he’s saying that anyone motivated by money would have taken such an offer, and so Google’s founders clearly were motivated by a desire to change the world. 

I’ve no doubt they do want to change the world and are doing so, though I do wonder slightly how that reconciles with having shopped their deal early on.   The shopping business sure sounds more like what Graham was saying about a value disconnect.  Just out of curiousity, let’s play the numbers the way the iBankers would be presenting them to Google and their investors. 

Haque says there were $3-5B offers in 2002.  Google’s numbers for 2002 were $347M in revenue (4x what they were the year before), and the earnings were $186M (17x what they were the year before).  Most investors suggest that a PEG ratio (PE/Growth) of 1:1 represents a good buy.  So a “good buy” for Google’s 2002 earnings would be 1 x 17 x 186M = $3B.  In other words, $3B would have been a bargain for that business.  Clearly they also had to know pretty clearly that Google was hugely more successful than the vast majority of startups in terms of dollars, not just hype, and so deserved more than a bargain price.  Whether you’re motivated by money and financial sensibilities or changing the world, I can’t see why they’d spend much time on a $3B offer.   

By comparison, as I write this, Yahoo is trading at a 3x PEG which doesn’t even reflect Microsoft’s full offer value.  That would imply that back in 2002, for Google to be valued as Yahoo is today, it should have been valued at 3 x 17 x 186M or over $9B.  That’s almost 2x the $5B Haque says was at the high end.  And recall Google would’ve looked a lot hotter then than Yahoo does today in term’s of its potential.

Dude, Umair, it looks to me like Google didn’t get an offer that a cold blooded iBanker would have told them was what they were worth.  I gotta think the advice was to let it ride, we can triple the business again and go public at a better valuation.  Graham called this one right: blame the acquirers for being arrogant enough not to value Google properly.  Imagine if Microsoft had paid $10B then for Google instead of $42B for Yahoo today.  Of course Google probably wouldn’t have survived the assimilation.

BTW, the wonderful thing is that everyone’s interests would’ve been aligned–the money men would’ve held out for more, and the world changers would get to keep building an even bigger agent of change.  It’s a beautiful thing, and it has spawned one of the world’s greatest companies.

Next up, very little seed capital available, also credited to Paul Graham, and my major refrain here.  See for example, Where Did All the Software Seed Money Go?.  There’s a lot of transactions available, but very small dollar amounts.  Haque takes the VC’s to task on this, and that’s what I’ve been saying as well.

On to his response to Ashkan, who said basically Google had an unbelievable string of lucky market breaks.  Umair says basically, sure, but 2001, when Google was climbing rapidly, was an even tougher economy than today.  I think Haque’s perspective that firms influence and shape their environments is worthwhile.  To that, I would add the piling on effect of success.  People want to be associated with success.  Ashkan talks about those “exogenous factors” like they were all just luck.  Some were, but others were a function of folks wanting to align with the new new thing, which Google clearly was in 2001 giving their financial traction.  We see this time and again where one minute we can’t get people to return calls, and then they hear about success and suddenly its us not returning our calls.  We’re in agreement.

SmoothSpan is next up, which I’m flattered by, as Umair responds to my remarks on the subject.  Thanks for the link love, bro!  And if others are wondering what all the “Dude” talk is, I picked that up from Umair’s remarks when he characterizes my post as, “Dude, the IPO window’s been closed, by SmoothSpan.”  There’s something else there about NINJA loans and how the whole world could do IPO’s so why not VC’s?  BTW, those NINJA home loan guys have liquidity issues too, not sure they’re the best refutational role model.  But, dude, Umair, maybe its just me who thought the window closed, or maybe the business world also thought the IPO window was pretty tenuous during those years.  People like, um, BusinessWeek?

Heck, I may not know too much, I only just went through the core of that period at one of the few tech companies that did have an IPO back then (2nd guy on the left, yay!).  I might have heard a thing or two about how iBankers and VC’s think of the IPO market, but I probably just misinterpreted it.  NOT!

But it’s okay, Haque essentially goes on to say just what I said in my post, with, “the IPO window remained closed because venture guys weren’t investing seriously in meaningful new business models and markets – just in features and add-ons.”  We’re on the same page in the sense that this is what my post was all about. 

But, I think we view the way we got there differently.  I get the impression Umair thinks they just aren’t smart enough to invest in something besides features and add-ons.  In my experience, most VC’s are very smart people.  Many have extensive experience outside VC, have built companies on their own, and know many many entrepreneurs who they’ll be the first to admit they’ve learned from.  The trouble is, they’re sold on a model that says they can’t accurately predict what will succeed early on.  Who can blame them?  Seeing enough good ideas fail and going through economic hard times can do that.  So, they came up with the plan to invest later, after the world at large had validated the idea, and just pay for a higher valuation.  Again, this is not a dumb move.  It’s the Wisdom of Crowds at its best.

The trouble is, it is a good idea for an individual firm and a bad idea for an ecosystem.  If every firm goes that route, the seed money dries up.  How you gonna build much but features and add-ins for $250K in angel money?  Google had friggin’ $25M before they made a dime!  That’s why I say the problem is in the beginning, not in the middle with conviction (ala Umair), and not in the end with liquidity (ala Fred Wilson).  I’m all about the IPO window closure being somewhat temporary and said so in my post.  Sounds like we’re close to what an old friend used to call “violent agreement.”  We just came at it from different angles.

Umair muddies the waters a bit by bringing up Mixi and Megastudy, which apparently went public overseas.  He says my criteria (stable earnings, >$100M revenues, yada, yada) are bogus and there is an existence proof in these two companies of that.  Now mind you, Google way exceeded my criteria before they went public, and I thought that’s what we were talking about, but let’s look at Mixi and Megastudy and see if we can learn.

Mixi is out on the Tokyo Exchange listed at $50M in revenues with $10.7M in profit and trading at a $1B market cap.  How is this a counter-example, Umair?  These guys track Google pretty well.  If anything, I’d wonder why they needed to “sell out” in your terms so soon instead of following Google’s track?  After all, they’re profitable on $50M in revenue.  These guys fit my profile exactly for being able to IPO in the US in a year. 

How about Megastudy?  They’re on the Korean exchange.   They are doing $163M in revenue, $46M in profit, and a market cap of $2.3B.  Again, they have scale, they’re growing, they’re profitable, how is this different than what I’m suggesting for US markets?  Why are these guys so revolutionary and why are these other markets so much shrewder?

I don’t see these two as, “an existence proof that’s not the case.”  You don’t have to look too closely at the numbers to see that it’s quite the opposite.  Both are on a very Google-like track, could have followed my criteria, and IPO’d on the US markets, but they “sold out” to use Umair’s words and went public overseas, perhaps a bit sooner. 

Haque concludes by saying:

Dude, it was obvious that Google was, well, special - a general refrain. I think it was far from obvious: in 2002, Yahoo’s revenues were more than double those of Google. Google’s hypergrowth was dependent on the continuing success of AdWords, etc – and though it seems certain to us today, the very real story is that Google took massive risks to make AdWords truly revolutionary – while Yahoo evaded risk, and continued to buy and sell media exactly as it been bought and sold for the last century.

No Umair, I think it really was obvious that Google was special.  They were breaking all the records for startups of their size.  It’s one thing when this happens with your first $10M in revenue, and quite another when you are a $300M plus company.  Yahoo did evade risk, and to their downfall.  OTOH, perhaps it wasn’t even so much evading risk as it was in not having any deeper insight in what to do next.  A lack of vision in other words.  They are certainly not demonstrating any risk evasion in their Microsoft dealings today (they’re taking a high risk road to keep going on alone), and it’s the same decision makers. 

I love the passion Umair communicates: it’s good to get all fiery and romantic.  Startups need that to sustain them through thin times.  There are startups that sell too soon.  There are startups and VC’s that sell too late.  But a lack of passion and commitment is not the problem with the industry.  I meet tons of great passionate entrepreneurs with fascinating ideas.  Let’s get started building some new stuff besides features and add-ons.  No more feed aggregators, ways to Twit, Twitch, or Tweet on 27 different lifestreaming services, or other Inane 2.0 innovations. 

Let’s change the world.  On that I bet we can agree.

Are Entrepreneurs Happier Than Others?

From Fred Wilson’s great post “Ten Questions About Entrepreneurs” comes one that invites comment:

Are Entrepreneurs Happier Than Others?

Having founded 3 startups, I am generally a happy person.  I am happiest when my day is entirely entrepreneurial: doing what entrepreneurs do best.  I agree with Fred’s definition of what they do, BTW, which is turning ideas into businesses.  The act of creation, in general, is something I really enjoy.

Inevitably, there are also days that are decidely not entrepreneurial.  This happens more frequently as a company grows, although having been at Borland in the hey days, I can tell you a $500M a year company can still feel very entrepreneurial.

What is that feeling?  Well, having said what it is that entrepreneurs do, the feeling is one of momentum on that trajectory. 

Do you have momentum towards converting your organization’s ideas to businesses?  Does your organization even think about creating new businesses, or are  you mired in survival mode?  Does your team think about creating new businesses, or are they more internally focused on some other issue?

Political infighting, expense cutting, post-acquisition transitions, these are all decidely non-entrepreneurial focuses.  Sometimes they’re essential to the health of the business, but they’re anathema to the entrepreneurs.  I’ve said for a long time that a large company’s ability to keep growing is a function of how well it cares for its entrepreneurs.  After all, every product peaks.  If you can’t start new businesses, how do you get beyond your plateau?  You’d better either be able to nurture your entrepreneurs, or you’d better get good at the acquisition game.

Oracle, when I was there, was lousy at nurturing entrepreneurs.  They, including me, couldn’t wait to move on.  Google, OTOH, seems to have a remarkably entrepreneurial flair.  It will be interesting to see if they have the management and organizational chops to take their herd of small businesses and get them to the next stage before the core plateaus.

As for me, I’m on the lookout for my next opportunity to translate ideas into businesses.

The Disruptive Entrepreneur’s Dilemma: Seeds Ain’t What They Used to Be

Robert Scoble has an interesting post. He muses about the difficulty one entrepreneur has getting funded versus another.  Andrew Mobbs has a dream of using cell phones to replace credit cards.  It’s an interesting idea.  The trouble he has is a little chicken-and-egg problem.  It’s a big idea that requires a fair amount of capital to test.  In the old days, there were lots of deals rambling around where “a guy and a slideshow” could get a couple of million dollars to build the product and get the first customers.  Yet investors these days expect you to come to them with ideas that are at least partially tested.  They’ve moved out of the seed business, despite what various rounds may be called.  The current paradigm expects you to develop your 1.0 product and get some initial customers signed up for it on angel money.  That typically means $500K to $1M at most. 

Scoble contrasts Mobbs idea with that of Omar Hamoui’s AdMob, which is a mobile advertising network.  Apparently it got funded by top-tier firm Sequoia within 24 hours.  Why?  Because they had a product and customers before they went calling on VC’s.

The Seed Funding business has gone way South in the wake of the last Dot Com bubble bursting.  I’ve written about this before and put together some data on it:

I’m sure the VC community feels like they’ve taken a less risky approach that will improve returns, but you have to wonder.  Returns tanked almost in exact synchrony with the move out of seed funding:

There’s another important factor at work here that Scoble touches on.  Reducing access to capital will tend to focus the deal flow around deals that can get done with minimal capital.  That’s why we see so many me-too ho-hum Web 2.0 deals.  It’s easy to build the software.  The Valley and its current bootstrapping strategy has got everyone focused on quick experiments that don’t add a lot of value.  It’s fun, but it seems to be largely a fad that isn’t discovering many new killer apps.  What happened to asking whether an idea is a feature, a product, or a business?  How does Fred Wilson’s new investment baby, Disqus, add lasting value?  It’s an add-on to blog comments.  In other words, a feature, not an application or a business.  Why can’t the top 2 or 3 blogging platforms add the Disqus functionality and commoditize it out of a future?  It’s not even that there’s just one of these.   We also have IntenseDebate, TechStars, SezWho, and CoComment.  Wow, now there are 5 companies focused on this feature for blogs?

Mathew Ingram reports that Fred Wilson says that he seesthe company as doing for comments what RSS did for blog posts and other information, and that Disqus could be the one that “unlocks comments from blogs and brings them into the mainstream” and also “surfaces the most interesting blog comments and blog commenters.”   Let’s suppose they’re successful, which is a big if, because I’m not sure comments are as valuable as RSS.  RSS boiled down to one company, as David Winer has lamented, and that was Feedburner.

There’s a whole passle of similar deals out there.  I just signed up for the latest wunderkind, FriendFeed, becauseScoble said he’d converted and saw it as a TechMeme and Google Reader killer.  Scoble got bored with TechMeme because of the sameness and big media presence (yeah, I warned you this would be the case) and he was fed up with the performance of Google Reader.  ”Does FriendFeed solve a problem or highlight it?” asks Josh Catone.  Well, it puts things in one place, sort of.  I haven’t found a way to import the OPML from Google Reader yet so I don’t know how Scoble imported his 800-1000 feeds.  Perhaps he’s just quit reading them and gone totally aTwitter.   But, now that you have all that stuff there, it seems like you’re tee’d up to be a total Attention Overload victim.  I can’t see much in the way of tools to help you manage that.  It’s just another simple minded piece of software that’s cute and was quick and cheap to build with modern web technology, but does it really help anybody?  Is it profound.  No.

Maybe it’s time for VC’s to move on from Web 2.0, at least if this is as fresh as it’s going to get.  Marshall Kilpatrick points out that the long tail is absent from MySpace just as on Facebook.  I’m not sure it’s really absent, but it is pretty slim pickings.  More importantly, maybe its time to actually consider looking into funding something significant.  VC’s are not unlike any other portfolio manager.  If their portfolios are too highly correlated, risk increases.  If they’re correlated with their whole market, their returns regress to the mean. 

Who is going to do something different to change this boring status quo?  What Would Warren Buffet Say About VC Investing Today?  We’re missing out on a lot of good ideas simply because the initial capital required is too great for today’s model.

Time to move on, these are not the droids you’re looking for.

Related Articles

VC Confab:  Please, no more Social Networks…

Web Services Not Web Sites: Monetization Just Got Harder

“The Future is Web Services, Not Web Sites,” says Steve Rubel.  Rubel’s point is that every site can’t be a destination.  Aggregation will happen because the Attention Crash will force it ot happen.  The way to survival is therefore not creating sites, but creating web services so that whichever destination your “eyeballs”, excuse me “customers”, move to, they can still get your content via an API.  Fred Wilson says, “You cannot be a destination exclusively on the Internet anymore. If you are not a open web service, you won’t get nearly as far these days.”  He’s goes on to cite Twitter and its api as proof that the strategy works because now Twitter is everywhere.  Google and Facebook are vying to see who can set the standard for how these api’s should work.  MySpace is just rolling out their Open Social support.  YouTube is suddenly offering to be something of a white label video service. 

These days, you can’t just be a web site, and you’re likely not successful enough to be a platform, so you neeed to make sure you can be a service on someone else’s platform or destination web site.  Yahoo has opened up search, want to be a service on their platform/destination?  Heck, Will Fastie just quit his job as powerful Hummer Winblad VC to go be CEO of a widget company: clearly he believes and voted with his feet.  Widgets are neither fish nor foul in my mind.  They’re sort of like being a destination because you moved in and squatted on someone else’s destination.  Oops, there goes the neighborhood!  Amazon gets it and has rolled out Facebook widgets so your friends can buy you the books you want without ever leaving Facebook.

Is this really what the future holds?  Is it healthy, sustainable, vibrant, and most importantly for the continued deal flow, is it lucrative?  Michael Arrington brings us a bit of counterpoint.  He wonders why people will want to access things they mostly can and should access elsewhere in FriendFeed?  Why go to FriendFeed to Twitter instead of Twitter itself?  The vast majority of what’s being read in FriendFeed is Twitter, Blogs, and Google Reader (more blogs?).

I agree with Arrington.  I don’t think folks have thought through very well what this all means strategically and financially.  There is a great deal of risk lurking out there.  This is one of those times when there is a race of gripping one hand above the other on the baseball bat and eventually there will be no room left to grip.  Conventional wisdom likes to ask whether a new startup idea is a feature, a product, or a business.  If players are not real careful, becoming a web service is making the strategic decision to become a feature on someone else’s product.

And what about the aggregators?  Why let someone new like FriendFeed even get a foothold?  Let’s take the grungiest, oldest, most out of date aggregator on the planet, and ask what we’d do if we were driving the bus.  I’m referring to Microsoft Outlook, of course.  It can sort of do RSS feeds already.  I would do a total facelift on the thing and kick it up a notch.  Make Outlook the be all and end all aggregator.  Make it do Twitter, blogs, and every other conceivable thing.  And while we’re at it, let’s make it do these things well.  Let’s Silverlight enable it.  Wouldn’t that be a kick in the head from Microsoft?  Isn’t just the thought of it a cautionary tale for how this can wind up?  As everyone becomes a service, we lower the friction.  As so often happens, and as is so counterintuitive, lowering friction here will reduce diversity of aggregators.  There’s just not enough differentiation to sustain a lot of players, so the Microsofts and Googles can win.  Maybe this is the value of Yahoo to Microsoft.  It can be the destination site for everyone else whom Microsoft can regard merely as a web service.

How the heck do you monetize these web services in a world like that?  You’ve ceded the value of being the destination.  You have customers, but only by virtue of your destination partners.  What are you really?  You’re the OEM software that gets bundled with the PC.  Anyone who has ever been involved in one of those deals knows it’s a sorry business.  There’s no money in it.  You become the flavor du jour:  here on today’s PC, replaced by something fresher on tomorrow’s PC.  You are absolutely not in control of your destiny and you wander the world hat in hand.

Rubel is right.  Every site can’t be a destination.  It is probably better to take sloppy seconds than not to exist at all.  But have no illusions about building a huge business around this stuff.  I think it will be very hard.  Will Fastie may in fact be in a good place.  He, at least, is selling blue jeans and pans to the gold miners rather than heading out on the Yukon trail himself.  Trust a wily VC to see the silver lining in the dark cloud!

Is Startup Software “Bought” or “Sold”? Startups Discover Demand, They Don’t Create It… (And Zoho HCM is Out!)

Got an email note from Zoli Erdos, whom I read religiously, about a new SaaS HCM offering from Zoho that’s being launched this morning.  Cool!  Love to see more SaaS entrants.  I believe fervently in the model.

Zoho has been a fascinating company to watch because they produce so much.  Here is a startup sized company that is just cranking out products right and left.  And they’re quite good too!  The thing is, there is so much activity, at times I’ve wondered what they’re up to.  What ties it all together?  Zoli’s note this morning had the answer, at least an answer that I latched onto.  In it was a short passage that speaks volumes:

…there are no marketing and sales plans.  It will just be released out on the wild, like all other Zoho apps.  I am known to be a fan of the “pull-model”, software “bought” rather then sold, …

I too am a big believer in the “pull-model”.  I don’t believe startups can create demand.  They are too weak, they don’t have enough money, and demand is way to expensive for them to create when you look at how conventional companies go about creating demand.  Instead, startups discover demand.  I like to use an analogy for what demand discovery is like that’s fairly graphic.  I liken it to breaking through the window on a jet airliner.  We’ve all seen the movie clips where one minute things are pretty calm and then the window gets broken and suddenly there are hurricane force winds and it’s all anyone can do to keep from being blown out into the void.

When a startup is searching for the right product/market fit, they’re tapping on various windows with a hammer.  The window itself is brittle, and not all that hard to break.  It represents getting the word out to a large enough critical mass that you can tell whether the hurricane will develop.  Most windows have dead air behind them, so you have to keep looking.  If you hit on the right one, you’ll be catapulted into a growth crowth that will take all your energy just to keep up with.

Coming back to Zoho, they’ve clearly figured this out.  They’re tapping on windows like crazy, and by all accounts they’ve found several promising ones.  Perhaps this new SaaS HCM application will be the latest.  Check it out.  The first 10 users are free for your organization.

Zoli, in a follow on post asks whether it isn’t crazy for an enterprise app to be launched simply by announcing it, without sales or marketing.  I don’t see this as all that crazy.  I’m not saying you don’t need sales and marketing, but I do think it can be brought to bear prematurely, particularly for startups where cash is king.

This comes under the heading of marketing and sales being “tragically knowable.”  Many companies do tests of messaging before putting wood behind the arrow.  Traditionally, this is done in secret, with focus groups and one way mirrors.  But why keep things secret?  The web lets us move faster and with less friction.  By launching the package without much fanfare, Zoho gets to see who wants to be an early adopter.  They can look for themes among that crowd and then amplify those themes with sales and marketing to bring more along.  I think it is an interesting way to change the order things are done in.

The biggest risk for startups is lack of information.  They should be far enough off the beaten path that they’re not just doing what the big players are doing.  To combat the lack of information they have to get out there and collect some.  When you’re dealing with uncertainty, setting up a Darwinian system with lots of cheap experiments works.  Monitor the results, double down on what works, and try some more experiments.  Eventually you’ll find the right window.  You will discover the demand that’s waiting for your startup and its products.

Startups Have One Job: Get to Their Product/Market Fit ASAP

Lots of folks are optimizing for a proxy, instead of for the real problem when it comes to startups.   It is very easy to think you’re optimizing for the right thing, but to find out later you optimized something peripheral, a proxy for the right thing.  The trouble with proxies is that they contain enough of a grain of truth to be distracting without really guaranteeing you’ll get what you want. 

What every startup needs to be doing with all it’s energy and resources is getting to a product/market fit as soon as possible.  Achieving product/market fit is having a great product, where “great” is defined by market uptake.  Let’s look at some of the conversations in the blogosphere about what startups need to do to be successful and analyze it in the light of achieving product/market fit.

There are two big areas that seem to be centers of controversy:

1.  A startup’s job is not to save money, it is to spend it in whatever manner gets it to a successful product/market fit as fast as possible.

Jason Calcanis, Michael Arrington, Fred Wilson, and others have said that startups have to save money.

Money is the ultimate fungible tool.  Save it only so that you can spend it on something more important to achieving a product/market fit.  I see a lot of folks getting wound up to save money for all the right reasons, but in the process they create work and friction that slows down the process of getting to a product/market fit.

Some of the big ideas for saving money make me wonder:

-  Outsourcing:  Great idea to outsource things that don’t matter to your distinctive competency (which is getting to a product/market fit!).   HR and accounting, sure.  BTW, it may cost you more to do this, but it keeps the distractions away.  OTOH, outsourcing to the midwest to get talent cheaper as Calcanis suggests makes me wonder.  Productive software development is all about good communication.  Any outsourcing, working too much from home, or remoting interferes with communication.  Are you moving close to product/market fit doing that?

-  Don’t buy a phone system, nobody will use it.  This really depends on the startup and business model, and I’m sure the folks recommending it have models that are commensurate.  A SaaS company will likely still still need a salesforce of some kind and they’ll need a phone system to talk to customers.  A social network will not.  There are no blanket suggestions–all are viewed int erms of what impact they have on achieving product/market fit.

-  Bring lunch and coffee in, don’t let people go out.  I could not disagree more.  My favorite setting for a startup is a downtown area.  My last company, Callidus, was in downtown San Jose.  There was a Starbucks and a Peets across the street and dozens of bistros for lunch.  Calcanis underestimates the value a good break can have in clearing the mind for renewed energy.  He also underestimates the value of unstructured communication and getting a little exercise with a short walk.  Trying to keep people bottled up interferes with creativity, clear thinking, and communication.  It is a false economy.

2.  A startup’s job is neither to fire people who are not workaholics nor to molly coddle diletantes who like the idea of being in a startup but who aren’t producing results.  It’s job is to bring together the people that are going to produce that product/market fit as fast as possible in an environment that facilitates their doing so.

This was a big source of the firestorm backlash against Calcanis.  Mike Arrington and Zoli Erdos are on Calcanis’ side in cracking the whip.  It’s a pretty common attitude, especially among the higher ups.  But it doesn’t always work. 

The problem is in equating activity with results.  I’m here to tell you that for creative pursuits, and software is one such, that is not necessarily the right thing.  It is a function of the people and the stage things are at.  It is a function that it is very hard to schedule inspiration.  There is often a stage at the beginning of a startup’s life that just requires a lot of brainstorming.  It isn’t about grinding out a product.  Zoli is closest in saying that passion counts, but passion may not express itself as cubic man hours in front of a computer or at one’s desk.

In the end, these 2 ideas of saving money and hiring workaholics are micromanagement, not epiphanys.  They are not the secrets to startup success.  I’m not even sure they’re highly correlated to startup success.  They’re worth thinking about, but think harder about how to drive faster to you product/market fit.

The Hidden Gems that Social Graphs Bring to Light

YouNoodle.com claims to be able to predict which startups are more likely to succeed.  While I hesitate to endorse the idea that their predictions are accurate, the methods are quite interesting.  According to the NY Times that introduced YouNoodle from stealth:

their algorithm uses sophisticated modeling pertaining to how social capital and networks can affect an organization’s performance.

They also say that they are focusing in general on assessing the experiences and social and business contacts of entrepreneurs who start a company, and on how the entrepreneurs within that company might fit with one another. They will not disclose precisely what factors they use to predict a start-up’s success, or how their algorithm processes those factors.

If you visit the site, YouNoodle is still not revealing all, but it looks a lot like a social network for startups.  Here’s the entry for startup SnapTalent, for example.

What does all this have with the likelihood for success?  I can but speculate, but my speculation goes something like this, and is based on my own experiences as an entreprenuer.  I suspect the Social Graph piece is attempting to determine whether the founders are connected enough to reach critical mass in getting their ideas noticed.  That fits well with “using sophisticated modeling pertaining to how social capital and networks can influence an organization’s performance.” 

Can a startup succeed without social capital?  I doubt it.  After all, they have to get the word out somehow.  I’ve suggested in the past that maybe startups ought to insist on having a top-notch blogger on staff, but these guys are taking it another step up altogether.  They seem to insist that a startup be sufficiently linked in to the right groups of people.  It’s a fascinating premise.  As we interact with the web, we leave behind our footprints.  Suitable forensic research can determine from those footprints something about our networking and sales skills.

A lot more is likely possible from a detailed analysis of Social Interactions on the Web.  LinkedIn recently announced they were going after the investment community.  Tim O’Reilly described the service thusly:

While the service isn’t going live for several months, Mike outlined the core of the value proposition, which I could sum up as a Web 2.0 version of the Gerson-Lehman Group’s expert network. Gerson (or GLG as it is often called) has made a splash in investment research by assembling a network of experts on virtually any topic. Subscribers pay a hefty subscription fee for access to that network.

Think about it.  If it’s true that it isn’t what you know but who you know, the Internet could be the ultimate wealth enabler.  This kind of information is very new in the world.  Even ten years ago, what mechanism would have been available to assess from afar how well networked various people are?  Social Graphs are revealing new and compelling hidden gems of insight that can be mined for various purposes.

What other uses can such information be put to?

Microsoft + Yahoo the Only Counter-Google Combination that Makes Sense? (The Force is Strong in Another One)

Microsoft’s unsolicited bid for Yahoo sure has the blogosphere working overtime.  There are lists of what products will stay or go.  The answer is that those products that are aligned with Microsoft’s strategic intentions and are not redundant will stay, but they will have to be rewritten to fit those strategic intentions in Microsoft’s de riguer .NET tool set.  Some of the key questions and thoughts boil down to:

- Email is really big for Yahoo.  But how does their cloud computing offering square with Microsoft Outlook and the Exchange business?  I’d hate to deal with just the meetings that will be required to decide who will be in charge of the overall Microsoft E-mail efforts and what trade offs will be made.  You can count on some eggs being broken while that omelette is made.

-  The Email question is just the biggest piece of an overall question:  Will Microsoft use Yahoo to accelerate a move into the cloud, possibly weakening some of their existing desktop software, or will they stick to their guns?  ZDNet says ask Ray Ozzie, who has been making the right cloud noises, but Microsoft is extremely adept at talking the talk while walking a completely different walk.  Jeff Jarvis puts it well, “I’ll bet that Microsoft is just as likely to destroy as to exploit what it gets from Yahoo. That is often the history of these takeovers, when a company tries to buy the strategy it doesn’t have: AOL and Netscape, Time Warner and AOL, Yahoo and Broadcast.com, and on and on.”  I’ve seen several of these from both sides, and what is about to happen is a collosal tussle of personalities and ideas.  It gets very emotional, very aligned with interpersonal issues, and often will not make much sense after it’s done.  Anything can and will be rationalized in the heat of battle.

-  I think OpenID will be a great test question for how the new behemoth will operate.  If they unconditionally adopt it across all Microsoft + Yahoo properties, that’s a good sign.  If they weasle at all, that’s a bad sign.

-  Microsoft has likely made their business case on the idea that advertising and search synergy pay enough to make the deal worthwhile.  The rest is just icing on the cake.  Don’t look for them to exercise too much care preserving every last bit of the icing.  Some products will die.  It will be done quietly, but it will be done.  Customers will wake up one day to discover it’s over for their product, and I’ll bet very little warning will be given.  It’ll take at least a year even to sort through it all and decide.

There are discussions about how Google and others can and are trying to block or slow down the shotgun wedding:

- Scott Schnaars recalls how Microsoft spent tens of millions of dollars hiring the key talent away from Borland.  This was a little while after I left Borland, but I remember the exodus of talent, and it was truly debilitating when people like Anders Hejslberg left the Delphi group to go to Microsoft and build things like C#.  It’s a lot cheaper to drain talent this way than to beat Microsoft’s $44B offer, but I wonder if it would be as effective with Yahoo?  I’m not saying they don’t have talent, but it isn’t clear there are key people aligned with a few key offerings that matter enough to do harm if the people are snagged.  So I don’t think it’s worth making truly ridiculous offers, but it is probably very worthwhile to make generous offers if companies see valuable talent that is already unhappy about going to work for Microsoft.

- The anti-trust argument is fascinating.  On the one hand, Google couldn’t buy Yahoo without falling prey to monopolist complaints.  On the other, Microsoft claims this is good for competition, but there is potential fallout.  Cote worries about the impact on Firefox versus IE, for example.  Make no mistake, Firefox is out and IE is in at MicroHoo.  Nicholas Carr puts it well when he says that when Google adopted “don’t be evil” as the cornerstone of its corporate code of conduct, what it really meant was “don’t be Microsoft.”  That’s really the fear many have, and they are right to be afraid.  Soon Yahoo, a very decent company on the “don’t be evil” scale will be a tool of Microsoft.  OTOH, Read/Write Web’s poll indicates most people see this as fear mongering and not a real monopoly threat.  In their view, Google can’t claim to be David to Goliath.  While Google is no David, you have to laugh at Microsoft’s claims that it is the saviour of openness. 

- There are strategies Yahoo could pursue.  It could tie up its search business inextricably by making a deal with Google that can’t be broken.  Remember Peoplesoft’s deal to allow customers to get all their money back if support and new releases for products were dropped?  Similar thinking.  Didn’t stop Oracle or even slow it down much.  Find another suitor?  News Corp, Apple, Private Equity, eBay are all mentioned.  The problem is that Yahoo is more valuable to Microsoft than any of these, and MSFT is well-equipped to pay more.

Of course there is also a large contingent that say this acquisition isn’t the next big thing, which is where I’m at.  One of the funniest is Fake Steve Jobs’ “Monkey Boy’s Three Legged Race.”  Those that think this acqusition is no threat to Google at all wonder why Google bothers to fight it at all.  In fact, if, as many have said, it is good news for Google, why not encourage it?  In this respect, Scoble has it exactly right in terms of what Google is doing.  The reason the deal is good for Google is because these mergers are so messy.  Nothing gets done for a long time.  Key people leave.  Those that stay spend way too much time thinking and talking about it no matter what Jerry Yang tells them.  If Google can prolong and deepen the uncertainty, it compounds this effect, even if the deal goes through.  Google has little to lose playing this time honored game, and potentially a lot to win as each day devalues the transaction.  Henry Blodget maps out what a disaster this deal can be for both companies, from the pre-deal purgatory Google wants to extend to the idea that Microsoft is ill-prepared to start fighting yet another way.

While I do think the deal is not the best news for Microsoft, and is good news for Google, others are very much afraid the deal is terrible for Silicon Valley in general.  There is concern that a Microsoft+Yahoo marriage eliminates a prolific acquirer and could thereby put a damper on the Internet startup game.  Bill Burnham’s post on why the merger is bad for Silicon Valley is probably the seminal essay on the topic, but Fred Wilson takes up the refrain as well.  The last time the bubble burst, VC returns never did come back and there has been a dearth of seed funding from VC’s ever since.  While VC’s often seem to have an almost pathological need to find something to worry about, this one is interesting. 

On the one hand, it’s hard to imagine that so many Internet startups have been counting on just one company like Yahoo to make it all worthwhile.  Can the loss of one player really close down the party?  On the other hand, as was pointed out in the articles I mentioned, part of it was the competition between the big giants that drove up valuations.  The other thing the analysis overlooks is just how prolific an acquirer Yahoo can afford to be if it continues independently.  These guys are at the point of sharpening all available pencils.  Yahoo Music Unlimited, for example, is being shut down and traffic redirected to Rhapsody.  More of that sort of thing will follow regardless of whether Yahoo is acquired.  Fred Wilson points out that people were already starting to leave Yahoo’s services like Flickr and Delicious and MyBlogLog.  The Microsoft thing is just the wake up call telling folks its time to smell the coffee.

Dare Obasanjo asks if you ran Microsoft and didn’t like the Yahoo deal, “What would you do instead?”  I’d buy Amazon if I could.  I think it is a much more interesting play.  Yahoo isn’t strategic, it’s market share.  Traffic, in other words.  There is not a single jewel in Yahoo’s crown that is really strategic.  Yes, they can help grow Microsoft’s search business and portal businesses, but it’s very tactical.  The most likely strategic move would be to place a big bet on Yahoo’s cloud email over Outlook+Exchange, but I have a darned hard time seeing that.

But where did this Amazon thing come from?  I think Amazon is the next up and comer on the web in terms of big scale.  Huh?  That’s right.  Here’s why if Microsoft wants to own a big web property and a strategic one at that, they should buy Amazon:

They own a hugely valuable search franchise: shopping

You want search?  How about shopping search?  Now imagine feeding additional traffic from Microsoft’s other venues through that.  Now add to that even more traffic because Microsoft could afford to buy Amazon as well as Yahoo.  One of the reasons search is so important to advertising is because people often search just before they buy.  An ad picked up during that important period is much more likely to influence behaviour than an ad that runs while a user isn’t even thinking of buying, for example when they’re watching a funny YouTube video.  But Amazon is a search engine for many many e-tailers.  If you are on Amazon you know folks are ready to buy.  Yes, it’s more cosumery and less technie than we think of Microsoft, but it would be a very valuable addition to their empire.  And, according to Compete.com, Amazon gets nearly as many visitors as MSN.com each month.  The difference is these people are all shopping and presumably ready to spend money.  No wonder Amazon’s market cap is higher than Yahoo’s was before Microsoft floated an offer.

MicroZon is geographically proximate and easier to digest in every way

Hey, both companies are in Seattle.  Amazon does not consist of a million little unrelated divisions that were once separate companies that got poorly glued together.  Amazon does not have a disaffected staff that was already in the process of walking out the door.  They are not being run by a founder that was off on vacation while a technophobe ran the company for years.  They are a healthy entity that could be brought in relatively undisturbed as a division at Microsoft.  Yahoo will require a massive amount of surgery, some tissue will die, and other tissue will have to be removed.

Google can’t just absorb the value by attrition

Nothing about combined Microsoft + Yahoo will stop the attrition that’s been going on for years.  In fact, many think a merger will accelerate that attrition.  Google’s got nothing going on that competes with Amazon.  They’d have to scramble to think of something.  Meanwhile, the franchise can be brought over intact and likely made to grow even faster.

I saved the best for last:  Amazon Web Services

There is no better way for Microsoft to own a huge piece of the future of Cloud Computing than Amazon Web Services.  It does not require all the hard business cannibalization questions that things like E-mail or other office apps in the cloud bring.  It is a fabulous SaaS model.  It is strategic because it is an operating system in the clouds.  Google has not yet been able to unveil a competitor so Microsoft steals a huge lead.  In one fell swoop Microsoft can gain a fantastic start on the operating system position its used to having on the desktop, only this time it happens in the Cloud, which is the Future.  What’s that?  You wonder how big Amazon Web Services really is?  Guess what, they just announced the traffic to web services is bigger than the rest of Amazon’s offerings.  Let me quote Read/Write Web because this is huge:

web services bandwidth now accounts for more bandwidth than all of Amazon’s global web sites combined. To put this in perspective, comScore ranked Amazon the 7th most visited site in the US in December. The retail giant was 6th in the UK, 9th in Canada, 11th in Germany, 11th in Japan, and 20th in France. In other words — Amazon is big, which means AWS-powered sites must be really big (collectively, at least).

Adoption of Amazon Elastic Compute Cloud (EC2) and Amazon Simple Storage Service (S3) continues to grow. As an indicator of adoption, bandwidth utilized by these services in fourth quarter 2007 was even greater than bandwidth utilized in the same period by all of Amazon.com’s global websites combined.

As TechCrunch’s Erick Schonfeld points out, “That means startups and other companies using Amazon’s Web-scale computing infrastructure now bigger collectively than Amazon.com, at least as measured by bandwidth usage.”

On top of the interesting scale, momentum in a strategic direction, and other tasty reasons to look at Amazon, we have that it is readily monetizable.  These guys sell servers!  There is real money there, folks.  More all the time.  AWS is the big fat iceberg that holds up the tip we think of as Amazon the book and music e-tailer. 

Amazon would have been a better bet for Microsoft than Yahoo,

and it may turn out to be a better bet for Silicon Valley too.  At some point, Amazon will start acquiring like crazy too.  They’re doing some acquisiton, but imagine how easy it is for them to acquire companies that built on Web Services.  This could be the business model the Harvard B-School kids are reading about for years to come.

But the really scary scenario is:  GoogleZon

That combo would pretty much own Cloud Computing.  The amazing thing is it even looks to me like it should pass anti-trust, whereas GoogleHoo wouldn’t.

Try On All The Moccasins Before Deciding: Big Co vs Small Co

Zoli Erdos wrote an interesting blog post about hiring big company executives into startups.  Dharmesh Shah tarted up Zoli’s already nice linkbait “Beware of Suits” with “Why Your Startup Shouldn’t Hire Seth Godin”.  Dharmesh skirted dangerously close to the “only young people make good entrepreneurs meme.”  What are these guys saying and what does it have to do with Moccasins anyway?

Let’s start with Zoli, after all, he posted first.  He was prompted by that dilemma that startups can find themselves in when they’ve grown to a certain point of whether to bring in “adult supervision” (i.e. people with long track records, the suits as Zoli calls them) or to stick with pure startup folks.  Zoli has evidently had a lot of bad experience hiring people with too much, um, experience.  Now comes the speculation about why it didn’t work out:

- These people had done it already and so would be bored doing it again and couldn’t perform well without challenge.

- Too much success makes it hard to take the pain inherent with any startup.  Highly successful people may be looking for smooth sailing, and so may not be the fighters a startup needs.

-  You can’t hire people who take the job for equity.  You can’t hire people making a lateral move.  You need hungry driven fighters who have to step up to do the job. 

-  You want people who are after passion and lifestyle, not a job.

-  Corporate hotshots are leaders, not doers.  Startups need both in one package.

-  You gotta catch the right wave:  1st wave want to create success from nothing.  2nd wave want to make something popular more successful.  3rd wave want to join a successful environment and preserve the status quo.

Dharmesh adds to this:

-  Even if past success predicts future success, it assumes similar circumstances.  Every startup will be different.

-  More about how prior success leaves people not feeling hungry enough for a startup.  They don’t have a point to prove, they’ve already proven it.

-  Startups are an arbitrage game.  Good startups can hire world class people below market value.  Startups are playing a passion arbitrage game.

-  Executives from big firms are helpless without the giant budgets and resources of big firms.

Okay guys, that’s all very interesting, but way too black and white.  Let’s dig in.  I’ve been in both worlds a lot in my career.  I’ve founded three startups, two of them very successful.  I’ve been at world class big companies like Oracle and Borland (in the Borland heyday I ran their 350 person R&D team).  I’ve worn both pairs of moccasins, in other words.  And as the saying goes, “Walk a mile in the other man’s moccasins before judging him.”  I’ve seen all of these things you mention, but I look at them a lot differently.

Let’s start with passion.  Passion exists at all levels and all company sizes.  Startups do not have a monopoly on passion.  If you’ve never met someone who is completely driven and passionate from a Big Company, it’s your loss.  These are the people that carry on with hard jobs that require passion to sustain them long after they’ve made enough money for multiple mansions, countless Ferraris, and jets.  If you think Steve Jobs, for example, doesn’t have passion, you just haven’t ever watched the man enough.  This kind of Passion takes hold and is not controllable.  If you have the real passion we’re talking about, it can be painful.  Your family and friends look and wonder what your problem is.  Why can’t you settle down and relax a little bit?  You don’t need the money.  Ease up, don’t give yourself an ulcer.  Most of the people I’m talking about have known passion all their lives.  They didn’t just discover it and start a company.  It’s part of their DNA.  People with passion ignore the pain.  Their real pain is not being able to exercise their passion.  It triggers massive impatience and sometimes anger.  Passion is unreasonable.

Take Scoble’s recent post about Facebook’s Zuckerberg.  The Zuck says a lot of his problem with PR is because he is extremely shy.  Yet Scoble felt the passion from this guy in spades.  You can read it in his post.  Shyness just makes it worse.  Here’s a guy exploding with passion but too shy to get it out there.  He’s a steam boiler with the safety valve screwed all the way shut and the pressure building.  So what does he do?  He goes with a vision and creates a place where shy people can expose some passion on the Internet.  Do you think his passion goes away because of money or what he’s already accomplished?  He could likely sell the company for a quarter of that $15B valuation and net more money than he could ever spend.  There’s probably a list of companies that would pony up that cash right now if the deal were offered.  Zuckerberg is already past the stage where he could be hired by the standards of these posts.  Money or past success can’t take this kind of passion away. 

So look for passion in the people you interview at a startup.  Find the people who are obsessed, who can’t sit still, who light both ends of the candle and then set the middle on fire too.   Find a way to measure and test for passion.  And keep in mind, people with passion are unreasonable people at some point.  Drive past the interview face and test for some unreasonability.  If you can’t get them to disagree with you on anything, maybe there is no passion.

Next point is what I call content producers versus managers.  This was definitely brought up, but again, I look at it differently.  It is the leader/doer angle.  This is related to the requirement for a lot of resources to get anything done.  A doer can produce content for their job description of some kind.  A pure leader can only evaluate other people’s content and help push them forward.  Pure leaders are not necessarily inappropriate, but having both leadership and content creation capability is more helpful for a startup.  To many pure leaders and the startup can’t get anything done.  The Big Co has the opposite problem: tons of raw talent that is very hard to marshall, organize, and fire up.  Figure out how you’re going to evaluate whether your new hires are doers.  What can they produce that’s relevant to you.  I like to use working brainstorming sessions to do this.  See how well your candidates can riff on your space and ideas. 

Rather than refute all the rest of the points already brought up against looking at people who’ve done it before or that are in large companies, I want to talk about things those people have going for them that a talented and very impassioned but raw alternative may not.

First is the past success predicting future success.  If you don’t have any past success, what exactly is going to be the predictor?  Why go out of your way to ignore past success because you think it may have tainted a person?  Hopefully I’ve dispelled that notion.  Dig into past successes.  How varied are they?  Does the candidate have an ability to adapt to broadly different situations?  My own resume is a crazy hodgepodge of desktop software, tools, Internet software, and Enterprise application software.  People ask me what I want to do next and whether I’m an Enterprise only guy and I just laugh.  Serial success players have skills, talents, knowledge, and tactics that get them over the hump.  Figure out what those are and whether they apply to your situation.

Second, folks in larger organizations and with many successes have more contacts and credibility.  Both are extremely valuable to a startup.  Startups have to sell up out of a hole.  They have to convince people they’re credible.  As a very talented executive recruiter friend once told me, people like to associate themselves with success.  Startups that don’t have any yet can benefit from the surrogate success of their players.  When people are considering a purchase from a startup, there has to be a reason.  What’s different about this startup?  One of the answers is that someone with credibility is there with a lot of passion for the startup.  Don’t sell that short.  Also don’t sell short the ability of that person to lean on their network to get things done.  To bring more talent into the startup, for example.  To hire the right person or agency because a past relationship lets them know that person or agency will succeed.

Last point is experience matters.  I’m fond of saying that old age and treachery can often overcome youth and enthusiasm.  Get some of that experience on your team.  It doesn’t matter how smart you are, if the other guy already answered the question a long time ago and knows the answer, he will beat you to the punch while you’re figuring it out.  Having experience to draw on is a rich source of data, and startups are data challenged.  Don’t fall into the trap of thinking the startup only has to do everything completely differently from what’s been done to win.  There may be a winning formula there, but there will also be lots of failed startups if you take that to the extreme.  As an entrepreneur and startup, you don’t have the luxury of the VC’s portfolio effect to sort that out. 

If it isn’t obvious by now, I’d hire Seth Godin in a heartbeat.  You’d be silly not to if you’ve read his stuff enough to realize he has the qualities I’ve talked about.  The real question is whether you could get it together to convince him to join you.