Are we watching the Death of Independent Enterprise Hardware and Software Companies?

While at lunch with a good friend and senior executive, we were discussing the trends in hardware and software startups. His recent company was developing a new high performance server with the quintessential secret sauce; however after four years they closed the doors. Unable to gain market traction with a product which actually worked was a big frustration. His primary reason for the startup’s failure was the lack of acceptance of new vendors by Fortune 2000 customers. Assuming that the product worked and market entry was the issue, the discussion centered on the consolidation of the software, server and storage markets. This begged the question “Are we seeing the end of independent technology companies in enterprise software and hardware markets for the foreseeable future?”

In the enterprise storage market, EMC, NetApp and IBM own the market with 70%+ share between them. Of the 185 storage companies which were founded and funded in 2000, only a handful survived. BlueArc, 3Par, and Lefthand are most likely the most successful of the bunch. BlueArc and 3Par are slugging it out for scraps. Lefthand had a decent exit via M&A recently. When it comes to electronically stored information (ESI), Fortune customers are under increasing pressure store and produce ESI for compliance and litigation purposes. Who wants to be unable to retrieve compliance or litigation information with the excuse that their startup storage vendor’s equipment malfunctioned? Can we say career ending sanctions, fines and potential jail time for spoliation? The bar is extremely high these days for storage vendors and getting higher with the changing Federal Rules of Civil Procedure regarding ESI storage and production.

In the server world, HP, Dell and IBM control the market. Fabric7 tried to break into the enterprise server market with little to show for it other than a large venture capital loss. Egenera is battling it out but has shifted to a software strategy. With the huge capital expense associated with custom server development and the strategy shift to software, the jury is still out if they will success or failure with a bifurcated hardware/software strategy. Again, the feedback from the Fortune 2000 customer is that they want few vendors to manage not more vendors.
Enterprise software world has also been shrinking with Oracle, IBM and SAP the dominate players. Salesforce.com has been a star from a marketing perspective; but the financials are less than stellar with the SaaS model. The complexity of large enterprise applications is a huge headache. The need of significant customization to meet most business demands is expensive, as well as a significant lock-in strategy which impedes new software entrants. Adding multiple enterprise applications increases staffing needs, customization costs, integration expense and management challenges. There is little incentive for a CIO to deploy more than one enterprise application.

There is a finite customer set of enterprise level software and hardware customers (see “Are there Plenty of Fish in the Sea?” - The Abundance or Scarcity of Startups market targets). CIO want solutions, not point products, which is repeated in every edition of CIO magazine. Established vendors like HP, IBM and EMC offer customers security and safety, as well as products and solutions. Market maturity and consolidation in the software and hardware markets have limited exit options and reduced returns for venture capitalists and startups. Startups with a excellent product will still likely have the potential of a M&A exit with one of the big boys; but, the number of IPO exits in enterprise software and hardware will likely be much lower than the proceeding decade. At the macro level, the historic technology investment profile of Silicon Valley has changed and we are watching the demise of new independent hardware and software companies.

Phoenix from the Ashes: Will the Financial Crisis help some Silicon Valley Startups?

As the ripples in the financial crisis expand from their Wall Street epicenter, the US economy is in total shock. Rumblings of economic distress in Europe are emerging. Everyone is holding their breath and waiting for news of Asian economic distress, as the ripples expand. Startups in Silicon Valley seeking capital are hyper-anxious, as venture capitalists’ attention is focused on the crisis and capital is in short supply. However for a select few, the financial crisis has an enormous strategic silver lining.

While at an alumni function where Dr. Ray Fisman was speaking about his new book Economic Gangsters, the alumni milled and chatted on world events. Several alumni were at startups and were worried about the impact of the financial crisis on the Valley and their businesses. The majority of the discussions were pessimistic and projecting fear of future turmoil. However, a few alumni were extremely optimistic. Several had recently closed funding rounds and were sitting on a mountain of cash, unlike their competitors who were in the process of raising second or third round and struggling in this fear driven environment. Their perspective was that the financial crisis is a huge competitive advantage for startups with low burn rates and cash in the bank. With capital the scarce resource, the Valley will see cash poor startups implode. The cash rich startups will face less direct competition and have the pick of the Valley’s best engineers. As one alumnus commented, this is the time to build a company and it is likely we will see the next Google arise from the ashes of this crisis.

Fear and Loathing in Silicon Valley – VCs and startups are feeling the economic pain

Chicken Little cried, “The sky is falling”; but it was just an acorn. Is the sky financial falling or is it only a short term liquidity shock? The current credit derivative swap debacle takes us back to the implosion of LTCM. Only this time the entire financial market is intertwined together in the credit swap insurance scam. The troubles on Wall Street are rippling through all other financial instruments and impacting global markets. The impact to Silicon Valley is…..bad.

Venture Capitalists and startups are feeling the pain. In a recent study by Dow Jones Venture Source, 2008 is shaping up to be the worst year on record since 2003. There hasn’t been a viable IPO market in over a year and it is not predicted to improve any time soon. There were only seven IPOs accounting for only $551 million this year. The worst news is that M&A, the staple of Silicon Valley, is down 65% from 116 to 66 deals during the same period last year. It seems that the proverbial sky is falling.

Weathering the storm is going to be challenging. Based on feedback from VC friends, venture capital funds are keeping their powder dry and only investing in their existing startups in hopes of getting them through this bad spell. As supply/demand shifts to the venture capitalists favor, the competition for follow-on funding is expected to be very high; therefore, VC will get preferred terms. The expectation is that there will be numerous startups that will be forced to close the doors. Generating revenue may not be enough to get new capital, if startups are not near cash flow positive. Entrepreneurs seeking series A funding are going to have a harder battle, as venture capitalists appetite for new high risk investments has evaporated for the time being.

Building a Business Plan: Hard work, but someone has to do it

No one likes to sit down and write a business plan. It is hard work to take the visionary hat off and think objectively through the potential challenges of one’s favorite idea. It is simply more fun to only look at the idea’s virtues than its potential irredeemability. The most common argument is that the business plan will just change anyway, so why do it. Change is a constant in both business and life; however, that is no excuse for not planning in the first place. The exercise of working through the business plan formalizes the process and uncovers warts and flaws, as well as uncovers new opportunities. If a team can side step a subtle trap and uncover a gold nugget, the time spent on building a business plan is worth every last second and then some.

A business plan should be as short as possible and as long as needed. The plan should be focused on quality not quantity. It is a document that concisely outlines your plans and objectives. It shows investors that you have done the necessary homework and have thought through the plan. Having all the answers is not necessary or possible. Investors are looking to see if a team understands the opportunity and the challenges that the business will face. Discussing both will gain a team significant credibility and demonstrate maturity. However, a business plan is not a time to write a dissertation. The plan’s purpose is to gain a conversation with an investor, not to show off everything you think you know. The time to divulge detail is during the investor meeting when they ask for it. As a rule of thumb, a business plan outline should contain the following:

• Executive Summary - one page
• Company Overview – one page
• Product/Service details – two to three pages
• Market research and analysis – three to four pages
• Strategy and Competitive Advantages – three to four pages
• Management background and structure – two pages
• Financial forecasts and charts – three to five pages

The individual parts can be longer or shorter depending on relevance and need. As a general rule, keep the fluff to a minimum because it will alienate investors; investors have seen it all before. A business plan is a necessary and critical step in the idea development and funding process. One always hears stories of founder getting away without them…but they are mostly just stories.

If you were to board a plane in San Francisco and the pilot came on the intercom and said “We thought about making a flight plan, but it will only change anyway. So, we are going take off, fly east until we hit the coast and hope we find New York.” The message would not make you feel “warm and fuzzy”. However, this type of argument is what investors hear every day from entrepreneurs. Today’s, pilots have a flight plan where they calculate plane’s weight and balance, fuel consumption, flight time, flight path, and potential weather issues before ever taking off. Once airborne, the pilots are in constant communication with the ground to get updates and make changes to flight plan when necessary. Pilots are professionals and a flight plan is an expected and necessary part of the job. Whether creating a flight plan or a business plan, a plan is a basic necessity to understand where you want to go, how you are going to get there and what is needed to get you from here to there. As a business professional, a business plan is an expected part of your job.



© 2008 Morris Strategy Consulting - All Rights Reserved - http://www.morrisstrategyconsulting.com/
Building a Business Plan: Hard work, but someone has to do it

Startup exit planning: M&A or IPO

It is the dream of every Silicon Valley startup to have a refulgent IPO. Venture capitalists, entrepreneurs, employees and investors all want a positive liquidity event to drive the investment/harvest cycle, as well as increase their personal net worth. But which is more likely and which is more lucrative? Thomson Financial and the National Venture Capital Association (NVCA) have recently updated their M&A and IPO data. With the Sarbanes-Oxley Act increasing the IPO expense and the current economic market challenges, should startups plan only for IPO or hedge their bets?

Looking deeper into the 47% of successful startups, as discussed in Venture Capital and Entrepreneurial Success: The Exit Funnel and You, the 2002 through 2007 data outlines that 85% of the exits are M&A and 15% are IPOs. From a percentage perspective, M&A wins hands down. A consolidated data set from Thomson and NVCA Q108 Exit Poll Release shows:









Year by year the percentage of M&A deals versus IPO of each graphically are respectively:

Obviously, M&A is more likely than IPO, but at what cost? Are the M&A deals larger or smaller than the IPO?

From public information, data for IPO companies is highlighted above in the red curve. Since M&A deals are often private transactions, the disclosed M&A deals represent approximately forty-six percent of the total M&A deals. The blue curve outlines the disclosed average M&A transactions by year. With fifty-four percent of the deal terms undisclosed, it is challenging to draw concrete conclusion in comparing the average M&A transaction to the average IPO transaction, especially over such a short time period and an unknown curve distribution. It is inconclusive which is more lucrative M&A or IPO from this set.

Below is the data from 2007 and first quarter 2008 on the breakout of return on investment on disclosed M&A deals.

It is about an even split of companies that earned a “4x return or greater” versus “less than 4x”. Given the typical venture capital liquidation preferences, the “less than 4x return” exits were most like a wash for founders and employees, as well as for venture capitalists and investors.

From the data, startups that actually get to IPO are small number. M&A is more likely exit strategy, especially in a volatile economic environment. Based on the above data, startups need to plan for M&A and hope for IPO. Having quality venture capital to facilitate introductions and qualified corporate development talent to create the foundation, develop and manage top several acquirers is a strategy that would increase M&A potential, increase valuation, and increase personal wealth creation. However, most founders are usually infected with “The Baby Bias” and want the big IPO.

© 2008 Morris Strategy Consulting - All Rights Reserved - http://www.morrisstrategyconsulting.com/
Startup exit planning: M&A or IPO

Venture Capital and Entrepreneurial Success: The Exit Funnel and You

Every entrepreneur loves their baby and thinks their idea is the next big thing. However, facts don’t lie. Reviewing the venture capital exit funnel from 1991 to 2000 reveals the harsh reality for startups and the challenges for venture capitalists.


There is a delay in performance information for startups, since it can takes three to seven years to determine success or failure. The National Venture Capital Association’s Venture Impact study highlights the winners and losers between 1991 and 2000. Of 11,686 companies founded, only 1,636 (14%) had an Initial Public Offering (IPO). Another, 3,856 (33%) were acquired. Combined there were 5,492 (47%) startup companies that had positive exits. Of the remainder, 2,103 (18%) were outright failures and 4,090 (35%) are presumed “walking dead”. The “walking dead” or “bobbers” are the startup companies that haven’t failed outright, but have never made enough revenue to break loose. For the majority, it is just a matter of time before the doors close. Therefore, winners to losers are 47% to 53%. Ironically, it is the same odds as betting “black” on the roulette table in Vegas (to stave off tons of emails -remember that there are two greens on the table, too).

Unfortunately, there is little detailed information on why startups succeed or fail. They are much harder to analyze than public companies whose information is by definition pubic. The successful founders typically have stories, but not complete ones. The failed founders are relatively reticent.

So, how does a startup get into the successful 47%? A team that can work together under stressful conditions and has a breadth of skills from engineering to business is the most cited criterion in successful startup stories. Quality capital is another. Having a good top tier venture capitalist that knows the landscape, understands the business and can make introductions is critical. These introductions often provide the catalytic nudge to propel a company forward and past the competition (if your product works). Obtaining capital from friends and family for my first startup was an exercise in absolute frustration, as I spent a large amount of time on calls explaining the business and its fundamentals, as well as chatting about when they would get their money back. My advice is get smart, quality capital. Competition is another big challenge. Competing with other startups can drive the business to new heights and help build a new market. However if Microsoft, Oracle, Dell, Apple, Cisco, Intel or other 800 lb. gorilla has made your strategic vision their corporate goal, a startup cannot compete; get acquired or find another niche. As a rule of thumb, it takes ten times the capital to compete against an entrenched player. Spending a little on stock options to retain quality advisors is also a common theme in success stories. Being able to bounce ideas off someone that has been there and been successful is worth every last stock option. Startups need to make sure advisors will be available for calls and meetings, but don’t expect them to run the company. Building out a startup’s war chest of capital, talent, and advisors yields significant benefits over those that don’t.

The category which entrepreneurs never want to be classified as is the “walking dead” or “bobbers”. So, how do you tell if you are “bobber”? Being objective is a good start. Personally, they are the most demoralizing companies with which to meet. After being retained for acquisition due diligence in 2007, I meet with a couple dozen startup that were founded in 1999 through 2004 throughout the US. Most were struggling along and bringing in some revenue, but it was enough to barely meet expenses. Most did not have the capital to fuel R&D, much less expansion. Like a swimmer on the growing waves of an ocean storm, the companies were just barely keeping their metaphorical head above the water…just bobbing up for a quick breath then down again. With five to seven years of their lives tied up in their startup, the founders would pitch their companies with such passion and conviction, but the stress and strain of the years weigh on them, like an anchor. You could see the desperation in their eyes and hear the quiver in their voices, as they tentatively asked about next steps. They knew that their technology was becoming outdated and there was nothing that they could do about it. Since their original venture capitalists’ funds were timing out after seven to ten years, most were in a race to obtain new all venture capitalist, get acquired, or simply close the doors. Without cash flow to fuel development and growth, technology companies atrophy and slowly die. Succeeding or failing early is a godsend; languishing year after year without either is pure hell. If this description resonates, the startup is a “bobber”.

Although every entrepreneurs’ idea is the next big thing and they all love the baby, the facts are that 53% of all startup fail. Venture capitalists know this fact and are thinking about it from the second an entrepreneur sits down with them. They also know that capital is only one aspect of a startup’s success. To improve the odds, entrepreneurs must have assembled a strong team, done their market homework and thought through the business, not just their idea.

© 2008 Morris Strategy Consulting - All Rights Reserved - http://www.morrisstrategyconsulting.com/
Venture Capital and Entrepreneurial Success: The Exit Funnel and You

Venture Capitalist have bosses? Yes, they do and you will be shocked who they answer to!

Unless you are independently wealthy or homeless, you have to answer to someone, a boss, venture capitalist, the board, customers, and/or the bank. If you are an entrepreneur and are making the rounds on Sand Hill Road, it is hard not to spot the high-end BMWs and Mercedes, as well as more exotic vehicles, parked throughout the garages. Walking through the smartly decorated Sand Hill offices can be a shock for new entrepreneurs, which are likely in or just out of the dorm room. It can look like venture capitalists are “Kings of the World”. But, never fear Venture Capitalists have bosses too. And, their bosses are typically much more demanding than any boss you will ever have.


Where do venture capitalists get their money? Primarily, they get it from you. Shocking, isn’t it. Sources of capital are the following: 42% private and public pension funds, 25% finance and insurance, 21% endowments and foundations, 10% individuals, and 2% from corporations operating funds (not pensions – Corporate Venture Capital or Strategic Investment Capital) (source Venture Impact 4th edition - prepared by Thomson Financials using 2003 data).









The large institutional investors are the managers that handle your pension investments. They utilize multiple vehicles with different risk and return profiles for portfolio diversity. Most of your money goes into low risk vehicle for income preservation. However, a small percentage is invested in high risk vehicles, i.e. venture capital, emerging markets, etc. You never thought your grandfather was instrumental in providing seed capital to found Google, Intel, and others, did you. Finance and Insurance companies obtain money from individual investor also. Whether investing in stock market funds, mutual funds, life insurance policies, etc., these companies have capital to deploy and need to earn a return on for you. Again, a small part of the overall portfolio goes into venture capital. Endowments and Foundations are permanent funds that are bestowed upon an individual or institution. Examples are The John D. and Catherine T. MacArthur foundation and Harvard, Columbia, and Stanford’s Alumni endowments. These organizations grow capital to meet their mission objectives, which may be social ideologies or operationally focused, i.e. grow capital to grow a University. A small part of their capital goes into venture capital each year. Another source of liquidity is Individuals and Families which contribute to venture capital funds. These are typically wealthy individuals that invest directly into a venture fund. However, this is a little misleading since an each fund’s Limited Partnership agreement stipulates that the fund managers (venture capitalists) must invest 1% or more of the total capital raised and this is included in the Individuals and Families number. This means when venture capitalists invest in your startup they are investing their own money in you and your grand idea. Does this explain all the phone calls you get from them? Corporate Operating Funds are corporate venture capital funds. The best know corporate venture capitalist is Intel Capital. These funds usually are setup to keep the corporation’s abreast of emerging technologies and to invest in strategic directions.


Venture Capitalist subscribe to a larger ideology. It is not about a single startup. The dream is to create a vibrant economic model where entrepreneurs can obtain capital, grow a business and achieve a positive liquidity event. Liquidity events give growth capital to the business, delivers returns to investors and entrepreneurs and fuels the next cycle of entrepreneurial investments. Without positive returns, the venture model dries up, startup funding stalls and the capital flows into other financial vehicles.


In this structure, venture capitalists answer to the above mentioned investors on their fund performance. Just like startups have board meeting with their investors, venture capitalists have meetings with their investors who review their investments and portfolio status. The venture capitalists’ investors (institutional managers) in turn report on their investing activities to their investors (you); you always wondered about those little prospectuses you got in the mail from Fidelity, Morgan Stanley, Vanguard, etc. Actually read one some time. If returns are good, everyone is happy. If not, the institutional managers pull back on investment in high risk vehicles. Venture capital, subsequently, reduces investment in startups.


In a unique turn of events, the guys that look over the shoulder of the venture capitalists are the pension, 401k, and mutual fund investment managers, which are the guys that manage your money; therefore, venture capitalists really work for us all. It is a hard gig because I know my father is intractable with a couple hundred dollars. I cannot imagine his response to an entrepreneur’s request for couple million. Venture Capitalist provides a valuable service to both, the investment market and entrepreneurs. Venture Capital is a challenging job; but, they do have a boss, just like everyone else. To be successful, entrepreneurs need to remember that fact in order to respond to the venture capitalists needs and understand the pressures that they face.




© 2008 Morris Strategy Consulting - All Rights Reserved - http://www.morrisstrategyconsulting.com/ Venture Capitalist have bosses? Yes, they do and you will be shocked who they answer to!