OwnYourVenture.com has put together a pretty cool simulator that lets you model basic VC investments over multiple rounds to determine the relative equity shares of founders, investors, and an option pool for executives and employees.  You simply enter in a few variables and it spits out pro forma ownership stakes for all parties.  The tool provides an excellent way to visualize how founders’ shares get diluted over multiple rounds of financing.

Venture capital math is not that hard – but the results always tend to be the same.  VCs tend to end up with 70%+ of the company’s equity while the founders and option holders split the rest.  When it comes to the pot of gold at the end of the rainbow, investors get their original investment back first and anything that is left after that gets split amongst all shareholders on a pro-rata basis – unless the VCs have negotiated even higher liquation preferences (i.e. until they get all the money up to 3x their initial investment before the proceeds are split with all shareholders on a pro rata basis.)

It is important to note that Venture Capital is a high risk business – most investments never payoff and for those that do, they need a very high rate of return.  Conversely most entrepreneurs cannot fund the development of their startup on their own – they lack the personal wealth or bank credit.  It is certainly better to own a very small piece of a valuable company than to own 100% of something that has no value.  One fact of Venture Capital investment you cannot escape is that for a very successful company, the VCs will make 3 to 5 times as much money as the founders in any successful liquidity event.  If your company has better than average success you might be lucky to return the investors’ original investment which means that as founders you end up with practically nothing.  If you are not comfortable with this reality then funding a startup with venture capital is not for you.

Let’s consider a hypothetical example, MyReallyCoolIdea.com.  This is a company that you have been dreaming about for years and you are finally ready to take the plunge.  In addition to yourself, you have two co-founders, Jim & Sue.  In the beginning, you spit the equity up three ways – you get 40% and Jim & Sue each get 30%.  Once you have built your proof of concept and gotten a few early adopter customers you are ready to go chase some venture capital.  For the sake of simplicity let’s assume that MyReallyCoolIdea.com is an absolute killer in the marketplace and that you are able to raise $1 million in a seed round, $5 million in a Series B round the following year, and finally $20 million in another two years to blow the doors off of sales and marketing on a global basis.  The following table summarizes what this fundraising cycle could look like:

There are lot variables in these types of calculations – pre-money valuations, whether the option pool comes out of the pre or post-money valuation, liquidation preferences, etc.  The basic math, however, tends to be the same.  The following chart puts the founders’ dilution into a bit more perspective:

While this math might be a little grim for the aspiring entrepreneur, it is important to look at how valuable a successful exit could be.  Taking this example a bit further, we can see how a founding team could achieve the dream of ‘walk-away money’.  The following table illustrates the hypothetical growth of MyReallyCoolIdea.com and some exit valuation and payoff assumptions.  The funding assumptions are the same as in the prior example, except that the VCs have a 2x liquidation preference.  Valuation assumptions are based on the typical valuations for public SaaS companies as of early 2010.  There is a big difference between VC funding valuations and actual market valuations.  Technology companies are typically valued based on multiples of their revenue or profitability.  In the case of SaaS companies, average valuations for slightly profitable SaaS companies generating >$40 million in annual revenues is between 2.3x to 3.7x trailing twelve months revenues.

As you can see, in Year 5 the founders’ payoff finally exceeds the magic $5 million ‘walk-away money’ number.

A more humbling approach is to consider that MyReallyCoolIdea.com stalls out in the fifth year and drops to flat or no revenue growth.  Relative valuations can drop and in that case the payoff to the founders is practically nothing:

The moral of this story is that budding entrepreneurs need to spend some time understanding the true dynamics of Venture Capital financing before they plunge deeply into its waters.  While you can argue with the assumptions used in these models, at the end of the day, the results tend to be about the same.

An interesting blog post came up on my Google Reader the other day that really resonated with me.  Adam Smith founded Bessemer Venture Partner’s Herzliya, Israel office.  He blogs at Savants in the Levant.  Last week he did an interesting post entitled Wanted: Small, No Name Customers.  Adam’s central thesis is that tech companies have a higher probability of success if they eschew trying to sell large scale enterprises and instead focus on mid-market or individual consumers.  Adam has invested in and profitably exited from a number of startups so he has a clue about what he’s talking about.  Here are a few interesting quotes:

“Large Can Be Longer, High Touch, Expensive, Non-repeatable & Unrewarding.  A lot has changed since then. First of all, post 2000 these large customers have grown wary of working with and relying on start-ups, hundreds of which have disappeared, changed direction or simply never reached scale. The result is that the sales and testing processes of large customers is longer and more arduous for start-ups than ever before. Additionally, the procurement process of these large customers is more stringent, built on the premise that they are always better off buying from a select group of large, established vendors(even with an inferior product). Even where they have no alternative, their reluctance to buy from start-ups persists with attempts to indentify a middle man, place the start-up’s IP in escrow(in the event of shut down), or extract a hard commitment to fulfill the product roadmap(rarely accompanied by any NRE dollars). And once an order is finally placed, the long coveted joint press release is blocked by the legal department”

“Small Can Be Quick, Low Touch, Repeatable & Inexpensive. With large customers no longer worth the effort, start-ups should consider focusing on smaller customers and/or consumers. Luckily, several trends play in favor of such a “no-name” customer strategy. Performance marketing including targeted online advertising and affiliate networks allows start-ups to reach a wide audience cost effectively and with minimum up-front investment ( see “When Marketing and Sales Becomes Scientific”). Similarly, advancements in delivery methods, including downloads, virtual appliances and software-as-as-service lower the cost of sales, deployment and maintenance. Of course, strategies focused on small customers and consumers do not preclude sales to large customers as mentioned in my previous blog post “A Preferable Route to Market.” The challenge for Israeli companies is to build a product that emphasizes usability and simplicity as much as technology and performance. I have little doubt that such skill sets exist in Israel, but the key is to make this a priority.”

I have been in the technology business for almost 27 years.  I spent the first 18 years of my career in the classic enterprise software market.  We targeted the 15% of the Global 2000 that drank the 1980’s Information Engineering Kool-Aid.  While our products targeted a niche, it was a very profitable niche that grew into a $300 million business by 2000.  The bulk of our revenues were concentrated in about 500 global enterprises.  Other companies I have been an executive of worked to ride the coattails of large ERP companies like PeopleSoft and Oracle.

The overarching theory was that big enterprises were always a much better market than mid-market and the SMB space.  The challenge with this strategy is that most enterprise software companies only ever succeed in winning a small share of the Global 2000.  As Marc Andreessen recently noted during the launch of his new venture capital firm, Andreessen-Horowitz “The problem is that there aren’t valuable companies being formed. And there never have been . . .There are on average 15 tech companies launched a year that will ultimately do $100 million a year in revenues, and these companies are responsible for 97 percent of the returns in the venture industry overall.”  I also attended a CIO Roundtable event last week where 40 Atlanta CIOs gathered for a panel discussion.  Most of the CIOs were from multi-billion dollar enterprises like Coca-Cola, GE Energy Services, First Data and even Popeyes Chicken.  The theme of the event dealt with the challenges of buying and selling technology in today’s world.  Several of the CIOs discussed their concerns with working with startups.  They told a few war stories about how they had ‘crushed’ startups through their tough, global requirements.  Most admitted that they focused their procurement on a few, large, well known vendors that they had long track records with.  A key take away from that event was that most startups today had a better chance of winning the lottery than they did trying to crack their way into a Fortune 500 shop.

For the past 9 years of my career I have worked with firms that targeted both the enterprise space as well as the mid-market space.  By mid-market I mean organizations with revenues between $50 million and $1 billion a year.  Conservatively, there are about 25,000 organizations in that size range in the United States.  There are probably another 75,000 outside of the USA for a global market of 100,000+ organizations.  In comparison to the Global 2000, the mid-market offers fifty times more opportunity to sell a solution to a specific customer.  Without a doubt, the deal sizes are radically different.  For a typical enterprise-scale customer, a technology company can reasonably expect to extract $2.5 million of revenue over the life time of that customer.  For a tech company that focuses on the mid-market, the number is more like $50,000 over the customer life time.  When you do the math, 25 enterprise customers generate $62.5 million in life time revenues.  It takes about 1,500 mid-market customers to generate the same amount of life time revenue.

Selling to mid-market customers is fundamentally different than selling to enterprise customers.  First off, the classic enterprise software big elephant hunter sales team strategy does not translate into the mid-market space.  Enterprise sales people typically have annual quotas of $1 million to $3 million.  They use a direct sales model and focus on closing a few very large deals to make their annual nut.  They spend countless hours courting, wining, dining, and developing relationships.  They rack up massive travel expenses since there are typically only a few elephants in their home towns.  Some sales people may go 18 months between closing big deals.  When they land a deal, however, the massive commission checks more than makes up for the dry spell between deals.  Startups that hire enterprise sales people often find, however, that while they may be able to close one deal, most often they are unable to repeat that achievement before the company’s venture funding evaporates.

Mid-market selling is typically done without the rep ever having to travel or meet their customers face-to-face.  The telephone and webinars replace on-site visits.  Web-based demand generation and lead nurturing replace the enterprise sales person’s personal rolodex.  A typical mid-market rep will close between 100 and 300 transactions a year in comparison to the enterprise sales person’s 5 to 10 deals.  Mid-market teams are highly dependent on their company’s ability to establish a well known brand in the marketplace and highly credible/effective web-based marketing.  Mid-market reps become expert at long distance conversations.  They are rarely in the same room as their prospects so they must learn to hear the signals their prospects are sending instead of being able to read their body language.  Successful mid-market technology firms are masters of execution when it comes to selling and supporting their customers.  In fact, superior company execution often makes up for technical deficiencies in their products and services.

Another strategic benefit for startups focusing on the mid-market versus the enterprise space is revenue risk.  Startups that focus on the enterprise space tend to have ‘lumpy’ revenue.  The revenue tends to be concentrated in a few very large customers and comes in fits and spurts based on when the big deals close.  Given the challenges of today’s economy, predicting when a new deal will close is always tough.  Also, recurring revenue (like software maintenance fees or monthly usage fees) are concentrated in a few customers.  The loss of any single customer, or groups of customers, can be catastrophic.  Historically, the finance, banking, & insurance vertical has been one of the richest for enterprise software companies.  Dozens, if not hundreds, of enterprise software startups has shutdown in the past two years because they focused on the finance vertical and their target market simply stopped spending money on new purchases and significantly curtailed the spend on maintenance contracts.

Technology firms that focus on the mid-market don’t share the same risk.  Typically their revenues are spread out across hundreds, if not thousands of customers in dozens of verticals.  The loss on any single customer is not catastrophic since a single customer contributes such a small percentage to the company’s overall revenues.  This benefit, however, is tempered by the fact that for such firms, revenue tends to grow slower than enterprise-focused firms because it takes time to acquire hundreds of customers.  While the revenue may come on slowly, it also tends to decrease slowly in tough economic times since it requires the defection of hundreds of customers before revenues are materially impacted.

In the middle of 2009 if I were given the choice of joining a technology firm that either targeted enterprise customers or mid-market customers I would choose the mid-market player.  As discussed in this post there are simply too many barriers to entry in the classic Global 2000 market place today.  I’d rather take my chances that superior execution against a market with 100,000 participants could lead to the pot of gold at the end of the startup rainbow.

Some interesting takeaways from the data:

• Out of 24 software categories, pure play SaaS companies are the third most valuable from an Enterprise Value/Revenue multiple, second most valuable from an EV/EBITDA multiple perspective.
• The pure play SaaS category had the strongest year over year revenue growth of any software category
• SaaS companies have posted a median 73% year over year stock market return.  Almost half of the companies have posted >100% return and three firms have posted >20% return
• There is significant variation in valuation metrics amongst the pure play SaaS companies – ranging from a high a 7.2X EV/TTM Revenue multiple to a low of 0.2x EV/Revenue
• SaaS firms are generally EBITDA profitable, with an average EBITDA % of 8.2%.  About a quarter of the companies have negative EBITDA margins. 
• Gross profit margins are lower than traditional license software firms, with a median gross margin of 68%
• Surprisingly, high ttm revenue growth rates do not correlate to high valuations or high year over year stock market returns.

Click through the following presentation to get a detailed look at the data and trends.

CDC Software’s unsolicited offer represented a 21% premium to Chordiant’s stock price over the preceding 30 days – a premium that CDC cited as above the median 19% premium paid in the enterprise software space in the past few months.  CDC Software offered two options to Chordiant’s shareholders – 40% of the consideration in cash and 60% in CDCS stock, or 50% cash and 50% CDCS stock.  On the surface, it looks like a low-ball bid – with Chordiant having $49 million+ in cashon their balance sheet, CDCS is basically offering to buy CHRD with their own cash and some CDC stock, as shown in the following table:

This is not the first unsolicited offer CDC Software has made.  You might remember CDC’s attempt to acquire CRM provider Onyx Software in 2006.  In the end, Onyx went with a deal from Made2Manage Systems, a portfolio company of Battery Ventures and Thoma Cressey Equity Partners.  The deal chronology is pretty interesting and you can read the whole chapter and verse here in an abstract from the proxy filed along with the deal.  Onyx ended up going with M2M primarily because of the all cash offer versus CDC’s cash and stock offer and a pattern of ‘inconsistent statements’ and behavior from CDC throughout the process.  While the shortcomings cited by Onyx in 2006 may have been true, since that time CDCS has established their credibility as an effective acquirer and they have grown the value of their equity consistently.  The CDCS’ deal for Chordiant has a few similar undertones, the fact that CDCS walked away from the deal less than a week after starting it shows that things have changed in the past four years.

When you peek behind the numbers a bit, you will see that the CDCS offer is pretty much in line with the overall market.  To begin with, let’s contrast the financial fundamentals of the two companies:

CDCS’s revenues have been basically flat until 2009 while Chordiant’s have been in decline for a number of years.  While CDCS profits have grown significantly over the past three years, Chordiant’s EBITDA continues to decline.  Chordiant is suffering the same fate as a lot of mid to late stage enterprise technology companies – their ability to materially grow revenues in their core market has evaporated and regardless of how much money they invest in execution, they still can’t stop declining revenues.  They are also sitting on a huge pile of cash that they have been unable to deploy to drive organic or inorganic growth.  Chordiant took a stab at acquiring their smaller competitor Kana Software in December by trying to interrupt their deal with Accel-KKR, but failed to get the Kana board to take them seriously. 

As the following table indicates, the Street considers CDCS to be more valuable than Chordiant:

What is more interesting is that CDCS’ offer is very much in line with how the market values CRM, marketing, and sales companies in January 2010.  The Software Equity Group publishes monthly, quarterly, and annual analyses of enterprise software M&A and valuation trends.  In their January Flash report, they reported the following metrics for their CRM, sales, and marketing category:

While the Chordiant Board may not like it, the market considers unprofitable late stage CRM companies with a history of declining revenues and an inability to deploy large piles of cash to drive growth not to be that valuable.  Most strategists and bankers would agree that Chordiant needs to combine with a larger company that can leverage economies of scale to lower costs and a large, pre-conditioned customer base to cross-sell their offerings to, which is pretty much what CDCS is proposing to do.

It is hard for a management team and a board to decide to sell, and to sell at what might be considered to be a discount.  In the case of CDCS and Chordiant, the initial offer was just enough of a premium to get over the typical Revlon Rule-like fiduciary responsibility requirements.  Just this week alone, three other enterprise software companies agreed to acquisitions where VC and private equity investors barely broke even, much less made significant money on the transactions.  These deals included Progress’s acquisition of Savvion ($49 million in consideration versus $52 million in VC funding), CA’s acquisition of Oblicore (estimated $25 million consideration against $20 million in invested capital), and Lawson’s acquisition of HealthVision ($160 million in consideration versus $136.7 million in invested capital.  The investors did get a 3.5x return on their investment due to their creative use of leverage — check out this WSJ piece on the transaction).  Tech companies go through a predictable lifecycle – they are born, go through adolescence, become mature, and then eventually reach retirement age.  While I am not advocating ‘death panels’ for technology companies, I wish they were clearer standards that boards and management teams could use to honestly assess their options when revenue growth is no longer a viable option for the business.

A challenge investors in companies like Chordiant face is determining how to effectively value the upside potential offered by a cash and stock deal, like the one offered by CDCS.  At the end of a conference call conducted by CDCS on Friday January 8^th there was an interesting Q&A exchange between CDCS’ CEO Peter Yip and a Chordiant investor.  At one point in the discussion, the Chordiant investor remarked:

“You’re trying to get me – convince me to sell to you. So I’m saying to you, great. I agree with you. You can run it better than them because you have run your company better.  But if you’re going to pay me, you need to pay me what the company’s worth because you and I both know that it’s very, very cheap here and that we are at an historical bottom in a cycle.”

The investor felt that the price should reflect the value CDC Software would create in the combined company after the restructuring and integration.  He wanted to be paid now for the value CDC Software would create in the future – value that Chordiant has not been able to generate on their own account.  Perhaps investors will come to realize that taking a bet on an acquirer’s stock will yield a significantly better return than letting a management team that has not produced continue to struggle on until their asset becomes worthless.

“Fund managers aren’t likely to get any help from the White House. President Obama has expressed support for raising the carried interest tax, and his budget would start taxing carried interest as ordinary income in 2011.

“Private equity will endure, but the draconian tax hike, if enacted, will unquestionably slow the flow of capital to companies struggling to get back on their feet during this very fragile economic recovery,” said Doug Lowenstein, president of the Private Equity Council, a trade group.

University of Colorado tax law professor Victor Fleischer, whose views caught the attention of Congress two years ago, agrees with this approach. He notes that profits earned by managers from their own money invested in their funds—typically a small percentage of the total fund size—are appropriately taxed at capital-gains rates. But he said the portion of pay managers get for investing other people’s money should be taxed at ordinary income rates, just like other forms of salary.

“It’s amazing to me that at the same time the U.K. is imposing a 50% excise tax on bankers’ bonuses, the private-equity guys aren’t even willing to pay the usual ordinary income rate,” Mr. Fleischer said. “You would think they would recognize a fair deal when it’s offered.”

Private equity firms generally earn money two ways:  management fees and carried interest.  PE firms typically charge their investors a 2% annual fee for funds under management, and then claim 20% of the profits (aka carried interest) when the investment is sold (the infamous 2 and 20 rule).  Historically, carried interest has been taxed as a capital gain in the United States since the profits are only realized upon the successful sale of an investment, not unlike what happens when you sell shares of stock you have held for more than a year.  The legislation bouncing around Congress now would change this historical approach and raise taxes on carried interest from 15% to 35%, the rate for ordinary income.  It is important to note that this change typically will not impact the returns received by operating executives of the PE firm’s portfolio companies.  Most executives are incented through stock options that vest on an exit event.  The proceeds from stock options are taxed as either short or long term capital gains – not ordinary income as in the case of PE firm carried interest.

Basically, this change will reduce the returns earned by a private equity firm by about 24%, as shown in the following spreadsheet.  If a private equity firm invested $100 million in your company 4 years ago, and sells your firm to a strategic buyer in 2011 for $600 million, the proposed change in the tax laws will reduce their return by $100 million or about 24% in comparison to what they could if they sold your firm before the tax change goes into effect.

So what does this mean for executives of PE firm portfolio companies?  Quite a few things.  If the tax hike goes through as planned, starting in 2011 a private equity form will need accept either a materially lower return for their investment, or seek higher sales prices to generate the same amount of returns they would have had under the old tax regime.  Seeking higher sales prices could result in much longer exit horizons.  Alternatively, PE sponsors may seek an interim return on their investment via dividends.  At the height of the recent private equity bubble the leveraged recap and dividend.  Under this approach, a portfolio company would take on new debt and pay a significant portion of the raised money to their private equity sponsors as a special dividend.  With the collapse of the credit markets in 2008 leveraged recaps have temporarily gone the way of the Dodo.  Sponsors could still fund dividends by having the portfolio company significantly ratchet up their profitability and then distributing the newly generated cash as a dividend on a quarterly or annual basis.  Using cash to fund dividends versus investing in growing the business is a hard trade off that boards of directors and management teams will need to make.

Perhaps the greatest issue for portfolio company executive teams is that in 2011 there will be a significant mismatch between financial incentives for private equity firms and their management teams.  If the plan is for your company to achieve some type of exit in the next two years, private equity owners are highly incented to achieve such an exit in 2010 versus 2011.  As shown in the following spreadsheet, owners can yield the same return in 2010 at significantly lower sales prices than they could in 2011. 

That means that PE firms could accept up to 25% less for their properties in 2010.  While the PE firms returns are not impacted, portfolio company executives and other option holders would see a 25% reduction in their payoff for a successful exit.  The pressure to exit will certainly rise in the second half of 2010 as the inevitability of the pending tax law change becomes reality.

If you are an enterprise or mid-market technology company and you have been in business for more than 5 years your revenue growth rates have probably declined into the single digits.  Markets in the early stages of the Technology Adoption Life Cycle tend to have very high revenue growth rates – markets in the latter stages of the life cycle tend to have significantly lower growth rates.  If your company’s products/services are in the middle to latter parts of the life cycle it is harder to sell new customers.  In 2010 a lot more companies will be looking to acquire social media analysis/monitoring platforms, hardware/software virtualization, and cloud computing services than those looking for ERP solutions, mainframe job scheduling, or electronic data interchange.  This does not mean that there are not significant revenue opportunities for older technologies – it just means that you have to work a lot harder since most buyers do not wake up in the morning and say “I really need to buy some middle-aged technology today!”

Manufacturing revenue is a reality for mid to late stage technology companies.  The first revenue generating technique we are going to talk about is euphemistically entitled ‘bowling league sales.’  Generally, in the early majority/late majority stages of the technology adoption life cycle, people prefer to buy technology solutions that have been endorsed by their peers and competitors.  The most credible buying influence is an honest recommendation from a friend or someone in the local area that is well known and respected by their peers.  Kind of like the people who might participate in your bowling league, local United Way campaign, or even your Church.  The goal of the bowling league sales program is to develop dozens of influencers in specific geographies and verticals that can assist you in your sales efforts.

How the Technology Buying Process has Changed in 2010

The bowling league sales strategy is predicated on the fact that the technology buying cycle has fundamentally changed in two key ways in 2010.  In the 1990’s prospective customers read trade magazines like ComputerWorld, Dr. Dobbs Database Journal, or PC World to keep abreast of industry developments.  Or they talked to industry analysts like Gartner or Forrester.  They also called the sales teams of leading vendors and had them fly in and give ‘informational briefings’ on new technology trends.  In 2010 the first stop for prospective technology buyers is the Internet and Google.  Online research is now the predominant way that prospective customers learn about potential solutions for the problems they are looking to solve.  The second key trend is the concept of lead nurturing.  How many times have you visited a vendor’s website only to be interrupted from a pop-up window inviting you to a live chat with one of their representatives?  9.9 times out of 10 you decline the chat opportunity because you are not ready to engage that directly with a sales person.  Lead nurturing recognizes that prospects go through several levels of education and interest before they are willing to expose themselves to the onslaught of your sales machine.  Lead nurturing is a recognition that only a few of the visitors on any web property are interested in buying right now.  As noted in the great book, Digital Body Language by Eloqua’s CTO Steve Woods, the three major goals of lead nurturing include:

1. Maintain permission to stay in contact with the prospect: This is by far the most important goal of lead nurturing, and one that is most often overlooked. If a prospect emotionally unsubscribes  you have lost your connection with them, and you may in fact be marked as spam.
2. Watch for signs of progress through the buying cycle: As you nurture prospects, you can watch their digital body language to give you an understanding of when they are moving to a new stage of their buying process 
3. Establish key ideas, thoughts, or comparison points through education: A prospect you are nurturing may not enter a buying process for many months, if not quarters. However, if you can educate prospects, and by doing so, guide their thinking slightly to incorporate key requirements and ways of analyzing the market, when they do become buyers, you will be much better positioned

One of Steve’s core concepts is digital body language.  Since Internet research has replaced face to face meetings as the primary mechanism for prospects to learn about solutions, traditional sales teams are at a disadvantage since they can no longer read the body language of prospects.  Instead, vendors have to rely upon their ability to understand a prospect’s digital body language:

What we are referring to when we talk about Digital Body Language is the aggregate of all the digital activity you see from an individual. Each email that is opened or clicked, each web visit, each form, each search on Google, each referral from a social media property, and each webinar attended are part of the prospect’s digital body language.

In the same way that body language, as read by a sales person managing a deal, is an amalgamation of facial expressions, body posture, eye motions, and many other small details, digital body language is the amalgamation of all digital touchpoints. 

The Bowling League Sales Program

The Bowling League Sales Program is composed of four major activities.  We explore each of these items in more detail later in this post.

Geo-location Profiling.  The process begins by analyzing the geographic locations and verticals of your existing customer base.  By knowing where your existing customers are based you can identify high potential geographic locations where you can find other customers and help focus your resources accordingly.

Success Stories Blog.  Stories, written from the customer perspective, about how they achieved significant business benefits or solved hard problems.  The focus of these stories is not your technology per-se, but the results individuals were able to achieve leveraging your solutions.  These stories will become the key content that will entice prospects to learn more about your firm.  You will publish these stories in a purpose-built blog that is loosely affiliated with your brand.  You will attempt to turn these existing customer successes into influencers in your market space.

Geo-Specific Social Media Broadcasting.  As you post each story you will broadcast it via a number of social media platforms and build a social network of individuals that are interested in your stories.  This includes not only prospects but other social network participants with market credibility who are looking for content to publish on their own web properties.

Digital Body Language Monitoring.  Finally, you will put in place the basic tools and technologies to monitor the digital body language the of the participants in your business social network so you will know when and how to engage with them once they are finally ready to start a formal buying process.

Now I know this sounds like a ton of work, but guess what, that’s what it takes to manufacture revenue.  It’s like panning for gold – you have to move through a ton of stuff to find a few golden nuggets.  Take a look at the 2009 performance of your firm’s marketing programs.  If you are lucky you were able to convert 0.10% of your prospects to a paying customer.  In other words 1 out of every 1,000 people your firm connected with ended up buying a technology product or service from you.  You need to find ways to better leverage the Internet and the power of social networks to grow revenue.  You can always stick with strategies and tactics you used in 2009 and you can expect about the same results.  Or you can stake out a position at the start of a new year to at least try something innovative.

Geo-Location Profiling

The process begins by profiling the geographic locations and verticals of your customer base.  This information will allow you to focus your energies on a few geographic locations.  Consider the following map of one company’s 8,900 customers in the U.S.

As you can see, a significant portion of the customer base is concentrated in five states – New York, Georgia, Illinois, Texas, and California.  It would not be too surprising to find that there were sales offices in all of these geographies at one time or another.  This company specializes in software solutions for manufacturing and construction companies.  Take a look at the following table to get an idea of their relative market share in each of these states:

The table shows that there is still plenty of untapped opportunity in each of these geographies.  The goal of the bowling league sales program is to raise the visibility and awareness of the company in the thousands of prospects in each of these geographies.

Putting together analyses like these is a pretty straight forward process.  First you need a dump of your customer information: name and address.  You can supplement that information with vertical info, such as the customer’s NAICS code.  Third party services can append this data to your customer list for a nominal fee or your team could spend a few days data mining the information off of the Internet.  The Google Maps API provides a simple way to generate maps and the Census Bureau’s Economic Census can give you tons of stats about the number, size, and employment of companies in a host of verticals on a national, state, or metropolitan statistical area basis.  If this seems like too much work you can always hire a local geography professor who should be able to crank out the analysis for less than $500.

Success Stories Blog

Next, build a basic blog that you will use to publish success stories written from the customer’s perspective.  The blog should be independent of your corporate website and existing blogs, but branded in a similar manner.  The goal here is not to hide the fact that your firm is sponsoring the blog, but to put the focus on your customer’s stories and experiences.  You can use something as simple as a hosted WordPress instance and either a free or low cost WordPress theme.  You should also establish social media identities for the blog on a variety of business centric social media platforms such as Twitter, Facebook, LinkedIn, FriendFeed, Slideshare, Technorati, Digg, StumbleUpon, etc.  You should also implement decent web analytics such as Google Analytics.

The primary content of the website will be relatively short, one page posts about the business success a customer had with your technology.  The posts can either be attributed to the customers or genericized.  Many customers are reluctant to publicly endorse a vendor’s solution.  In situations like that the post can be written in a generic manner that does not specifically identify the customer’s organization or the individuals who were involved.  People love to see their names and accomplishments in print.  It helps to validate their successes and build their reputations both inside and outside of their companies.  The most successful ad I ever ran was a one page piece in ComputerWorld that had the pictures of ten customers who enjoyed tremendous success from our product.  The ad was simple – their picture, name, title, and location.  We got more leads from that one ad than almost anything else we did.  I have visited several of those customers ten years after the ad ran and they still have a framed copy of it posted in their offices.

To get started you can use a simple, interview-like format of five questions to structure the content for the posts (tell me about your company, what problem were you trying to solve, how did you go about solving the problem, what hard and soft benefits did you achieve, what did you learn that you will apply next time, etc.)

To jumpstart your content you can repurpose your existing customer references, testimonials, and success stories.  At the same time you can start building up your editorial calendar by approaching your customers and soliciting their participation in the blog.  You should target posting two customer stories a week, interspersed with other content you choose to create or co-opt from other sources.  If you have hundreds or thousands of customers you can find a hundred or so that would like to have their successes chronicled on your site.  There are several tactics you can use to solicit participation.  Some ideas include:

1. Ask the sales team to nominate up to ten of their best customers as candidates.  Ask the rep to set up an introductory call and ‘listening’ session with the customer and see if you can entice the customer to participate in the process.
2. Take a look at your customer support statistics and identify the top 200 customers with the most inquiries and tickets.  These types of people are very actively engaged with your company – the customers with the most ‘problems’ are actually some of your best customers.  It’s the customers who don’t complain that you should be worried about.  Find the primary customer support reps who deal with these customers and ask them to solicit participation the next time they call or email.
3. Add a message to the next invoice asking for volunteers to participate
4. Add a message to the home page of your corporate website asking for participation

There’s no doubt that it is a lot of work to solicit participation, draft the posts, and go through whatever review and approval processes your customers will require.  As noted earlier manufacturing revenue is not a simple or overnight program.  The benefits of building good content, however, last for a long time.  You will also find that the process of engaging with customers on a positive basis will not only improve customer satisfaction, but drive incremental revenue as well.  Most mid to late stage technology companies only engage with their customer bases when they have something new to sell them or to offer them a discount in an attempt to drive short term revenue.  Take a look at the last ten direct marketing pieces you sent your customers and you can get a pretty good feel for how you have been communicating with them.

Geo-Specific Social Media Broadcasting.

As you post each customer success story, broadcast it to you ever growing business social network.  The goal of this process is to continually build a geographically targeted list of followers and blog readers in the geographies you have targeted.  Broadcasting your posts using technologies like Twitter, Facebook, LinkedIn, SlideShare, and StumbleUpon will help to build the reach of your blog and message.

Building a Twitter follower network is one of the better investments you can make.  You want to focus primarily on active Twitter users that have some association with your industry in the specific geographies you want to focus on.  I am not going to get into the details of building a Twitter following here — there are hundreds of thousands of Twitter strategy guides available on the web (Google only reports 34.5 million).  The key to building a successful business social network is relevant content and that’s what your customer success stories can bring to the table.

Digital Body Language Monitoring

Once your blog is up and going and you have some decent content there you can begin to monitor your visitors’ digital body language.  You can use free tools like Google Alerts, Google Analytics or HowSocial to get a basic feel for how your content is being consumed.  Two key Google Analytics metrics to monitor are traffic sources and key words.  Understanding how people are accessing your content and the search terms they are using is critical to formulating content and key words.  For example, referrals from people or sites you consider to being influencers in your space is an important trend to understand so you can reinforce it to build even more traffic.  Keyword trends are also critical.  Keywords are the primary way people search the Web today.  While this may change with the advent of the ‘semantic web’ for now understanding how people search and where they go is critical to building awareness amongst your target audience.  You also need to monitor your corporate website to see how much traffic you are driving to it and where the traffic is going.

Every two weeks you should put together a summary of key metrics, trends, and learnings.  What posts generated the most interest?, how many folks became actual prospects?, what posts were the least successful?  The goal here is to use some basic, quick to pull together stats to assess your progress.  The primary metric you are trying to grow is the number of visitors/readers/subscribers who are NOT your customers.  These are the folks you are trying to condition and influence at the end of the day.  A secondary metric is the number of existing customers.  This metric will demonstrate the relative level of web engagement with your customers

Free tools, however, have limitations.  If you really want to understand the digital body language of your visitors you need to invest in a modern marketing management system like those offered by Eloqua, Manticore, SilverPop, or LoopFuse.  These solutions provide the functionality and work flow management that is required to track and action prospects based upon their digital body language.

My first exposure to private equity was in 2003 when I became an operating executive for a portfolio company of Golden Gate Capital and Cerberus Capital Management.  This was at the beginning of the private equity boom that lasted through 2008.  At that point in time it was inconceivable that a serious private equity backed firm would ever go bust.  It was also inconceivable that a portfolio company’s debt would ever trade at a discount.  Such events would be considered professional suicide – a bankruptcy or downgrade would seriously impinge a firm’s ability to raise debt or equity in the future.  In 2010 the world has changed and the stigma of bankruptcy simply is not what it once was.

As shown in the following table the pace of PE backed bankruptcies in 2009 significantly accelerated in the first half of 2009 and then tailed off dramatically:

The types of firms filing for Chapter 11 protection should be no surprise:

Was there some economic miracle that started in May to slow down the pace of filings?  The answer is no.  As noted in the peHUB.com article:

“We can attribute the slowdown to a little thing called Amend & Extend (or, as Mark Patterson of MatlinPatterson called it, “Amend, Extend and Pretend”). Midway through the year, lenders realized they couldn’t be complete jerks about their loans if they didn’t want a tsunami of bankruptcy cases on their hands, so they relented, allowing sponsors and their companies to “kick the can down the road” (another buzzy phrase of the year) and extend debt maturities.”

I have some anecdotal evidence to confirm this trend as well.  In December I visited with a number of New York City based hedge funds doing some consulting on market trends in the supply chain management space.  During more than half of the discussions I had we were interrupted with news of a critical meeting to do another ‘amend and extend’ deal. 

You can download peHUB.com’s complete list of PE-backed bankruptcies here.

Best and Worst Industries of Decade, or, Why Children’s Clothes Makers Need to Get Into VoIP.  Paul Kedrosky, Infectious Greed

Stealth Startups, Get Over Yourselves: Nobody Cares About Your Secrets.  Vivek Wadhwa, via TechCrunch

The Startup Visa And Why The Xenophobes Need To Go Back Into Their Caves.  Vivek Wadhwa, via TechCrunch

Rangel Puts Carried Interest Back On The Agenda.  Wall Street Journal Private Equity Beat

Memo to Congress.  There are legal issues with taxing carried interest as ordinary income.  Paul Koenig, peHub

15 Google-y Perks That Will Make You Jealous.  Nicholas Carlson, Silicon Valley Insider

Why Don’t Fortune 100 CEOs Care About Social Media?, JCM at SpataillyRelevant.org

Disney’s four funnels.  Forget fairy dust. M&A in the Magic Kingdom is all about process.  Richard Morgan, TheDeal.com

Barack Obama Has Better Things to Do Than Tweet.  Ryan Tate, Valleywag

Sometimes Twitter Accounts About Sh*t Your Dad Says Get You TV Deals.  MG Seigler, TechCrunch

Things VCs Never Say . . .

Perhaps ZL should consider suing in the UK where libel laws are different.  As the New York Times’ Sarah Lyall noted in her recent article ‘Britain, Long a Libel Mecca, Reviews Laws’:

“English libel law is the opposite of America’s in many ways. In the United States, the plaintiff, or accuser, must prove that the statement in question was false; public officials must also prove that it was made maliciously, with “reckless disregard” for the truth.  In England (Scotland has its own system), the burden of proof rests on the defendant, whose statements are presumed false and who has to establish that they are true.”

It has ceased to amaze me how far ZL will go down the litigation route.  Even when the current case gets dismissed I am sure they will declare some type of Pyrrhic Victory. Perhaps ZL could consider the advice given by Vivek Wadhwa in a recent TechCrunch post.  Vivek “is an entrepreneur turned academic. He is a Visiting Scholar at UC-Berkeley, Senior Research Associate at Harvard Law School and Director of Research at the Center for Entrepreneurship and Research Commercialization at Duke University. Follow him on Twitter at @vwadhwa.”  I met Vivek almost 20 years ago when he was the CTO of a major competitor of mine.  I’ve competed against him, almost joined his company, and later partnered with the follow on startup he created, Relativity Technologies.

In his recent post, “It’s All About Selling for Survival”, Vivek explains that from his perspective that the best sales people in a startup are its developers, not the $500,000/year enterprise software elephant hunter sales guys.  I am going to quote rather liberally from Vivek’s article because it best explains how ZL might have a shot at turning their business around:

I started my career as a geek. I ended up as Chief Technology Officer of Seer Technologies, a software startup which we grew from zero to $120 million in revenue and took public in a short five years. And then I became CEO of my own very successful startup called Relativity Technologies (until I burnt myself out and needed to shift gears).  A number of skills helped me through this ascent. I learned a lot about motivating and managing people who were sometimes smarter than me, about understanding markets and communicating effectively, and also a few really boring things like accounting, finance and law. But if I had not learned how to sell then my company would never have made it past three guys in a room with a phone and some laptops.

. . . Then I got the chance to become CTO of a startup which would market technology which my team had built. Selling became an even more important skill. We all were living on borrowed time and the only thing that would give us more time was sales to put money into company coffers. We had a truly amazing product, much better than that of our competitors. But the stark reality was that unless we could really sell well, our competitors had a big advantage. They were a known quantity. They were not going out of business tomorrow. They played golf, went out for beers, and had lunch with our competitors.

My guru and mentor was my boss, Gene Bedell. One of the first things Gene did when we launched our company was to put everyone through a sales training boot camp. Gene had run billion-dollar businesses and reached the executive levels in investment banking. He had even convinced IBM to seed our company, a software spinoff from Credit Suisse First Boston. At first my technology team protested at being taught to learn about qualifying prospects and closing sales rather than the latest version-tracking software tools.

Within months, we were closing multimillion dollar sales with blue-chip customers across the globe. We did this with only two experienced sales reps and part-time sales support from our development staff. That’s because developers with sales training are incredibly valuable as a part of the sales process. They have two essential ingredients that make people persuasive—credibility and trustworthiness (for the most part).  So while a prospect may not really believe a salesperson, for example, when he says a system is reliable, they’re far more likely to believe a developer they respect.  This is a very powerful ingredient in the sales process, and one we used regularly.  We would compete with some of the largest software companies in the world—and win the sale almost every time. As CTO, I also took it upon myself to sell strategic partners. My biggest catch was a deal with IBM-Japan worth $8.6 million.

With a culture that put customer support and sales above everything else, we grew  into a profitable $120-million-a-year revenue machine. Our developers formed long-term bonds and friendships with our customers. They would go to great pains to understand customer requirements and build products that would sell. More often than not, new development projects would be funded directly by customers. Whenever there was a customer-service problem, our top engineers would voluntarily work around the clock and fly all over the globe to personally provide support.

There are some parallels here for ZL to consider.  ZL believes that they have the best product out there, just as Vivek believed.  They were in markets that were dominated by much larger and more established players.  Vivek addressed his sales problem by making everyone on his team a strategic sales person.  At this point in time it looks like ZL has decided they can’t compete with the big guys and would rather embark on a Don Quixote-like quest to gain victory through litigation.  For 2010 perhaps ZL might consider a different strategy and purchase a copy of Gene Bedell’s book Three Steps to Yes: The Gentle Art of Getting Your Way.  The $780 it would cost to give every member of the ZL team a copy of Gene’s book would definitely yield much more revenue and success than any lawsuit will.