To Netpreneur Exchange HomeTo Funding & Finance Home

AdMarketing | Funding & Finance | Netpreneur Corner | News Center | Quick Guide | Home

Finding the Golden Needle
Netpreneurs Discuss Their First Funding Experiences

The Forum

Mr. Riechers: I have had the good fortune of knowing everybody up here for between six months and forever, and we are a lead investor in one of these companies. One theme here is persistence, but they haven't come close to telling you how hard this is. You can accomplish what they have, if you have a great idea and you have the stomach to fight for what you believe. It is hard, though, and you get a lot of no's. I spent 16 years in technology companies mostly raising money, and fortunately those companies worked out reasonably well. But raising money is a challenge and you have got to be persistent.

Mr. Pittinsky: Bob's sheet makes it sound so easy. I wish I had had that in the beginning.

Mr. Nelson: The June 1998 issue of Wired magazine has an excerpt from a book called "Burn Rate," which is not available yet. At one point, the company in the article is nominally worth $25 million. All of a sudden, there’s talk of a merger, and valuation shoots up to $60 million. The poor entrepreneur is just beside himself that his company is going to be worth three times as much and he asks, "How does that valuation stand?" The VC looks at him coolly and says, "There is no valuation, there is only orchestration."

Ms. DeFife: Usually it works the other way. You are thinking 10, they are thinking two, you know?

Q: I'm Russ Williams with The Training Place. We have beta test customers and we are a small company, so our hook is, "We'll give you 10 free seats, and put you in our Web-based training user's council." That's our beta test program. How do you position having beta users to potential investors? How does that rank?

Mr. Schmonsees: We were in that situation when we got funded. There are betas that you give to somebody who is a friend of the company. That’s your "user’s council," and that's fine. The first question I would have as a VC is, "Did these guys pay any money? Are they there because it's nice to be part of this council or are they getting value for the software?" You really need to get past those beta users who know you. Get down to somebody you have never seen before, who is actually getting value from day-one and who can talk to the VCs. VCs are going to call several people at that beta company, not just your friends. You can't restrict who they talk to as part of their due diligence research.

Mr. Pittinsky: It's always better to have customers who paid money for the product. You're trying to prove that the market really will bear whatever price points you argue it will. It's so tempting to build up and install betas for a number of customers. But whether they paid makes all the difference. The second thing to consider is the type of client you target in beta. For whatever it's worth, having Cornell or Yale or some of those institutions as our clients says something about the pedigree of those who are willing to work with our technology. Find the corollary in your industry.

Mr. Thomas: Keep in mind that clients, whether beta or "real," take up time and energy. If you're going to make these clients successful examples, you have to put everything that you have into these accounts and make sure that they are going to put as much back in to you. We made a mistake on that when we first started. We got a client who signed up who wasn’t really willing to work with our software. That was like beating our heads against the wall. Look for clients who are going to see value. They are not going to put as much into it as you are, but enough that you can feel good and push your product forward.

Mr. Schmonsees: That's a great point because there are always people out there who, if the freight isn't too high, love to try anything. When you have a new idea, you have to look the person in the eye and make sure that they have some skin in the game. I would suggest that you make sure betas pay, almost as much as real customers. Maybe you can give them a deal on the product when they really deploy.

Q: I'm Raj Khera of Khera Communications. How much of your company did you have to give up? Did you pitch going public or being acquired as your exit strategy, and did you find that it made a difference what you pitched as your exit strategy?

Mr. Schmonsees: I said earlier that valuation isn't that important. We ended up going at about $4 million and it was about 50% of the business. We were just coming out of beta with a product and had some very early sales successes. Because we were a pure vision play, we didn't know whether we would be a public company or whether, somebody might snatch us up in an acquisition. We told VCs that we were going to look for an exit strategy as soon as possible, and we were flexible about which way we could go, based on which offered the fastest return. We were unique in that we didn't have a model so that you could say, "Here is somebody who has done exactly this before."

Mr. Pittinsky: Before I started this process, I had heard of only two exit strategies: go public or get acquired. A VC told me the third: the management team gets kicked out. Obviously that's not the exit strategy that we're all looking for. Blackboard is not talking about our valuation in public, because we are only now launching a venture capital round. Suffice it to say, it is not a science. Michael Chasten, the co-founder of Blackboard and the financial genius behind the company, went out and searched every bookstore in the Greater Washington area for a book with the formula for figuring out the value of our company. It obviously doesn’t work that way. We walked in with a healthy ego and one principle: it's better to be a small fish in a big pond than to be a big fish in a small pond. If you focus on that, and on what takes to grow the company, the valuations discussions can go much easier.

Ms. DeFife: Valuation is what the market will bear. If five or six funds want to talk to you, they can bid the valuation up, but the real valuation is what the market will bear. I agree with Bob Schmonsees completely. The issue is not the value of the company, it's what will happen if you don't get this funding versus what will happen if you do. Implementation and being able to build your company are most important. 100% of nothing is nothing. Step back and look at the potential in your company and how much you could own of that company. In the first round, we gave up more than a third of the company. We were looking for $500,000, and we raised $630,000. At the end of the first round, I owned 37% of the company. At the end of the second round, I owned 25% of the company. We raised another $950,000, and the valuation did go up. I'm looking at the potential and what I can make in the end. If I sat back and said, "I'm going to hold out until I get this valuation," I would own 100% of a company that wasn't going anywhere.

Mr. Thomas: My group is pretty quantitative. We are all management consultants and we built spreadsheets on the valuation of the company, every which way. It was kind of funny when we got down to it. I'm not going to say the exact amount, but we actually did not give a whole lot of our company away. Most VCs don't want to take control of their company. This goes back to the very first thing that I said, "They are investing in you." Most VCs are not trying to take so much that you don't have an incentive to go forward anymore. If that happens, they don't have much left. Maybe if you have a great product they can take it and kick out the management team, but, truthfully, that's not their goal. These guys sit on tons of boards. They are looking for new companies and trying to roll-over their funds. If they have to get in and hire a team to manage a company themselves, it's not meeting their goal. Focus on getting what you need to run with, and the VCs will take care of themselves. You are the most valuable part of the equation.

Mr. Nelson: I was talking with a venture capitalist once about valuation and he smiled and said, "The first company is the one where you become successful. It's the second one where you become rich." We have done a good job, we believe, of retaining capital. With all of our fundraising, we now have 12 investors and we've only had to give up 97% of the company [laughter]. We are counting on being really rich in the second, maybe the third company.

Q: I’m Mike O’Horo of Sales Results. When you are doing something that's never been done before, like Brandy and Bob, how do you figure out what it will take to build this idea to a marketplace scale, to where you have a credible production model?

Mr. Schmonsees: I got lucky. I had been trying to solve the problem that WisdomWare solves for about 25 years in my other jobs. I've been trying to get salesmen more productive for 25 years while running large software sales organizations. Because of that, I knew the best talent in the industry. I got them in a room and I said, "Hey, let's figure out this problem." It didn't work. They came back with traditional solutions. Then I had breakfast one day with a bright young guy who sketched out a solution on a napkin for me. It looked like it would work, so we went from there. It was blind luck from our standpoint.

Mr. Thomas: We built more spreadsheets—top down, bottom up—than you could shake a stick at. But we could not get it. We had no idea. So we stepped back and said, "What do we need to get to the next milestone?" We knew what we needed in eighteen months. That made the problem not only something we could handle in that time, but also something that we could explain to our investors a lot better.

Mr. Nelson: Washington is rich with people who work in huge systems integrations firms and for defense contractors. Our chief technology officer has that experience, building large systems. He knows how to size them, scale them and project them out. We also have two people who came from Lockheed Martin in New Hampshire, who have had a lot of experience determining the number of people and the amount of man-hours it takes to finish a big project. You could also outsource the problem to people who do this for a living. In the Washington area, there are some companies that just do software development for a living. We have chosen to use The Adrenaline Group (http://www.adrenalinegroup.com), which many of you know. These guys write code for a living. If they can't figure it out, then you shouldn't build it.

Mr. Pittinsky: Steve Jobs says that great artists steal, and in this case I’ve adopted that. We actually shared the blurbs that Gene used tonight to introduce folks, via email in advance of the panel. Brandy's introduction for Online Monitoring Services is compelling and powerful. It’s exactly why he's been as successfully as he has. You can see that and understand exactly what his software does. Even if it's a new market, it intuitively makes sense. I read this and I thought, "I would invest in this. What a great idea. Why didn't I think of that?" Although Brandy doesn’t know it, I took that paragraph and just changed it to suit my company. But we have been doing this for eight months and we are not close to that level of succinctness. My hat's off to you.

Mr. Thomas: Thank you, that makes me feel really good. Unfortunately, it wasn't that easy to get everyone else to believe in the size of the market. Most investors said, "I believe you, it sounds really big." But their next question was, "How big is it?" That continued to come back to us. You have to offer something they understand to help them get their arms wrapped around you.

Q: My name is Jim Rapp. It seems that now, in the Internet space, the idea is to grow big quickly. CDNow is partnering with all these companies and I read that iVillage has got $30 million. How do you compete and grow very quickly, which seems to be the mantra today?

Ms. DeFife: We have gone out and raised a lot less money than other businesses. We have a community-based revenue model, which is different than content and advertising. A lot of these sites are raising money because they are burning millions of dollars in cash to go out and advertise.
We've built the community 3,000% in the last year through a grassroots community-building effort. We have gone out and offered free media. We have worked with women's organizations that represent nine million business women in this country. We have collaborated with Web sites and big companies that promote what we are doing. We offer the community, which we leverage with all of our other partners. IBM has spent $100,000 promoting us. National Discount Brokers just did an ad campaign for $170,000. That's money that we are not spending. So it's a different model, one that some investors were willing to take a chance on; others weren't. We have a different model that really takes advantage of the Internet. We could spend a lot less money in order to become profitable faster. We will be profitable by the end of this year. iVillage says that they won't be profitable until at least 1999. Women's Wire says they’ll be profitable by 2001, and they are raising $17 million.

Mr. Nelson: One other key for growing a company quickly is to surround yourself with people who have done it before. This region is not rich in those yet, but you can find people who have built a company from zero to $100 million. Getting to those people is hard, but you can do it.

Q: I’m Ann Shack with MapSys. In the due diligence process, many times investors indicate that they are interested in talking to your clients. If you work with government clients, that probably doesn't matter. But with commercial clients, it can be a considerable concern. When you are dealing with your first clients, who don't know how small you are, you don't want them to find out and feel insecure. What are your thoughts about that?

Mr. Schmonsees: I believe clients and venture capital people aren't stupid. Unless you are a very unique business, they know, in most cases, how big you are. We were really clear up front that we were doing something new. Our clients wanted us to be successful. They liked what we were doing, so they were more than willing to talk. You may have a different business model, but we didn't have that issue.

Ms. DeFife: We talked to all of our corporate partners that we were going to put on the list for VCs to contact. Three were corporate, three were women's organizations and we had personal references as well on the list. When IBM, Gene Riechers and many of our other investors came in to sign the deal with us, they walked through my kitchen into my sunroom. So they knew we were working out of the back of my house. Honesty is the best way to go. I called each corporate partner to explain who was going to be calling. I talked about the kinds of questions that they would be asking, and explained that they were not looking for guarantees of business or numbers. I told them to talk about the relationship and the market. VCs were going to ask, "Why do you think that's important? Do you think these revenue numbers are realistic?" I don't think you can get around it.

Mr. Thomas: We had a very similar issue. When we went in, most of the people we talked to, like the NBA and Nielsen, didn't want to deal with us because we were too small. We had to knock the ball out of the park with them. When it came time for the investor visits, these guys were really excited to talk, believe it or not. Don’t treat your first clients as "just clients." Treat them as partners. You can only go on so long with people believing you're bigger than you are. We tried. Tell those clients, "This is what we are. We are knocking the ball out of the park for you, and we need your help now. With this help, we're going to do even better, and it will be better for all of us." But it really did scare us a lot of times in the beginning.

Mr. Riechers: I'd like to add something to those comments. A venture capital investor spends 25% of his or her time talking to customers of potential portfolio companies. We are pretty good at communicating that we believe in the company. We wouldn't be making the phone call if we didn't. We are not going to invest without talking to the customers. If we are not good at it, word is going to get out. "I had that VC talk to someone and I lost that customer." My reputation would be gone the day after that happened. We are selling your company alongside you. You can coach us about things to say. You can tell us about a sensitive spot, or ask us not to talk about a particular topic with a customer.

next: The Forum (part 2) >


 

AdMarketing | Funding & Finance | Netpreneur Corner
News Center | Quick Guide | Home

By using this site, you signify your agreement to all terms, conditions, 
and notices contained or referenced in the Netpreneur Access Agreement
If you do not agree to these terms, please do not use this site. Our privacy policy.
Content copyright 1996-2016 Morino Institute. All rights reserved.

Morino Institute