This is part of my set of notes from the Startup School 2006 sessions at Stanford.

Ann Winblad is the co-founding partner of Hummer Winblad, a VC firm in Silicon Valley focused solely on software. She started off with a number of general observations on the state of the venture capital and software markets:

• The market has been very constant over the past three years, with about $21B a year invested on average. Around 35% of all dollars invested go to software companies
• Microsoft stock took the hardest hit it’s taken in the past five years, down 11%. The winning stocks? Saleforce, new analytics companies
• Winning used to depend on platform shifts (PC to client/server to Internet distributed); now, if you’re an incumbent it’s like playing wack-a-mole with the competition. We’re at the beginning of a four-year step function of innovation. For software, the real boom is now.

The challenge for founders is really understanding the customers, creating competitive advantage, and turning that into a business.

Starting Your Software Business Plan

• What is your idea? The goal is to hook them in 15 minutes. For example, consider one of their portfolio companies, Hyperion. Jim and Bob walked into Hummer Winblad office, and Jim unfurled a list of all the customers he was going to call – after one meeting, Hummer Winblad started due diligence. In another case, Voltage Security, Ann saw their pitch as a finalist judge in a business plan competition and immediately knew it was a fundable business because they had been able to distill the essence of their idea: “Voltage Secures Anytime, Anywhere business communications”.
• Do you understand the market? Unmet customer need + growth – the VCs are expecting any startup to say it’s a billion dollar market. What’s really important is to talk about the customer, their needs, and if you solve that customer’s problem/interest, will you have an ongoing revenue relationship with that section of the market? Is it a vitamin or a painkiller?
• Are you defining the market or jumping hurdles already in place? You have to define the market, as opposed to having the market defined for you. You need to be creating the barriers to entry.
• Who are your competitors? Put together a picture of who you’ll be up against – even if you don’t show it to anyone, do this exercise.
• Is this a product or a company? Companies do not live in the Products section of their corporate web site.
• Will customers beg? Are you creating the Newton or the iPod? How is this product inspiring? Biggest challenge in the consumer market is to make the product inspirational. In Enterprise, it’s about tight fit to consumer need.
• Who are your customers?
• What is the secret sauce? What is really giving you that competitive advantage that no one else can reproduce? In the case of Voltage, it was math. What’s your advantage? Technology/IP? Business Process? Partners? Domain Knowledge?
• Engineering roadmap: Can the product be built in less than one year? Anyone that comes to them that can’t bring the first release of the product to the market in less than a year is not going to get funded. Sit down, write out your engineering roadmap to show how you’re going to get there.
• Can you attract excellence? 80% of the companies Hummer Winblad funded that were acquired were run by the founders. They are seeing the old world retiring, finding that most of the people they fund are doing it for the first time. Do not try to pack in your whole management team. The companies they’re funding are lean and mean, small. One company recently funded had five employees; another had three employees.
• Do you know what you don’t know? It’s fine to go into VCs and say “These are our assumptions” – it’s important to know what are assumptions, and what are facts. Michael Porter’s value chain is a good guide. Who do I think will be competitors? What do I think my route to customers will be? Write down your top ten assumptions, and track how they change over time.
• Do the numbers make sense? Do the numbers reach software economics (80% gross margins, 20% EBITDA)? Are services a major fraction of revenue? Is the total capitalization less than $15< ? Are COGS (Cost of Goods Sold) > 30%? Are sales and marketing commissions and quotas in line with industry? Does the Engineering plan match the Operations plan? Is the G&A < 10%, is it outsourced? Is the quarter over quarter growth? What’s the revenue per employee? How long will the initial investment last?

The Market Bats Last

• “I only swing at strikes” – Warren Buffet
• Ultimately, the VCs will call customer to ascertain if they believe in your product and team. Do the customers have budget to buy you product? Is there a common problem across customers, or does it need to be customized for each customer? And do you have a way to reach the customer (example: carriers in mobile applications)? How do you reach customers in a reasonable time, at a reasonable cost?

What VCs Bring to the Table

• 3 P’s: People, Partners Process
• 65 companies got their A round from professional investors in 2005
• The money does give you some competitive advantage, but not a lot. It’s the partnerships that you can leverage that build that advantage.

Do I Need to Write a Business Plan?

Not at first, but they will eventually to see your thought process. Six pages should cover it. In addition, you’ll need a pitch presentation consisting of 10 slides to cover the basics:

• Executive Summary
• Team
• Market Analysis
• Secret Sauce Overview
• Key Assumptions
• Customers (Potential or references)
• Product Plan
• Engineering Plan
• Sales model and marketing outline
• Business Model / Financials / Cash Flow

Audience Questions

• How would you respond to Joe Kraus’ philosophy of taking on money? It depends on the business in question. For one of the companies they funded, they only put in $650K – this company had major assumptions outlying that needed more interactions with customer to figure out which way to go forward. The VCs are interested in where this money will get you, and if it will get you to a milestone that will be of interest to follow-on investors. The worst situation is companies that try to take too little, and they haven’t achieved any milestone when the money is gone.
• Do you have a lower limit on the size of company you consider funding? Do you consider companies that are going to exit via acquisition differently than via IPO? Hummer Winblad focuses on startups that are going to become big companies. Ask yourself: Could I describe this company as a public company on an S-1? Even in the case of companies that got acquired, they made a choice to get acquired rather than to go for IPO. But an IPO was always an option. You want to be in a position to turn down an acquisition. Anyone operating such they need to be acquired to achieve an exit is in a precarious position. Companies are bought, not sold.