- Business Software
- Computer Security
- Internet and Online Business
- Managing Technology
- Telecom and Wireless
- Tools on Managing Technology
Tag Archives: Monster Worldwide Inc.
Outsourcing can allow even the smallest company to go after big game. Just ask Jack Sands. The chief executive officer of Intrep Auto Club Renewals, a Columbus, Ohio-based telemarketer, Sands has outsourced his firm’s website design, logo design, software design, and phone system design. His 75 employees, all of whom work from home, are paid through an outsourced payroll system. Even the company’s telemarketing software is outsourced. Piece by piece, Sands has outsourced to technology service providers in India, China, Turkey, Russia, and the U.S. In seven years, his business has grown to the $5 million to $10 million range. “It’s allowed me to portray an image of being a very large company when I wasn’t one, and at a very low cost,” Sands says. Sands then landed the American Automobile Association (AAA) as a client. “Most small firms couldn’t get a client this big,” he notes. Reasons technology outsourcing is on the rise A growing trend among larger firms for decades, even the smallest businesses are now turning to technology outsourcing as a way to improve efficiency and boost their bottom line. According to Yankee Group, 61 percent of firms with 20-99 employees use a contractor or business partner for IT services alone. In addition to IT, firms are outsourcing marketing, Web design, human resources, accounting, and administrative functions like data entry or customer service. And firms are just as likely to find their needs met by a North American firm found on Craig’s List as by a call center in Southeast Asia, industry watchers note. For many small firms, outsourcing just makes sense, explains Gary Chen, senior analyst and specialist in small business IT issues at Yankee Group. Many small and mid-size businesses “just don’t have someone to do these jobs, or they only have enough of a certain type of work to justify a one-fourth-time position,” says Chen. “You can’t hire someone to a one-fourth-time position.” Outsourcing can also give a company more flexibility. Intrep’s Sands outsourced his payroll operations to Rochester, N.Y.-based Paychex because his work-from-home employees are spread out across the country. “I couldn’t keep track of the different workers comp laws and tax rules,” he says. Outsourcing this allows him to hire the best telemarketers he could regardless of their location. Challenges of outsourcing One of the biggest challenges to outsourcing is losing local control over technology functions. If something isn’t working, you have to learn to rely on your outsourcer to fix it. Business leaders need to determine whether they are comfortable with leaving something to a company in India, Russia, or even in another part of the United States. There’s something to be said about being able to walk down the hall to the IT department and asking someone to fix a problem. When outsourcing, businesses also need to appoint someone to oversee the outsourcing relationship. Problems often arise and you need to make sure that your contract with the service provider allows the flexibility to make adjustments in your service, if need be. Lastly, leaving certain vital business services in the hands of another company can mean you are at their mercy if their service goes offline for any amount of time. You may need to have contingency plans. You may also need to read the fine print in your contract to make sure that you don’t have to pay for services that you don’t receive. Few outsource providers offer to compensate you for the business you lose when their service goes down. How to decide whether to outsource IT So, what should companies consider before they take the outsourcing plunge? Here is a checklist to help your business through the decision-making process: Cost. “Cost should be the first consideration,” says Chen. “It should be cheaper to outsource: that’s the bottom line.” To determine this, companies may need to do a little homework—checking into the potential cost of outsourcing, but also taking a hard look at how much the company is losing by trying to do certain tasks itself, says Chen. Can someone else do it better? “Do what you do best, and outsource the rest,” advises Fabio Rosati, chief executive officer of Elance, a Web-based firm that plays matchmaker between companies seeking to outsource and skilled service providers and freelancers. “You need to acknowledge that you can’t do everything well,” and that sometimes your company will need help, Rosati says. Will you lose control over your business? Are you comfortable with loosening the reigns and leaving control over certain functions to someone else? What will you do if there’s a problem? Businesses need to ensure in their service-level agreements with outsourcing firms that the firm will be responsive and will fix problems within a certain time frame. You also need the flexibility in your contract to do some fine tuning, especially if this is the first time you are outsourcing payroll or customer service. Will this help your business? Ultimately, you need to weigh whether outsourcing certain technology functions will help you focus on your business and improve profit margins. If the cost, time-saved, and expertise doesn’t result in business benefits, then you may need to think twice about outsourcing. Conclusion Outsourcing technology functions must be made after a review of your business. Some businesses, such as Sands’ company, have found that they are able to better focus on what they do best and leave the technical matters involving telecommunications and software to someone else. “We didn’t have anyone to do this stuff for us,” says Sands. “This way, we were able to find the best in breed for every task.” SIDEBAR: Improving Your Odds for Success If you’ve decided to look into outsourcing, where do you look? And how can you ensure success? Check online job-hunter sites. Sands used Elance to find many of his service providers, but settled on Paychex and Saleforce.com separately. Other providers include Careerbuilder, Monster.com, and other sites that specialize in freelancers or per-project workers for specific fields. Check skills, references. Exposing your business to newcomers can be risky. Approach choosing a service provider like you would hiring a new employee. Does the firm have the best match of skills, quality and price for your business? If across many time zones, is their location an issue? Do they have good references? Best not to rely simply on eBay-style rating systems provided by some sites. Articulate your needs. This may sound basic, but Elance’s Rosati says that firms need to be a specific as possible about what they want to get the best product and the best price. Develop a relationship. If you find good providers, treat them well so they’ll want to work for you again, say Sands. “Don’t cheat them on price,” he says. “You need them, and want them to put your needs first.”
To the founders of start-up dot-com Veritas Medicine, joining an incubator looked like a quick, simple, creative way to get seed money and get hatched. Who knew? There are maybe a dozen white Chinese-takeout cartons arranged in a neat rectangle on a conference table on the fourth floor of 840 Memorial Drive, but Robert Adelman dips into only two and places a few spicy string beans and a slice of white-meat chicken on his plate. The dinner meeting he’s attending in the offices of a biotechnology company in Cambridge, Mass., is an important one: it’s a chance to introduce an angel investor to Adelman’s Internet health-care start-up. Adelman can’t risk the brain drain that comes with a loaded stomach. Besides, he wants to keep his hands free to gesticulate as he maps out how his company, Veritas Medicine, will be the first in the world to match patients who have serious illnesses with the clinical trials that pharmaceutical companies run, while it ensures complete confidentiality on both sides. “We’ve been to Merck and Pfizer and go back to Merck on Friday,” Adelman says excitedly to the angel as he ticks off some of the behemoths that Veritas plans to take on not just as partners who will provide the trial information but also as the eventual source of the company’s revenues. “And we’re seeing Spicehandler at the end of March.” “Spicehandler. I can’t believe it,” says the angel, his eyebrows rising appreciably pateward as he picks string beans out of the carton with his fingers. “Spicehandler won’t talk to us.” Emboldened by the angel’s admiration for his clout (after all, he did arrange to get in the door of the president of Schering-Plough’s research-and-development arm), Adelman, 36, launches into the financing history of his barely four-month-old company: Stephen Knight, a pharmaceutical executive, came up with the idea for the business but wasn’t prepared to leave his job. So he sought funding from two venture capitalists in hopes of putting enough money into the company’s coffers to enable Adelman, a former orthopedic surgeon who was consulting in New York City, to run the show. When one of the VCs turned Knight down, he brought the idea to Cambridge Incubator. By early September, Knight had signed a deal to join the new incubator. The terms: for $834,000 in seed money and membership in the incubator, Knight handed over 51.22% of his company. The room goes silent. The angel’s long, full face gets less full and much longer, as if his cheeks have dropped into his jaw. “This is Cambridge Incubator that did this?” he asks. “This has to get fixed.” He shakes his head, trying to fathom what anyone — even the best-connected VC — could give a company that would be worth such a huge equity stake. “How can you keep people excited if as you build value you hear a sucking sound?” he demands. He looks Adelman straight in the eye. “You understand that you guys are on a very clear path to going public owning only your shorts.” When it’s time to market that matters most, the extra heat of an incubator can be a lifesaver. Internet incubators — a for-profit variant of the old-time government- or academic-supported not-for-profit entities — are sprouting up like dandelions in summer. Bill Gross’s Pasadena-based Idealab perhaps begat the trend in 1996. But it wasn’t until late last year that the dot-com-incubator spores really began to fly. The number of Internet incubators in the United States jumped from 15 in October 1999 to more than 50 in February 2000, according to Edward Black, a senior vice-president at the Aberdeen Group, who recently prepared a report on the subject. “It’s an emerging market in and of itself,” he says. The Internet-incubator concept is a simple one: typically, the incubators promise to take dot-com start-ups that are little more than an idea and give them a home (often a common one, where cross communication can flourish), business advice, connections to financing and high-level personnel, management and infrastructure services, and some capital. The last, the incubator founders say, is a primary reason for their being: to provide start-ups with seed capital. VCs, they say, can dole out only large chunks of money, because they don’t have the people power to be represented on numerous companies’ boards at once. Enter the incubators: purveyors of the $250,000 to $1 million or so that start-ups need to get going. In return for the incubators’ contributions, member companies turn over a hunk of equity: anywhere from 5% to more than 70%, reports Black, depending on the services and the funding provided. It’s hard to pinpoint a typical amount, but of the 11 incubators in Black’s study that disclosed an equity-stake range, 10 had ranges that started between 5% and 30%. The incubators like to speak of themselves as “accelerators” — hot boxes where companies can rocket from idea to launch in just 90 to 180 days. In a space where time to market can mean the difference between being an eBay.com and an Auctionharbor.com (who?), the extra heat can be a lifesaver. “The metaphor is an Indy pit stop,” says Mohanbir Sawhney, professor of electronic commerce at the Kellogg Graduate School of Management at Northwestern University, in Evanston, Ill. “The car comes in, and — bang, bang, bang — 20 guys work on it, and they’re off in 30 seconds.” Of course, within that general framework lie wildly divergent business models. Some of the for-profit incubators, like Cambridge Incubator, charge for everything from management services to Web design to the Mountain Dew in the communal fridge, take a 50% or greater equity stake, and expect member companies to be with them for about 12 months. Others, like the San FranciscoÂbased Camp Six, provide everything — even office space — free, take a 20% to 30% stake, and project a 3- to 6-month incubation period. And the business-building experience of the incubator founders swings just as wide. At one end of the spectrum is Bill Gross, 41, who founded three successful high-tech companies before he started Idealab, which has spawned such public companies as eToys Inc. (valued at more than $7 billion after its initial public offering, in May 1999). At the other end is Michael Stern, 20, a political-science major at Yale who’s cofounder of Aquarium Ventures, on the university’s campus in New Haven, Conn. With such a wide range of models — and no track record to speak of — the new for-profit incubators (many of which, like Idealab, plan one day to go public themselves) present today’s cash-strapped, time-pressed dot-com entrepreneurs with a seductive but difficult question: Is incubating my company worth it? On the evening of February 9, over spicy string beans and lemon chicken, Veritas Medicine’s Robert Adelman was just beginning to learn the answer. For the next six weeks, Inc. would be with him nearly every step of the way. Joining the incubator had seemed like a good idea at the time. It was late August 1999, and Veritas Medicine was no more than an idea in Stephen Knight’s head and a handful of slides. Knight, then 39, had just agreed to become the new president of Epix Medical Inc., and his wife had just had their second daughter. He knew that if Veritas were to see the light of day, he’d have to find someone else to lead the venture and enough money to enable that person to operate. Knight had no trouble lining up the first: Robert Adelman, a friend of his from Yale Medical School, was looking for a change and owed him a favor. As cofounder of the successful biotechnology company Operon Technologies Inc., in Alameda, Calif., Adelman had not just business experience but the savings that would allow him to work without a paycheck for a while. He came on board as Veritas’s acting CEO. Knight was in search of the funding he needed when he met Andrew Olmsted, head of development for Cambridge Incubator (CI), one evening at his health club. Olmsted suggested that Knight drop by and give the incubator’s CEO, Timothy Rowe, the Veritas pitch. “It was kind of a last-ditch effort,” says Knight. The deal that Knight struck with CI — the incubator’s first — was not ideal. After all, Knight did give up what would amount to 51.22% — when fully diluted — of the company. (That stake was split between Cambridge Incubator and SeaFlower Ventures. SeaFlower was brought into the deal, says Knight, because one of its partners, James Sherblom, is a former biotech executive whom Rowe went to for advice because Rowe knew little about health care.) Still, the deal turned what had been an entrepreneurial dream into an operating company with $834,000 in seed funding, office space, a technology infrastructure, and the ability to hire the beginnings of a staff. Knight’s idea for an Internet company was straightforward: Pharmaceutical companies constantly run clinical trials of the new drugs they’re developing, but the locations (and other details) of those trials are often secret, for competitive reasons. Many patients want to participate in the trials but don’t know how to find them. What if someone were to compile a comprehensive Web-based database of trial sites for, say, 40 life-altering diseases, along with crucial medical information? Then patients could enroll in the trials at will, and the pharmaceutical companies, which would fill up their trials faster, could save millions of dollars by getting their drugs to market sooner. It would be a win-win scenario. Tim Rowe certainly thought so. “Pharmaceutical companies have lots of drugs, and there are lots of pharmaceutical companies,” says Rowe, 32, recounting his reaction to Knight’s pitch. “You get very, very big numbers when you multiply them.” At the heart of Rowe’s Cambridge Incubator — the place where he expected Veritas and about 14 other start-ups to spend some 12 months — is the “venture campus.” At the time Adelman came on board, that 18,000-square-foot biometrically secured (it uses fingerprint scanning) enclave was under construction in Cambridge’s Kendall Square. Boasting a cafÃ, a stage area, and 14 open company bays that accommodate five to seven people each, the space was designed to be, Rowe says, a veritable petri dish of cross communication. He was particularly excited about the translucent, corrugated-polycarbonate walls that he said would surround the bays, allowing company owners to get a sense of the activity within the offices. They’re intended to encourage collaboration but keep from view the contents of the companies’ all-important whiteboards. Companies within the incubator, Rowe explains, will go from mature concept to prototype or product within 120 days. In addition to “active incubation” services (VC contacts, mentoring, and management services), CI provides some $250,000 to $1 million in seed capital to each of its incubated companies. Rowe is financing the incubator with $10 million he raised from the venture-capital firm Draper Fisher Jurvetson (DFJ) and the Boston Consulting Group, where he was a management consultant for four years. (His father, Richard Rowe, who sits on CI’s board of directors, lent him $500,000 to start the project.) CI has advertised since November that it plans to raise $100 million more, but at press time none of that money had come in. Until the venture campus was completed, on March 31, Veritas Medicine was housed, along with CI and its three other member companies, in bland office space across the street. Veritas’s 12 employees were socked away in three offices with gray melamine desks. There was generally a collection of crushed Mountain Dew cans and a box of shirts from the cleaner’s on the filing cabinet next to Adelman’s desk, and a stack of empty pizza boxes atop the trash can in the entrance area. “One of the stipulations of my joining the incubator,” says Adelman, jiggling the brown loafer off his foot, “was that they’d provide seven or eight cases of Mountain Dew a week.” Adelman, who has light brown hair that he slicks back for important meetings, wears rumpled beige khakis and moves with a gangly, nervous energy. Along with Joshua Schultz, 25, Veritas’s vice-president of business development, he honed Knight’s rough idea into a solid business model. Included in the model is the company’s goal for earning revenues: the pharmaceutical companies will likely pay Veritas a “percentage of value created,” that is, calculate the savings they’ve accrued by filling their trials so quickly and give Veritas a percentage of those savings. Another refinement is its so-called switchboard structure. It’s that structure that places Veritas so neatly, and so objectively, between the two markets that it serves. (Schultz had become familiar with the progenitor of the switchboard model when he worked at the Boston-based management-consulting group Corporate Decisions Inc.) Two outgrowths of the concept are an encrypted database that will store the trial information and automatically match patients and trials; and the idea of distributing the service not just through Veritas’s own Web site but through windows and other links placed on various health-care sites. Both Adelman and Schultz have no question that without Cambridge Incubator, Veritas would be weeks or maybe months behind where it is now. From day one not only have they had office space and furniture, phones, a T1 line, and a computer network, but they’ve had access to virtually all the professional services any good dot-com start-up needs to get going: Web developers, lawyers, public-relations and marketing specialists, and recruitment and human-resources help. Using CI developers, they’ve built their Web prototype for $20,000, as opposed to the $50,000 that it would have cost if they’d used outside help. CI has also been useful, Adelman and Schultz say, in helping them know what VCs want to hear and in providing VC contacts, including DFJ, in Redwood City, Calif.; and Polaris Venture Partners, Advanced Technology Ventures, and Atlas Venture, all in the Boston area. And CI has led them to an important health-care adviser, Dr. Hamilton Moses III, a partner of Boston Consulting Group who is based in Washington, D.C. Taken together, those ingredients have helped jump-start the company. “In this world,” says Adelman, “a week or a month can be the difference between life and death.” From the outside, the incubator appeared to have all the makings of a digital-age Camelot. But Adelman soon discovered that all was not well inside the Internet-incubator world. For starters, there is a question about the nature of CI’s contribution to Veritas: Is it simply an incubator, providing the environment in which the independent company can grow? Or is it actually a cofounder? When asked that question, Tim Rowe says that CI came up with Veritas’s distribution strategy; he uses that as an example of how CI acted as the company’s cofounder. That cofounder status, he says, justifies the incubator’s large equity stake in its member companies. (Rowe also repeatedly cites as justification for the large cut the Investment Company Act of 1940, an arcane federal law that implies that when a company goes public, it must maintain at least a 25.1% stake in the majority of the companies it has taken an interest in.) “Giving away equity in your business implies that you’ve got something that’s yours to start with, and that you’re giving it to somebody,” says Rowe. “In fact, what we’re doing is cofounding a business that didn’t exist.” Adelman, who is working toward owning 11% of that business, and Schultz, who owns 4%, have — to put it mildly — a different take on the matter. While they say they appreciate Rowe’s brainstorming with them to refine Veritas’s business model, in no way do they view him — or anyone at CI — as a cofounder of their company. “A cofounder is someone who is central to the origin of the concept,” says Adelman, ticking off himself, Schultz, Knight, and Knight’s wife, Elizabeth Quattrocki Knight, as Veritas’s cofounders. And the distribution strategy, he says, has for a few years been a standard one on the Web. And then there are the price tags attached to many of the benefits. Above and beyond the equity stake that CI took at the outset, Veritas has had to pay as much as $19,000 a month for the incubator’s infrastructure and the aforementioned professional services. Moreover, the recruiting function of CI has been so dismal that Veritas has gotten nearly all its staff itself, through Monster.com. And it used an outside graphics house to design its Web pages. Rowe acknowledges that the incubator’s recruiting services in February and March were below par. “I would say, without reservation, that at that time we were not providing enough recruiting support for Veritas,” he says. Aberdeen researcher Edward Black has this to say about the fee-for-service, pay-for-infrastructure Internet-incubator model: “It’s an interesting scenario. I give you this money, and basically, over the next six months, you’re going to give it all back to me in fees. You’ve got to love America.” To be fair, even at a rate of $19,000 a month, it would take Veritas some 44 months to give CI and SeaFlower their investment back in fees. Still, Black has a point — one that’s echoed by Edward B. Roberts, a professor of management of technology at MIT’s Sloan School of Management and founder of the MIT Entrepreneurship Center. “If you’re paying for all the services rendered on an as-you-go basis, then you are not partners,” he says flatly. “You’ve got a service contract, and you’ve given away ownership merely for the capital.” As Roberts sees it, incubated companies should pay for rent and for those services that vary from company to company, such as telephone calls and photocopying. But the in-house help and hand-holding, he says, should be factored into the equity stake. “You don’t pay a venture capitalist for advice,” he points out. That’s true. Even though every deal in the VC world is unique, VCs that do early-stage financing (Zero Stage Capital, in Cambridge, Mass., and Timberline Venture Partners, in Vancouver, Wash., for example) generally take a one-third equity stake in the companies they’re investing in and provide on the order of $500,000 in seed capital. Advice, mentoring, and access to management-level players are free. VCs that do mid- and late-stage financing provide their advisory and mentoring services at no charge as well. “If you know where you’re going and it’s speed you need, that’s where incubators can help,” says e-commerce professor Mohanbir Sawhney. For his part, Tim Rowe says that CI charges for high-level services because it’s difficult to allocate limited personnel resources. “The reason we bill is to provide an incentive for our member companies to be efficient about the amount of service they use,” he says. Rowe, who wrote the business plan for his father’s $308-million Internet company, RoweCom, while he was an M.B.A. student, doesn’t charge for his own advice. Neither do CI’s four other top executives, only one of whom has experience founding a dot-com himself and none of whom is older than 36. CI also has a five-member board of directors, but, Adelman says, “I haven’t had too much interaction with them. I met Dick Rowe at a party. And I met Phil Villers [cofounder of Computervision] a couple of times, just to say hello.” MIT’s Roberts points out, “One of the things an incubator owes to the companies that it’s incubating is some reality and the presence of the people who are advising.” Rowe acknowledges that “Veritas doesn’t interact directly with CI’s board.” Then he says: “Typically, what CI’s board does is, it designates one board member to each member company. But since none of our board members had medical knowledge, Phil Villers nominated [SeaFlower's] Jim [Sherblom] to act in that role.” He adds, “I don’t think his involvement is very deep.” Adelman, on the other hand, says that he has regular contact, probably every two weeks, with Sherblom, who, he says, is “a really knowledgeable guy in the pharmaceutical industry.” Contact between Adelman and the principals of other member companies appears to be minimal, too. When asked about idea swapping, which is one of the professed reasons all the nascent companies are housed in the same space, he responds, “Socially, it’s great.” Then he says: “There’s lots of small flow back and forth. It’s usually off-the-cuff.” Maybe part of the problem was that for Veritas’s first four and a half months, everyone was still operating behind closed doors and not within the translucent polycarbonate walls of Rowe’s $2-million haven across the street. As far as the VC contacts that CI has provided go, so far none has translated into financing. The VC that looks the most promising to date, says Adelman, is a prominent investor on the West Coast that focuses on health care. Veritas made the contact with the investor itself, through Seth Birnbaum, a coworker of the angel who hosted the Chinese-food spread on February 9. All together, has Cambridge Incubator truly acted as an “accelerator,” helping Veritas sharpen its direction and speeding its time to market? For that matter, can any incubator truly act as an accelerator? “My sense is that incubators do the speed part better,” says Kellogg’s Sawhney. “If you don’t know where you’re going, if you run like hell, that doesn’t help you. If you know where you’re going and it’s speed you need, that’s where incubators can help.” But even if you know where you’re going, is it worth it to give up a big piece of your company to get there, say, two, three, or even six months faster? “We won’t know the answer to that for three to five years,” says Andy Sack, 33, cofounder of the Internet companies Abuzz Technologies and Firefly. Sack is listed as an adviser at CI, but it’s difficult to see how much direct interaction he can have with the companies in the hothouse atmosphere of the venture campus. He lives about 2,500 miles west of the incubator, in Seattle. “As an entrepreneur, I’d look at them [incubators] pretty skeptically. But having done that and looking back, I think there’s a need for them in the financing chain,” Sack says. And given the newness of the breed, who’s to say that even the speed part of the equation will be borne out? “For the first 45 days it’s really valuable, and then there’s a slide for a while, and then actually I think there’s a slowdown,” says Adelman of his incubation experience. “Entrepreneurs need freedom.” Although venture capitalists have varying criteria that they use to choose the companies they’ll fund (DFJ, for example, primarily wants companies that have a market opportunity of at least $1 billion), there are certain variables that are important to them all. Among them is a balanced corporate ownership, for it is only with an equitable ownership stake that each component of the company — management team, investors, and future hires — will, in VC-speak, be “incentivized” enough to make sure the company keeps growing. The standard breakdown of ownership in a start-up after its initial round of funding, says Shari Loessberg, a lawyer who teaches entrepreneurial finance at MIT’s Sloan School, is either 40%Â40%Â20% or 30%Â50%Â20%. That is, 30% to 40% of the company is held by the investors, 40% to 50% is held by the management team (which includes the founders), and 20% is set aside as an option pool, a collection of potential stock that the founders will dispense as an inducement to new employees. In essence, VCs like to see at least 60% to 70% of the company in the hands of current and future employees after the initial funding. Because of the deal Veritas struck with Cambridge Incubator, the company’s corporate structure doesn’t come close to that. According to Adelman and Knight, here’s how the ownership pie is sliced: in addition to Schultz’s 4% and Adelman’s potential to own 11%, Knight has 23% to 24%, and Quattrocki Knight has 2%. That means that the management team (and the company doesn’t yet have a CEO) owns a total of 40% to 41%. Given the 51.22% potential maximum stake of the initial investors (CI and SeaFlower), that leaves an option pool of a meager 8% to 9%. (Although Adelman doesn’t give an exact number, he confirms that the option pool is “in the single digits.”) Thus, after Veritas’s initial funding, only 48% to about 50% of the company — as opposed to the recommended 60% to 70% — resides in the hands of the current and future employees. That could make it difficult to attract the key people the company needs. VCs agree that being in an incubator does not automatically work for or against a company as far as getting VC funding goes. But it can act as a red flag, making the VC look hard at what kind of value the incubator has brought — and will continue to bring — to the member company: Did the incubator help the company significantly improve its business plan? Did it introduce it to important business partners? Does it have solid experience in the member company’s industry? Did it help bring in key employees? How many other commitments does the incubator have? Is it incubating, say, 15 or more companies, which means that it’s likely spreading itself too thin? And it’s not the ratio of incubator staff to member companies that matters so much; rather, it’s the ratio of well-connected, experienced incubator partners to member companies. “We gauge the quality of the people who help incubate the member companies as the first cut for sorting through good companies from bad companies,” says Stanley Fung, a partner with Zero Stage Capital. Of course, it’s not enough for a VC to require, as a condition of providing financing, that a company be restructured so that its management team will have the proper incentives. For any restructuring to happen, the current investors must agree to the new terms, or they will blow the deal. Knight, Adelman, and Schultz were well aware of what needed to happen when they sat down, on March 1, for a third meeting with the angel investor. Talk turned to what the company’s valuation would be when it received its first VC funding. “New venture capital is going to dictate new terms,” said Knight. “Jim Sherblom is a reasonable guy. Tim Rowe is not in a position now to argue.” On March 23, 43 days had passed since Adelman was asked to question the worth of his company’s incubator experience over a dozen-plus cartons of Chinese food. How did the experience of Veritas Medicine measure up against the promises of Cambridge Incubator? Veritas had been in CI since the end of October — nearly a month past Rowe’s target date for a completed prototype. Adelman claimed that the company’s prototype was finished, but only 4 of the projected 40 diseases had complete scientific information, and the clinical trials listed were ones that Veritas had come up with on its own, sans the pharmaceutical companies’ participation. It’s the pharmaceutical companies, funneling their information directly into the encrypted database, that will make Veritas’s list of trials comprehensive. The start-up had one letter of intent in hand for a pharmaceutical partnership — from BASF’s Knoll, a connection that Veritas made on its own — and an oral commitment for another. Visits to seven pharmaceutical companies, which Veritas again had arranged through its own contacts, were on the calendar. The encrypted matchmaking database had not yet been built, though Adelman had commitments from two network-operations experts to construct it. The company had pushed its launch date from March to the end of June. “It’s contingent upon having enough partners to make it worthwhile,” said Adelman, who noted that five would be sufficient. Adelman acknowledged that things were going more slowly than he’d hoped. “We’ve cut our burn rate to compensate,” he said. The company, with $480,000 left in its coffers, had enough money for five more months of operation — if it slowed down its growth. It had added four staff members since the February 9 dinner meeting. No new money had come in yet, though talks with the West Coast VC were going well. On March 31, CI’s staff and three of its member companies moved into the touted venture campus. Veritas — after a bit more than five months in the incubator — did not go with them. It remained in its original location across the street, taking occupancy of the 3,300 square feet of space that Rowe and company vacated and paying rent not to CI but to the company that holds the space’s lease. Veritas now has its own phone system and T1 line. It pays a fee to use CI’s network and the new robust Sun servers that CI installed in late March. Adelman is particularly grateful for the money that Veritas is saving by having access to the latter. Tim Rowe tries to characterize the Veritas split as a matter of the member company’s having grown too big for the incubator space — though he offered Adelman 4 of the venture campus’s 14 bays, and with just 12 employees, Veritas could fit neatly into just 2. And Adelman’s take on the turn of events? He calls the move Veritas’s “graduation day,” even though the company hasn’t met any of the criteria — VC money, launch — that CI has posited for that. “Essentially, it’s an independent step. It’s a level of autonomy that we need to have,” says Adelman. “They’re looking at a Japanese style of business, a keiretsu. I’m more the American-cowboy style.” So, is incubation, for Veritas Medicine and any number of Internet start-ups, worth it? The answer — at least at this point in the story — is mixed. None of the players in this particular drama are the “bad guys.” Rather, inexperience on both sides, as well as very different personalities, business styles, and cultures, seems to have made the Veritas MedicineÂCambridge Incubator match a far-from-optimum one. “I think we should have a support group: how not to buy a boat anchor for people before they start companies,” says the angel’s coworker Seth Birnbaum. He’s joking about what it’s like to be a novice entrepreneur, but there’s a lesson in his statement. Stephen Knight openly acknowledges his navetÃ in negotiating the arrangement with Tim Rowe. “To be quite honest with you,” he says, “we don’t have a ton of experience, so I didn’t know exactly what was the right thing to do.” Howard Anderson, 55, does have a ton of experience. He’s a veteran businessman, venture capitalist, and founder of the Internet consulting firm the Yankee Group. He also recently started up his own Internet incubator in Cambridge, YankeeTek. On the subject of how much equity incubators should get, he puts on the boxing gloves (in contrast to Birnbaum’s white kid ones). “If anyone is stupid enough to negotiate away 50% of their equity for no investment, then he deserves to wind up owning a very small percentage of his company,” he says. “In Michael Lewis’s book The New New Thing, Jim Clark makes a pretty elegant case that at the end of the day, the entrepreneur deserves a lion’s share of the company.” Thea Singer is an associate editor at Inc. Please e-mail your comments to firstname.lastname@example.org.
FYI: From the editor In April we held our second annual Inner City 100 dinner, and a memorable one it was. The event, which celebrated the publication of this year’s Inner City 100 list (Inc., May 2000), was a star-studded affair designed both to honor the companies on the list and to generate support for the cutting-edge research and mentoring work being done by our partner in the project, Harvard professor Michael Porter’s Initiative for a Competitive Inner City (ICIC). Among those in attendance was basketball legend Earvin “Magic” Johnson, who for the past 13 years has been building his own substantial inner-city business, Magic Johnson Enterprises, and using his fame and fortune to encourage others to do the same. For that, he was presented with ICIC’s first National Inner-City Leadership Award, which will be given each year to someone who has made an extraordinary contribution to fostering entrepreneurship and enterprise in America’s inner cities. I had the pleasure of sitting with Johnson at dinner. The talk naturally turned to basketball and business. I commented on the remarkable turnaround of the Los Angeles Lakers this season under the leadership of head coach Phil Jackson, former coach of the Chicago Bulls. “Jackson is one of the few coaches left in the league who can actually manage the players,” Johnson said. “This isn’t a new thought, but today’s players are uncoachable. All they care about is the money. “Don’t get me wrong. The money was important to the players in the past. But there were other things, too. There was the love of the game. For a lot of players, they really cared about doing well in front of their fans, the hometown people. I’m talking about pride. When the only thing that a young player cares about is the money, everything changes. It makes them uncoachable. “I see the same thing happening in business,” Johnson went on, “and I’m not just talking about people at the top. I see lots of young people who care only about making a lot of money and making it real fast. That focus on money makes people unmanageable — unless you’re a Phil Jackson-type manager. I think it’s crazy to count on that. “If you ask me, you should try to figure out who those people are in advance, and then make sure you don’t bring them into your business in the first place.” Johnson sounded like a man who was speaking from experience — both on and off the court. The spin-off trap We followed up the dinner this year with a daylong conference at Harvard Business School for the CEOs and top managers of the Inner City 100 companies. One of the keynote speakers was Jeff Taylor, the chief executive of Monster.com, the leading online network for matching up job seekers with companies that are searching for talent. Among other things, Taylor talked about the most common, and lethal, mistake that established companies make in formulating an online strategy. “Whatever you do,” he urged the Inner City 100 executives, “don’t go out and spin off a dot-com company. It’s a strategy that’s destined to fail. Think about the message you’re sending to the people who built the brand. They’re going to feel they’re being left behind. The best of them will leave. So you’ll end up hollowing out the company whose brand you think you’re leveraging. “Meanwhile, on the dot-com side, you’ll recruit a lot of young people who may have energy and talent but who understand nothing about your brand or markets. So the new company will contain none of the DNA that made you successful to begin with. Instead of one thriving company, you’ll end up with two ineffective ones,” he said. A member of the audience noted that people on Wall Street were giving the opposite advice to established companies. “You’re absolutely correct,” Taylor replied. “The question is, are you willing to let Wall Street run your company? Look at it this way. Everyone agrees that the traditional economy and the digital economy are converging faster than any of us dreamed possible. So the challenge for every company is to learn how to become a dot-com, not how to spin one off.” Passing it on Later in the day, the Inner City 100 leaders heard a second keynote speech from Jeffrey B. Swartz, president and CEO of the Timberland Company, an early Inc. 500 company. Swartz shared his insight into the challenges and opportunities that a business faces as it is passed from generation to generation. “My grandfather started the company, making boots by hand, and everything about it was personal. When he sold you a pair of boots and promised that the boots would last a lifetime, it wasn’t a customer-service program. It was my grandfather looking you in the eye and making a personal promise that if anything went wrong, you could bring the boots back and he himself would make you another pair. “When my father took over, the challenge for him — as for so many second-generation CEOs — was to professionalize the business. Timberland wouldn’t be here today, and I wouldn’t be up here speaking to you, if my father hadn’t succeeded. “So what’s the challenge for me, the third-generation CEO? I think it’s to make the business personal all over again. Customers demand it. In many ways ‘making the business personal’ defines what a brand is today. The Internet is a wonderful platform for doing it, but it has to be about something more than a transaction. These days, when people buy something from you, they want to know who you are, what you believe in. My challenge is to marry the boots and the brand with a set of beliefs that has fueled my family’s mission for three generations.” I found Swartz’s remarks very timely, given the current mania for ramping up and cashing out as quickly as possible. I was also reminded how few companies are able to make the transition from first to second generation, let alone from second to third. So far Timberland is defying the odds. Please e-mail your comments to email@example.com.
REALITY CHECK: Oh, yeah? Try putting a traditional business on-line Click here for the word from the experts Dan Caulfield is a former marine who more than trusts technology; he loves it for the power it can bring. A couple of years ago he experimented with running his Chicago-based recruiting business, Hire Quality Inc., as a truly paperless office. It almost worked. The paper eventually crept back, but Caulfield says that reducing it boosted the company’s productivity by at least 300%. Caulfield put up his first Web site in early 1995, when the gurus were still talking about the information superhighway and America Online was an upstart challenging CompuServe for its E-mail business. So during last year’s Internet fever, he figured he’d better get a supersite going before Net-savvy competitors ate away too much of his business. “Every day, we’d lose customers to Monster.com or HotJobs or some Internet recruiter,” he says. Hire Quality specialized in placing veterans, and one of its biggest assets was its gigantic database of military résumés. So the obvious solution to its competitive problem was to get that puppy onto the Internet. Let employers post job listings and search for candidates themselves, Caulfield figured. Make it possible for companies to screen job seekers automatically with a short on-line questionnaire. Caulfield’s business had always offered traditional individual package placements, which went for $3,000 to $5,000 each. Now he hoped to expand his line of products and services by taking advantage of the Web. Using the Internet model, he would be able to sell listings alone for a mere $25 each — which was much more affordable for clients with less money to spend on recruiting. “Instead of turning down 80% of the people who call, because they don’t want to pay the fee, we could get money from all of them,” Caulfield says. Strategically, Caulfield’s move made a good deal of sense. He was confident of his company’s ability to deal with the glitches that came with the adoption of a new technology-based business strategy. He had been down a similar road before, when he tried to go paperless. But putting Hire Quality’s database on the Internet was a lot more complex than he had ever imagined. “We expected to put our system on the Internet and that people would be able to use it intuitively and quickly — and get the same kind of productivity gains that we got over the past three years,” he says. “That didn’t happen. The legacy database was very cumbersome. We almost had to rewrite five years of code to make this work on the Web with multiple users. Taking a client/server system and porting it to an Internet model was very hard.” By last June the site seemed ready to go. Caulfield started running a commercial on cable TV — which cost $8,000 a month — and sat back to wait for traffic to build. But once again his strategy was hamstrung by the unexpected quirks of a new technology. His customers couldn’t figure out how to use the site. “The system was just not intuitive,” he says. “If I could have given our customers a day of training — like I do my staff before they even touch the computer — they could have done it.” That wasn’t an option, so Hire Quality’s customer-service phone reps spent most of last summer walking clients through the steps needed to post a job. Meanwhile, Caulfield’s programmers raced to simplify the customer interface. “We thought this would be up and running in May. We didn’t get it up and running until September,” Caulfield says. By the time his programmers got the kinks out of the system, programming costs had eaten up his marketing budget. So even though the site had been improved, traffic growth was, until recently, disappointing. Caulfield says that it is slowly increasing, but “we had no idea how slow the volume would be and how slow it is to build the $25-placement business. We are holding on by our teeth to our cash flow and bank reserves.” Though all the Internet hype had led Hire Quality into a quagmire of a project, it also provided one payback. Caulfield ended up creating a new company called Hire Quality Technologies to do for other companies what Hire Quality did for itself. The business creates private-label software for posting jobs and screening candidates on the employment section of Web sites. The new company is worth five times the value of the original Hire Quality. Businesses making the jump to the Web should leave plenty of room for error, advises Caulfield. “Plan in time for technology that just doesn’t go as smoothly as you’d like it to go,” he says. “Give yourself an extra 30 days before you roll something out. Make sure the site is operational before you even tell anyone you’re doing it.” Then add another couple of weeks for quality control and customer focus groups, he adds. “The problem in innovating new stuff: it takes a hell of a lot longer to get it working than it’s supposed to,” he explains. THE 7 MYTHS OF THE WEB ECONOMY Myth 1: Building a Web site is easy The word from the experts Myth 2: Traffic will make you rich The word from the experts Myth 3: Smart money makes you smart The word from the experts Myth 4: Razzle-dazzle makes Web sites great The word from the experts Myth 5: Brand is everything The word from the experts Myth 6: Wild ads make Web stars The word from the experts Myth 7: Community, community, community The word from the experts Plus: Tales my guru told me Dispatches from the Web economy Back to Intro, ” I Was Seduced by the Web Economy”
In today’s fast-paced world of Internet finance, whom you know is just as important as what you know The thrill ride of financing Guru.com began to hit breakneck speed late last May. Brothers Jon and James Slavet were in the middle of wooing one investor for their Internet start-up when another prospect called and “wanted us to pitch to him right away,” recalls James. Just a few weeks earlier, things had not been going so well. The Slavets had been downcast by the glazed stares they’d received from the venture capitalists they’d approached about their San Francisco-based company, which offered job-matching and other Web-based services to independent contractors and soloists. But the brothers had now gained momentum, leveraging a network of contacts they’d amassed at Harvard Business School and from Internet companies at which they’d worked. Hats in hand, the Slavets had humbly drummed up financial backing from their old bosses at E! Online and Drugstore.com. They had tapped their Internet connections for leads to angel investors such as CitySearch Inc. cofounder Thomas Layton and Yahoo’s Matt Rightmire. Now Fred Gluck, a former partner and managing director of McKinsey & Co., wanted an impromptu face-to-face with the start-up. In San Francisco for a meeting, Gluck had some downtime before returning to his office in Los Angeles. He asked the Guru.com team to meet him at the airport’s Red Carpet Club. James and his second business partner, former Harvard classmate Al Yau, jumped into a cab and obliged. Slavet and Yau had been through their 20-page presentation a dozen times, but in the Red Carpet lounge, Gluck took their breath away by challenging them to identify the key uncertainties in Guru.com’s projections. Downplaying what was probably a heart-stopping moment, Yau admits, “It was a level of probing we hadn’t anticipated.” If their answers lacked clarity, it hardly mattered, because Guru.com had people pulling strings behind the scenes — where it really matters. A former McKinsey consultant had already put his own credibility on the line with Gluck in vouching for Guru.com. The start-up’s list of advisers – featured prominently in Guru.com’s pitch — also suggested that an investment in the company warranted serious consideration. Moreover, the management team — led by the Slavets — boasted an impeccable Internet pedigree. With all that going for Guru.com, Gluck decided to bet on the company, joining 19 other angels in a $3-million round of financing that closed last July. In interviews two months later, Jon, 32, and James, 29, exuded a boyish joyfulness that made it seem as though lining up a killer pack of angels were as easy as arranging a squadron of toy soldiers. As they closed in on a second round of financing — $16 million in venture capital — the Slavets’ enthusiasm for Guru.com was so infectious, it made you want to jump into the game too. After all, in the first half of 1999 alone, venture capitalists poured a record $5.9 billion into Internet-based companies, according to the VentureOne Corp., which tracks the venture industry. In this era of Internet riches, entrepreneurs can simply slap “.com” behind a catchy concept and watch investors rush in, right? Sure, just about everyone wants to dip a pan in the Internet and swish for gold. But Web-based start-ups thrive not on easy money but on smart money. “Easy money is like crack,” warns Robert Bingham, an Internet-entrepreneur-turned-angel in San Diego. Trouble is, with everyone vying for a taste of the Internet rush, avoiding a quick fix in favor of astute strategic investments has become harder than ever before. As Bingham puts it, “the bar has been raised.” These days, as Guru.com’s example shows, spectacular Internet business plans attract smart money only when paired with even more stunning management teams. When they first started, Guru.com’s founders might have thought their product was hot enough to get a fast investment. But they quickly realized that more than anything else they had to build and work a network. Savvy investors assess a start-up as much by its founders’ connections as by the founders themselves. And that’s all assuming the entrepreneur can rise high enough above the noise to catch investors’ attention. In raucous Silicon Valley, literally thousands of Internet proposals streamed into the big venture firms last year. “On a daily basis I receive a dozen unsolicited business plans,” notes Mayfield Fund partner Robin Vasan. “I look around my office, and there are dozens and dozens more.” Most, he admits, will never be read. Guru.com might also have languished at the bottom of the heap. Instead, the Guru.com team put their plan on top by piggy-backing on the success of others. That strategy provides a management lesson in how to get smart money from angels who can help guide and groom a company for venture funding and crucial Internet partnerships down the road. The story of Guru.com’s financing also serves as a tip sheet on how to act like a player in the new, new economy. It’s an economy in which money is merely a commodity, and strategic assistance is key. The dollars you’re after are a consequence of the relationships you build. Observes William Sahlman, a professor of entrepreneurial finance at Harvard Business School who is one of Guru.com’s investors and advisers: “The game that we’re talking about, you can’t play as an amateur …. It’s like running up rock faces, trying to get an edge with every move you make.” It’s 9:15 on a sweltering September morning in San Francisco, and Guru.com’s tunnel-like office space is coming to life. James Slavet, sporting a suit as black as his slicked-back wavy hair, munches on a bagel and cavorts with incoming staffers as they take their places around makeshift workstations. An imposing six feet five inches tall, James has to duck through the doorway as he enters the front room, where his older brother (a mere six feet three) has staked a claim on the only office with a view. Bristling with confidence, the Slavets explain that they’ve worked alongside each other before. In 1995 and 1996 they were both at Wired Ventures Inc., where they helped engineer the technology-magazine company’s on-line offering, HotWired; Jon on the ad-sales side and James in business development. Later Jon moved to E! Online, where, according to former president Jeremy Verba, he proved himself “a very street-smart, savvy salesperson.” James, meanwhile, headed for Harvard Business School and spent the summer between sessions on Drugstore.com’s team, sealing deals with partners like Yahoo. “We’re both Internet babies,” says Jon. The brothers’ experience at the feet of other Net-company founders provided the impulse for the launch of Guru.com. “I was more afraid of not taking the jump to start a company than I was of taking the jump,” Jon says. James is the more plodding, cerebral Slavet. “I’m the brakes in the operation,” he offers. From an investor’s standpoint, it’s an appealing partnership. “They’re the yin and yang of management,” comments Verba, who’s now at HearMe (which provides live-voice technology for the Internet) and is also a Guru.com angel. The brothers’ complementary styles create “the success recipe at Guru,” Verba says. “James has this very strong, analytical, strategic business mind. Jon is someone who, just through the sheer force of execution, can get things done.” “The game that we’re talking about, you can’t play as an amateur,” observes one investor. On this late September day, there are two tasks at the top of the company’s to-do list: raise a second round of financing and launch Guru.com’s premier product — a job-matching service designed for independent professionals. The launch is just eight weeks away. No one has had a day off since starting with the company; all the employees need sleep and haircuts but are upbeat all the same. Joking about the dim, disheveled office space, Yau, Guru.com’s 30-year-old vice-president of finance and strategy, says, “As a ratio of empty pizza boxes, I think our valuation is a little low.” Valuation is on everyone’s mind because, at noon today, the Guru.com team will meet with Greylock, one of six venture firms that the start-up has targeted for its second round of financing. Twice before, the founders have talked seriously with Greylock general partner Aneel Bhusri. The vice-chairman of the board of PeopleSoft Inc., Bhusri first heard about Guru.com in August, from one of the software company’s former executives, who had hired Yau as an intern when Yau was in business school. Having tried unsuccessfully to hire Yau full-time at PeopleSoft, Bhusri says, he was keen on learning about the former intern’s new business. Even more influential, though, was the good buzz that Bhusri heard about the Guru.com team from William Sahlman. “He couldn’t stop saying great things about these guys,” Bhusri recalls, adding, “I immediately felt that they were right on the mark.” It isn’t that Guru.com involves a mind-blowing technology play. Nor does it have a particularly innovative business model. Rather, in the increasingly familiar phraseology of the Net, it seeks to “amalgamate the unamalgamated” — in this case, the roughly 25 million Americans who work as free agents, or independent professionals, according to the company. What resonates with Bhusri is the way the Guru.com team talks about serving customers. Guru.com’s proposition holds that free agents (or “gurus,” as the company likes to refer to them), who lack the community and other trappings afforded workers in traditional office settings, will glom on to a site where they can create an alternative to the watercooler. These solitary folks will be drawn to a special place on the Internet where they can chat about “what it’s like to work in your boxer shorts,” as Guru.com’s content director, Todd Lappin, puts it. Guru.com intends not only to unite independent professionals but also to empower them — by peddling tools and services geared to making their work lives more productive. A key function in that respect: job matching. “A lot of Internet companies talk about the business — the advertising and other revenue streams,” Bhusri says. “These guys talked about what they were going to do for people who work on their own. When someone talks to you from the perspective of the customer, you listen.” The Guru.com team may have wowed Bhusri, but today marks its very first meeting with two other Greylock partners. “We have to assume that they know nothing,” Jon says as he delicately picks up what he calls “the valuation glasses.” In one dramatic gesture, he slips the sleek Matsuda frames onto his angular face and instantly transforms himself from earnest youngster into formidable deal maker. Jon laughs, but he’s only half joking about the glasses. Everyone at Guru.com fully understands the profound power of perception in the Internet-company finance game. As the Slavet brothers stride into Guru.com’s modest conference room, the perception — clearly — is that their deal is now in hot demand. They have at this point already talked with all six firms, making it plain in all their communications that they don’t want to see any term sheets until mid-October. They have also taken pains to keep the names of all the venture firms with which they are speaking under tight wraps. “We want to control the flow of information,” Jon confides. What’s most remarkable about this scene is that seven months ago, when Guru.com was a fledgling idea just out of Harvard Business School’s hatchery, venture capitalists were ambivalent about it. Among VCs, explains Mayfield partner Vasan, “there was the perception that the space they were going after was crowded.” Sites such as HotJobs and CareerMosaic were already up and running. Guru.com lagged behind those and other competitors in the job-matching business and had yet to prove its community-building concept. “That scared people,” says Vasan. The Slavets admit they were frightened, too, upon learning in late April that Monster.com was also moving into the talent market for independent professionals. Though they now deride the Monster.com competition as “a human auction,” at the time “they were really thrown off balance,” recalls Thomas Eisenmann, one of James’s Harvard Business School professors. Their disequilibrium deepened upon hearing that a hoped-for domain name (free-agent.com) presented serious trademark complications and was owned by enterprise-software maker Opus360 Corp. “We were completely bummed,” says James. Eisenmann calmed them, assuring them that the competition served as validation for their business model. The competition also signaled that Guru.com could not afford to waste time seeking venture capital. Even if the Slavets found a VC willing to take them on, doing a venture deal could require three to six months. “So much about the Internet is about speed that if there’s any way that you can jump-start your company, you should do it,” notes David Hornik, a San Francisco lawyer and business adviser to Internet start-ups. “If you are even a short time ahead of the pack, you will simply expand your lead over time because the growth is exponential.” “Everything conspired to make it very clear that we should go angel,” concurs James. The Slavets and Yau hit the streets, asking their old bosses and colleagues for advice, for money, and for leads to angels who would not only invest but also add genuine strategic value — through experience and through relationships with companies that could become Guru.com’s partners. Among others, Jon brought aboard Wired Ventures Inc. cofounders Louis Rossetto and Jane Metcalfe. Yau roped in Yahoo’s Rightmire and Steve Rehmus, an angel and start-up adviser he had worked with while at Goldman Sachs. Rehmus agreed to back the Guru.com team and gave the Slavets entrÃe to two other heavy hitters: former McKinsey partner and managing director Gluck and CitySearch cofounder Layton, who has invested in a total of 32 companies so far. “When Steven calls and says he’s got a company that he believes in and wants me to see, no matter how busy I am, I’ll find the time to see them,” comments Layton. The founders followed the same systematic approach with all their prospective angels, relying on personal contacts to introduce them to Internet heavyweights such as former Amazon.com VP for business development George Aposporos, two-time Net-business founder Ariel Poler, and even Allen & Co. managing director Stan Shuman. “We didn’t call anyone blindly,” notes Jon. The Slavets followed up every contact with a letter that reiterated their connections, identified their existing backers, and included a four-page summary of the business plan. “It gradually got easier as we had more investors come in,” notes Jon. “The last few investors said, ‘Wow, I know five of the people on your list.” From an investors standpoint, the brothers are an appealing partnership, “the yin and yang of management.” Of course, the founding team’s personal strengths were also a big draw. “I was willing to do this because I believe in James,” explains Mark Silverman, a Drugstore.com vice-president of business development and Guru.com investor. “It’s not because I perceive it as a great economic opportunity.” In at least one instance, though, the system failed. After spending eight hours in pitches to a husband-and-wife angel team, the Slavets were shut out cold, Jon says. “They wouldn’t return our calls.” By mid-July, just two weeks after completing the $3-million angel round, Guru.com had erected an elegantly designed “preview site.” The main page introduced Guru.com as “power for independent professionals” and defined guru as “an expert, a resource to others.” But for all its attractive look and feel, and lively, entertaining content, the site offered not a smidgen of job matching or other services. “It’s a juicy promise,” acknowledges the site’s designer, Steve de Brun. “It’s all about managing the perception.” Adds content director Lappin, who has stocked the space with a question-and-answer feature and guru profiles: “I’m like the guy in the circus who juggles flaming bowling balls until the elephants arrive.” Worried that the site might appear “half-baked,” two of Guru.com’s angels argued in a strategy meeting last July that the Web site should come down. It was a heated discussion, according to three people who were there. It also illustrated the degree to which Guru.com’s angels have been willing to get involved with the company, as well as the Slavets’ willingness to follow their own instincts. The Slavets opted to keep the preview site alive, a decision they now consider one of their smartest early moves. By September, Guru.com’s site had attracted some 20,000 users and had generated feedback proving that the company had hit a nerve with its audience. The 230 E-mail messages reviewed for this article were overwhelmingly positive, describing the site as “brilliant and indispensable” and “a fantastic idea for the Net.” One true believer gushed, “I have been waiting for more services like yours.” “The feedback almost seemed like it was scripted, it was so positive,” observes Bhusri, who reviewed E-mail responses as part of Greylock’s due diligence. Indeed, several Internet entrepreneurs interviewed for this article emphasized that having a bona fide site, as well as a loyal customer following, is crucial to attracting VCs. “You have to get an initial proof of concept,” says Alan Warms, whose Participate.com, which helps companies set up and manage on-line business communities, received more than $13 million in September. To be sure, Guru.com’s preview site generated great buzz. After it posted a press release under the headline “Guru.com Announces First-Round Financing from Leaders of the Internet Economy,” for example, CBS MarketWatch featured the start-up as its lead “Executive Briefing” item of July 26, highlighting the names of the company’s angels. Soon thereafter, a venture firm came calling, this time waving a term sheet and “trying to take a deal off the table preemptively,” says James. The Slavets and Yau turned down the offer, flat. Relying on the advice of their angels, they instead identified six “dream firms,” distinguished by partners and portfolio companies that Guru.com wanted to have involved with its business. The strategy was to have in-depth discussions with every firm on the list, get offers from three or four, and then choose two. The founders also made it clear that they would not use an offer from one firm to drum up higher offers from others, as some Internet entrepreneurs do. Instead, they proposed to “front-load the due diligence,” as James puts it, with a goal of both sides’ attaining an intimate knowledge of their prospective partners and reserving discussions of the deal’s terms for later. Because there’s much more money out there than there are good deals, some venture firms these days throw down a term sheet almost right away, seeking to lock up a deal for 30 days of due diligence, James explains. By contrast, Guru.com’s strategy put the entrepreneurs in control, enabling them to drive up the start-up’s valuation through a polite and restrained bidding in which they held most of the cards. What’s more, their strategy succeeded. In the second week of October (right on schedule) Guru.com received term sheets from four of the six firms. Jon and James then split the list and embarked on an aggressive final phase of due diligence, requesting five references from the contact partner at each firm. They methodically asked the same five questions of every reference: Why did you choose this VC firm? How effective has the firm been in securing deals and partnerships for your company? How effective has the firm been in recruiting additional board members? How has the firm helped your company increase its valuation? How would you rate the contact partner overall, on a scale of one to five? In the end Guru.com settled on two firms: Greylock and August Capital, which along with a few other investors put into the company almost twice as much as the Slavets had said they hoped for in September. Back then, the Slavets had cautiously pegged the deal in the $8-million-to-$10-million range. As this article went to press, in November, Guru.com was preparing to announce that it had raised $16 million — a stunning comeback for a company that had been casually brushed off by VCs just nine months earlier. “The first time out, we didn’t have anything. We were just three guys saying, ‘Picture this,” remembers Yau. “The second time out, we were able to say, ‘Look at all this backing we’ve got from this A-plus list of angels; look at our team; look at this feedback from our site.” Indeed, in the view of Guru.com’s new venture partners, the company is well worth its valuation. “These guys really understand the market,” says August Capital’s Andrew Anker. “They really see that for gurus, it’s a lifestyle, not just a job, and they’re going to give gurus all the things they don’t even know they need.” Greylock’s Bhusri, who has joined Guru.com’s board along with Anker, concurs. “They have done the right things for the right reasons. Not to get the highest valuation or the most money but to help them build a company.” Now the Slavets confront the real task of making that company work. “They’ve got terrific traction in a very interesting space, but they’re going to have to be very flexible and relentlessly focused on the needs of their customers,” says CitySearch’s Layton. “There’s no model for what they’re doing. They’re organizing something that was inherently unorganized before.” D.M. Osborne is a senior writer at Inc. Guru.com’s Seven Strategies for Financing an Internet Start-Up The formula for financing an Internet start-up is an imprecise mix of art and science, charisma and luck, timing and contacts. Some companies strike it rich right out of the gate, like Drugstore.com, in Bellevue, Wash. Founder Jed Smith’s concept for an on-line drugstore went straight to the top at Silicon Valley venture firm Kleiner Perkins because Smith knew an assistant to partner John Doerr. Other entrepreneurs, such as Blaise Barrelet of San DiegoÂbased WebSideStory Inc., have had to bootstrap their businesses and found outside funding only after proving their model in the market. Whether you’re on the high road to capital, like Guru.com, or on the low road, here’s a tip sheet for navigating the funding stream. 1. Go after smart money, not easy money. THE HIGH ROAD: Scour your Rolodex for deep-pocketed contacts in the Internet arena — and then check with all your friends, your boss, and your colleagues. That’s what Guru.com did in spades, and it clearly worked well. Have your contacts introduce you to people who can provide funding or act as strategic advisers. Feature advisers in your investor pitch, and update the list each time a new one comes aboard. “Once the dollars start to flow,” observes Salt Lake City entrepreneur Will West, “there’s a herd mentality.” THE LOW ROAD: No contacts? Drop in on your chamber of commerce and find out who’s involved in the local Internet economy. Track down your closest angel-investor group. Chat with the group’s administrator about the sorts of businesses its angels have funded and why. Find out how best to submit your business plan for the angels’ consideration. Do everything in your power to put off relying on relatives. In the Internet-finance environment, explains Harvard Business School professor William Sahlman, “from whom you raise money is often far more important than the terms.” 2. Use your first dollars to buy topflight management. THE HIGH ROAD: A truism these days among Internet angels and venture capitalists holds that a stellar management team is worth more than a supercool business plan. “The idea is irrelevant,” states venture partner Andrew Anker of August Capital, in Menlo Park, Calif. He’s exaggerating — but not by much. “So many people are focused on the Internet right now, the reality is that any great idea you may have, five other people are going to have, too.” Guru.com, for example, bet a lot on being able to hire technology director Kevin Kunzelman early on. Kunzelman, who had been the systems architect of E! Online’s Moviefinder.com and Match.com’s Internet dating service, was hard to woo. Guru.com had to up the ante twice — and in the end resorted to offering to pay for him to take a vacation anywhere in the world (he chose New Zealand) on top of a signing bonus. As Guru.com’s experience demonstrated, a team that has proved itself capable of running with an idea at Internet speed can break ahead of the pack. THE LOW ROAD: If you can’t bring top talent in-house right away, forge strategic alliances with others and then link their management with your concept. Remember, too, that customers speak volumes about a business. 3. Speed is paramount: get your site up and running. THE HIGH ROAD: It was the subject of heated dissension among investors, but Guru.com’s strategy on this score paid off in the end. Work out bugs in the business while you gain traction in the space. Instruct your Web designer to put a premium on users’ experience; look and feel are as important as functionality. Track usage closely and keep the figures on hand when you look for financing. Guru.com deployed user feedback to great advantage in its second round. “The very fact that they had collected it showed that they cared very much and were building a business to serve customers,” comments Guru.com venture partner Aneel Bhusri of Greylock. THE LOW ROAD: If you can’t afford the $1 million it will likely cost you to erect a bare-bones Internet business, seal a deal with a company that is positioned to help your business take off once you do go live. Chad Carpenter’s Klickback.com, an Internet-based rewards program headquartered in San Diego, recently forged a strategic alliance with paging company Metrocall Inc. “When we go live, we will be selling their paging services on our site, and they will use our rewards as their loyalty program for their 1.4 million consumer customers,” Carpenter explains. 4. In approaching venture firms, home in on a specific partner and make your initial contact through one of your advisers. THE HIGH ROAD: As Guru.com did so well, do extensive research on the venture firms you might want to have involved with your company. Look in their portfolios for companies with revenue models similar to yours and for businesses you could partner with. Ask your angels or advisers to give you entrÃe. Active angels can drum up VC interest in your business even before you have your foot in the door. THE LOW ROAD: If you have no VC ties, tap into the goodwill of other Internet entrepreneurs. Contact executives at companies that are funded by the venture firms of your dreams. Would they be willing to introduce you to their venture partners? 5. Don’t marry your first date. THE HIGH ROAD: There’s a lot more money out there these days than there are good deals, so explore all your options. Guru.com’s founders resisted the urge to snatch up the first term sheet that VCs threw down on the table. It’s smart to be choosy about whom you take money from. With every firm that grants you a meeting, take time to get to know the partner who will be your company’s primary contact (and possibly a board member). Ask the entrepreneurs at portfolio companies what their venture firms have done for them and others at your stage. Play your cards close to the vest, but be clear with VCs that you’re shopping around. VCs start to salivate if they have reason to think that your deal is in demand. THE LOW ROAD: It’s not the end of the world if no venture firms come courting. 6. Take the best deal, not the biggest deal. THE HIGH ROAD: Whether your capital is coming from angels or VCs, go with the deal that will not only carry you to your next planned round of financing but also add genuine strategic value. Consider the questions that Guru.com asked of its prospective investors: What’s the relevant experience of the partner who will join our team? What future partnership opportunities exist among the firm’s portfolio companies? THE LOW ROAD: Measly pickings? Take what you can get and run with it. Financing options for Salt Lake City high-speed Internet service provider STSN Inc. had become so thorny in early 1999 that founder Will West resorted to bridge financing. But as soon as West had inked a long-term deal with the Marriott International hotel chain, investors stepped right up: STSN vendor Intel and another major chip manufacturer suddenly wanted an equity position, as did two VCs. 7. Keep up your momentum. THE HIGH ROAD: In today’s supercharged Internet economy, even the leaders are constantly reinventing themselves. You should be, too. Momentum equals execution. When the founders of Guru.com discovered they had formidable competitors, they could easily have become distracted — and derailed their financing. After an initial panic, they instead came to view the competition as proof of just how hot the market for their services was, and got back on track. THE LOW ROAD: Even if money isn’t pouring in, stay focused on the business and look for other ways to fuel growth. And If You Can’t Get Venture Capital… Blaise Barrelet admits he “didn’t even know that there were venture-capital firms” when he and his wife, Agnes, started WebSideStory, back in 1996. The starting gun had just gone off in the race to cyberspace, and as he watched the throngs jockeying for position, Barrelet wondered, “How do all these people measure returns on their investment?” To answer that question, he built HitBOX, which measures Web-site traffic, taxing his credit-card limits in the process. At first, Internet start-ups refused to pay for the tool, forcing Barrelet to give it away free in exchange for ads on customers’ sites. Against all odds, the ads drove traffic to Barrelet’s own Web pages, where San Diego-based WebSideStory ranked sites by their traffic. “Instead of being paid with dollars, we were paid by traffic, and we found out a way, very fast, to make money,” says Barrelet, a 36-year-old Parisian. In short order the Barrelets’ fledgling business achieved positive cash flow as Internet companies lined up to advertise on the site — at the HitBOX opening page, as well as on pages with category-specific site rankings. Three years later WebSideStory is a booming business, with 350,000 HitBOX subscribers to date and more usage-tracking products in the pipeline. WebSideStory’s Web sites now get close to 500,000 visitors a day. And unlike the vast majority of Internet businesses, WebSideStory actually makes money. “They have been able to finance the business through internal cash flow,” observes Kurt Jaggers, a managing director at the Menlo Park office of TA Associates, a private-equity firm. That, says Jaggers, was a key factor in his firm’s decision last June to join forces with Summit Partners in plunking down $30 million for a minority position in WebSideStory.