Xobni Man Walking Some thoughts from an entrepreneur

Host software services. This is a pretty big deal for entrepreneurs looking for business opportunities. Let’s look at some examples.

LogMeIn, which filed to go public in 2008 is basically VNC with a web only client side and central servers that will facilitate NAT traversal across firewalls. Various VNC developers had written software to do this but nobody was willing to maintain the servers. That’s created a business opportunity and a competitive advantage against open source alternatives.

Fog Creek Copilot took advantage of the same opportunity, and in this case they actually used VNC software.

What about a place to host your MP3 play history for other people to see and for other software to mine? Audioscrobbler started to do this, but morphed into a startup called Last.fm.

I’m sure open source blogging software was around when Evan Williams launched Blogger.com. …and look what happened to Blogger.  I wonder what percent of blogs today are ran in the old fashioned way: someone went to SourceForge.net and installed it on their shared server, versus using a company set up to host the  blog for them. I’d bet in favor of the hosted service.

It’s too bad, really. There’s no doubt we’d have better software today if open source projects could get servers and operational resources for free. We’d probably all be using an IM client built around Jabber.

But it’s an opportunity for entrepreneurs, and one that will grow in the age of web services and web experiences. Ask yourself: what open source software exists that solves a big problem in a large market?

A friend just asked about spending at an early stage startup.  I thought I’d post my response in case it’s useful to others.

—

hey adam - what do you think your personal burn rate has been during these stages:

seed stage
- a dollars / month on rent
- b dollars / month on everything else personal

vc stage
- x dollars / month on rent
- y dollars / month on everything else personal

—

Seed stage (a) should be easy; it’s just the rent for your area.  In Cambridge we had a 3br apartment near Harvard Square for $2200 per month, but we subletted out one of the rooms for $800 per month and had Drew working from our living room for about $400 per month.  In Crystal Towers we paid $2600 for our 2br and then we had a stint of working out of my single which was also about $2600 per month.

I don’t know Seed stage (b) as much because I just didn’t keep track.  But I can triangulate based on our out of cash dates.  We were making $12,000 last four months, though that includes some consulting revenue from Matt working a weekend or two per month @ NASA for $55 per hour.  It was super low.  We ate bagels in the morning with cream cheese, and made turkey sandwiches with avocado for lunch.  Dinner was usually the Italian sandwich/pasta place next door.

Our burn was so low partially because we were working so hard.  When you’re working seven days a week for 14 hours per day that leaves little time else to get out and spend money.

Needless to say, we weren’t drawing a salary.  The company was essentially paying for everything.  Our philosophy was that we put our bank accounts into long term storage, like a secret agent on a 10 year mission would.  We didn’t withdraw from or deposit into our personal accounts.

Once VC stage hit we were slow to accelerate burn, which was smart in some ways and dumb in others.  Matt still didn’t want to spend the money for window AC units (dumb).  We raised our salaries to $72k (smart).  We continued to work out of my apartment until we outgrew it by headcount, not by bank balance (smart).

Matt was a champion for conserving cash.  Him plus our lowly roots made us, as a board member put it, “remarkably capital efficient.”

It caused me some cognitive dissonance, though, to see different spending habits WITHIN rounds.  When we were launching at TechCrunch 40 I had a hired hand we flew in sleep on my couch at home, but a year later while we were still series A we wouldn’t have hesitated to put him up in a hotel.  The people in the company had changed; it wasn’t related to being in series X.

So I guess to answer your VC stage (a) we got a lease for 3200 sq ft for $5000 per month by looking on craigslist.  A steal.

For VC stage (b), we paid all personal expenses by salary.  The salary could be low because we were working so much of the day.

That’s the prevailing effect.  High salaries in a startup are probably exactly correlated with low time in front of a computer.

I felt like I was entering another world today when I walked into the Expo floor at the Salesforce “Dreamforce” conference.

The expo is a room full of vendors that are trying to sell their solutions to Salesforce users.  I was certainly the most underdressed person in the room.  Everyone was in suits, and I was reminded of the cultural rift between sales and tech people.

You can tell how alienated these two groups of people are by listening to how they talk about one another.  One person giving me a demo of their solution said “Then we let Todd loose on the problem!”  If one group has some amount of disrespect for the other, it’s probably the developers with regards to the sales guys.  Sales people certainly respect programmers, even though they don’t understand what they do.

But the Salesforce conference is the land of the sales guy.  I find it both intimidating and exciting.  They have energy and enthusiasm.

Unfortunately they seem to be hurting when it comes to innovation.  I twittered that ninety percent of the solutions venders were either very labor intensive businesses (consulting) or were selling software that ended up creating more work for the user.

For example, there was a software company that helps you bring your email conversations with customers into the salesforce database.  This is a hole in the salesforce workflow, for sure, but their solution was a little convoluted.

Each user had to forward incoming email to this system, and BCC the system on all outgoing emails.  They have an Outlook addin that will automatically BCC the system on your outgoing emails.

Then there’s a tab in the Salesforce UI they add for you to create contacts around new, unknown email addresses.

It’s all very convoluted.  It doesn’t “just work,” yet most of the offerings of 3rd parties had this flavor.  I think that’s why there’s a long tail of vendors; nobody dominates because nobody is adding value in a systematic, high quality way.

I can also understand why.  Most products for sales people are driven by sales people to begin with, and most sales people don’t have good product and technical instincts.  Most people who have those instincts don’t understand sales people, and they especially don’t understand sales managers.  It’s all very depressing, but exciting at the same time.  There’s a lot to be done.

This post is a response to Matt Maroon’s post today called Poker People. Matt talks about how straightforward poker players are with each other as compared to Silicon Valley investors.

(more…)

…is when he is a refugee in Austria, escaped from Hungary. He badly wants to go to the United States. I can relate; there have been three or four times in my life when I really wanted something, in the way that you dream about it every night and you put infinite care into every part of getting it. Applying for Y Combinator, to start Xobni, was one of those times for me.

For those of you unfamiliar with Andy Grove, he was the third employee at Intel and its President (and later CEO) for over twenty years. He’s a prolific thinker and businessperson in the valley.

Andy is 20 years old. He had just interviewed with American students from the International Rescue Committee (IRC). These students are picking refugees to bring to America based on English skills, education, etc. He was to find out the results the next day…

“They had read off a list of names. According to people who heard the list, I wasn’t on it.

I felt as if someone had socked me in the stomach, then my heart started beating so hard that I could barely breathe. “Where are the IRC people now?” I asked. Someone said they were conducting another series of interviews at a school some distance away. I took off like a madman. I ran all the way through the cold, dark streets. My heavy shoes hurt my feet as I ran, but I didn’t care.

Sweat was pouring down my face by the time I reached the school. There was a familiar long line of people waiting to be interviewed. I didn’t wait. As the next person emerged from the interview room, I brushed past the person whose turn it was supposed to be and pushed in to stand in front of the table.

The IRC representatives were a different group of students than the ones who had interviewed me the day before. They stared up at me blankly. I didn’t give them time to stay anything. I swiped the sweat off my face with my hands and, still panting, started talking in English as fast as I could.

I explained that I had been interviewed yesterday, that I was not selected, but that I really, really wanted to go to the United States. One of the interviewers asked me why. I told him I had relatives in New York City who would take me in, that I was a chemistry student, that I thought I would become a good chemist, and that I belonged in the United States. The words poured out, not eloquently or coherently, but I talked and talked as if I could overwhelm their objections by the sheer volume of my words. I almost didn’t dare to stop talking, but finally I ran out of things to say. I stood there, panting slightly and still sweating profusely.

The students looked at each other and smiled, then one said, “Okay, you can go to the United States.”

I was speechless. I couldn’t believe my good fortune. I wanted to hug every one of the young men sitting on the other side of the long table.”

I’ve been thinking a lot about APIs lately. Xobni works with MS Outlook; we use its APIs to get to mail data. Xobni’s current value comes from organizing this data in novel ways for our users.

There’s still a ton of great things Xobni can do to (a) tap into other sources of data, including but by no means limited to mail data, and (b) make all of this useful data more accessible to other developers.

Xobni isn’t the only group of developers thinking about this problem. It’s clear to everyone that rich personal and inter-personal information is locked away in data silos.

Social Graph

People are trying to free social graph data, e.g. OpenSocial and the Social Graph Foo camp this coming weekend.

At the end of the day I think it’ll get done. The data is spread through email, social network, IM, and phone platforms, but that won’t stop progress if there is real value to be unlocked. That second piece is what I’m worried about; we are at a lack for compelling use cases of the social graph data. Here are the ones I know of: dopplr, evite invitations, setting permissions based on friendship, and search. What am I missing?

Other Personal Data

People are important but there’s more to life. Facebook, for example, has all kinds of data entities, and all of them are interconnected. It’s a powerful approach. Here’s my illustration.

(Edited: fixed a few accounting mistakes towards the bottom.)

Suppose you wanted to make $1 million per month by selling software. You can either go for a few lucrative customers or lots of low paying ones. A half minute in Excel and you have a table.

Ten minutes in MS Paint and you’ve got a nice graph.

The sweet spot for high margin software offerings seems to be in the sub-$10 per month range. Rhapsody charges $13 per month. Yahoo Mail is $1.60 per month. Mozy is $5 per month. [1]

Enterprise customers pay in the same range for commoditized products. MS Exchange costs about $10 per user per month. FogBugz costs $20 per user per month. I’m sure enterprise antivirus is a brutal market for providers, but I don’t have numbers because they don’t have public pricing.

Enterprise customers are willing to shell out the cash in non-commoditized product categories, though. Salesforce.com charges about $100 per seat per month, but they’re going to have to drop their prices soon because of pressure from Microsoft and others. Bit9 is a new kind of enterprise security, so they’re set for a couple of years.

Anyway, so this is the range we’re interested in:

How do we get 100k paying users? Just for fun let’s assume that you have a freemium model. Most users aren’t going to pay, but some will because they get the bike horn that makes the moooo sound.

The rule of thumb is that about 1% of free users will convert to paying customers. The number varies greatly by vertical, product, etc., but let’s just go with 1%. Some quick math and you have another table.

So if you charge $10 per user per month, and 1% go premium, you need 10 million users to hit $1M in revenue per month. For reference, Outlook has 500M users, Skype has 200M users, and Thunderbird has 8M users.

Skype had about 50M users when they were bought. At that time there were about 4M people simultaneously online, so only a fraction of those 50M were active. Why did they get bought for billions? My guess is that a large portion of active users were paying customers. They were obviously still in growth stage. They also enjoy high margins and had recurring revenue for each user.

So what would $1 million of revenue per month do for you, anyway? $12 million in annual revenue, to be sure. Beyond that you’re back in the land of heuristics. Google has a P/E (price to earnings) ratio of 50. If you got the same ratio with margins of 50% then your company would be worth a nice $300M.

Margins vary hugely by business. Grocery stores get about 2% margins in a good year. Software, luckily, traditionally has high margins because the cost of supporting an additional user is so low. 50% sounds extreme, but consider Skype. They don’t have infrastructure costs, and they probably have no more than 50 or 100 people. That’s the kind of company Xobni can be. This 50% margin on $12M annual revenues can support a burn rate can support a head count around 30 or 40 people. That’s not a bad place to be when you hit the $1M per month milestone.

Other public tech companies have similar but not higher ratios. Redhat is at 65, Yahoo is 50, Sun is 40, Oracle is 30. Microsoft is 20, but damn do they have lots of revenue! Salesforce.com is 1053, but until recently was infinite. They’re still selling the dream.
These numbers can end up all over the board. Zimbra sold for $350M on revenues of about $15M, and probably way lower profits. The list goes on. Growth and strategic value to acquirers seems to have the biggest impact. [2]

With some more elementary school math, we can use these numbers to derive a value per user. An average user on the $10 per month row gets us ten cents per month, or $1.20 per year. That’s sixty cents of profit. With a 50 P/E ratio, that’s $30 per user, not far from Fred’s numbers.

P.S. Xobni is hiring. We are currently looking for great software hackers and a senior QA lead.

Notes

[1] The sad part about these prices is that both Rhapsody and Mozy are low margin businesses. Rhapsody is net losing money per user. Yahoo Mail is a high margin business, but it doesn’t matter because the price is so low.

[2] If you want more examples, look here for a list of MS acquisitions, and have fun googling.

I forgot an important thought in my previous post, Raising Money.

Sam Altman: “Every morning wake up and say to yourself: ‘They need me more than I need them.’ Entrepreneurs are the limiting reagent in the startup equation, not investors.”

Oh so true.

I previously wrote to upcoming Y Combinator companies about:

1 - Having courage to face reality and change direction as appropriate
2 - Raising their next round.

Dear YC Graduate,

You’re presenting to a room full of investors this week. What should you know?

First, your demo will probably break, but that’s okay. Our demo broke. I fixed the code between our demo and the mingling. I remember telling investors “Look it works now!” but nobody cared. : )

Follow the introductions. Your lead investor will likely be a friend of an angel who you met through the advisor you met at your girlfriend’s father’s 55th birthday party.

Joe Kraus has written about this. He says Take a cookie.

Here’s the tree of how we met our investors, of who introduced us to who. Click on it to get the full version.

Y Combinator has the largest branching factor in the tree; they introduced us to nine angels and VCs. 23 out of the 28 investors we spoke with are descendants of Y Combinator in the tree.

I’ve written about the value of Y Combinator before. You’ll basically be borrowing their network. They kick ass. [1]

We spoke with 16 angels and 12 VCs. Angels made 24 introductions; VCs only made four. The average angel introduced us to 1.5 other investors, but the average VC only introduced us to 0.33 other investors. That’s a 5x difference!

So angels can be helpful even if you’re raising a mostly VC round.

It’s an unwritten rule in the valley that if node x invests then every ancestor of x must be given the opportunity to invest. They can’t be cut out of the deal. You can probably figure out why.

Okay, tree stuff aside, you want to have more than one major investor. If one firm is out of line then the other firm will be there to say This is unreasonable. You’ll get more varied inputs. Having more than one major investor means you’ll take a little more dilution, but I think it’s worthwhile.

Our series A didn’t happen quickly. We excited the people we met with, but we were timid about getting started having recently closed a $100k angel round. One firm had interest, so we thought “We better talk to someone else to make sure we’re getting a good deal.” That incremental approach went on for a few months. We were always in late stages with one investor but just beginning the dialogue with another. Deciding to raise money should be an atomic decision; don’t try to just dip your toe in.

You want a small option pool. The investors will tell you that the company needs a large option pool. Balony. The debate is really about who pays for the option pool. VentureHacks has a relevant article.

Traunching is bad for the company. If your investors exercise the traunche(s) then it means that the company is now worth more than they’re paying you, so you’re leaving value on the table. You might want to raise a smaller round and go to the market again when your valuation is higher. [2]

There’s also the 10x rule: you shouldn’t raise 10x more than your last round. I think it’s a pretty good heuristic. [3] (Credit: Josh Kopelman.)

But some people will tell you to take money whenever you can get it. There’s also some truth in that.

At the end of the day I’ve done exactly one financing and have very little experience. There are entire blogs devoted to these topics. I encourage you to read and learn all you can. Ask for help when needed. You’ve got a great network surrounding you.

Good luck, and best wishes,

Adam

P.S. I previously wrote to you about ‘Courage to Change Direction’ here.

Notes

[1] That said, don’t expect them to do the work for you. Just as the summer stage, you get back what you put into it.

[2] Yes, that does mean that you’ll spend more time raising money. And market conditions could change by the time you go to the market again. It’s a trade off.

[3] YC’s initial investment might not apply well as an input to this function.

(The latest group of Y Combinator companies graduate in two weeks. There are some thoughts I’d like to share with them. This is the first of a few letters.)

Dear YC Graduate,

First, I hope you’re excited. I remember the rush of the super early days. Wow, what a rush!

It’s important for you to focus on your demo for the next 10 days before demo day. Focus focus focus, and you’ll do great.

After demo day, though, I think you should consider where you’re taking the company in terms of its market/product/positioning.

You applied to YC with a promising technology and a vision for the future. After working on the company for three months, now would be a good time to do some introspection.

We worked on a product called Xobni Analytics over the YC summer. It was a great product, but not the right product for our market. We scrapped [1] that product and are now working on something much better.

The YC company that became Scribd was working on something totally different over the summer. They realized it wasn’t going to pan out and had the guts to change direction completely.

Do you need a direction change, or are you already on the right vector?

Is your market large and addressable? Does your product solve a real pain? Does it create lots of tangible value? [2]

It’s worth plowing through on your product over the summer without too much thought to Is this a $300M dollar company? But the time has come to ask yourself such questions.

This letter boils down to: Have the courage to say We need to change something. We were wrong about this or that. Be agile; don’t be stubborn.

Notes

[1] I spoke more about this in the ‘Idea Due Diligence’ paragraph of this post.

[2] All of these questions equal, ironically: Is it something people want?