Sales Tax in SaaS: A Beginner’s Guide

One of the great things about our Community platform at FirstMark is that it has become an amazing resource for our entrepreneurs to turn to when they’re trying to solve a problem. Recently, a CEO at one of our companies reached out for guidance on handling sales tax obligations for SaaS in certain states, which quickly led many others to chime in for additional information.  We quickly pulled together leading experts and had a full house session a few days later. It was a great example of how 8 years of deliberate stoking a community has turned into a powerful network, and I thought I’d share some insights from the session.

In spite of the fact that SaaS applications will generate $49 billion in revenues this year, there’s a lot of confusion and murky regulations to follow. If you haven’t put much effort into sorting through the sales tax issue, you’re not alone. Many companies’ first priority is to prove their market and scale their revenue, not to break ground on unsettled tax items.  It’s not uncommon for companies to ignore the issue and elect to throw money at it should an audit arise. An understandable position, but turns out the earlier you can prepare for the issue, the better.

Below are a few notes that came out of our roundtable on how to begin tackling the issue. While every business is different, there seem to be a few basic starting points. [Obvious disclaimer: This is not advice and consult your tax professional].

Is SaaS Taxable? – One of the trickiest parts of sales tax on SaaS is the state-by-state inconsistency in requirements. Only a few states have specifically addressed SaaS in their tax code. In some cases, digital delivery is not taxed, while some states consider all packaged software subject to sales tax regardless of delivery method. Additional levels of consideration include whether the software was delivered as a sale, lease or license, so the structure of contracts should be examined carefully.   

Gathering information for each state can be tedious. One tactic is to start with the top 10 billing states, then consider some outsourced accounting help to tackle states 11-50. Some states known to tax SaaS include: New York, Texas, Pennsylvania, Massachusetts, Ohio, Utah, South Carolina, Hawaii, Connecticut, Arizona, Illinois, Indiana, New Mexico, South Dakota, West Virginia and the District of Columbia. Keep in mind that these laws are evolving and can change any day.

The software company most commonly mentioned  in our roundtable to help with compliance was Avalara, a platform that automates sales tax compliance.

Nexus – Nexus is essentially an analysis of “sufficient physical presence” and the first real step in addressing sales tax on SaaS. This varies, as you guessed, state-by-state. Triggers could include channel relationships; physically locating employees or even independent agents within a state; or economic thresholds for payroll, revenue, or physical property. A little more below:

1. Click-Through: If a company has entered into an agreement with a state resident who refers potential customers to the seller directly or indirectly by way of a link on their website or otherwise for a commission. If commissions are greater than a specified dollar amount, nexus can be triggered.
2. Agency: A “vendor” includes a business located outside of the state that solicits sales of taxable, tangible, personal property or services through employees, salespersons, independent agents or representatives located in the state.
3. Economic: Thresholds for payroll, property and sales. For instance, a company may need to generate $500,000 in sales to trigger nexus.

Collection, Reporting, Remitting – Every company has its own complexities, which informs the need of outside resources. A large company with a clientele in many U.S. states or worldwide may choose to work with a tax automation software provider to help with compliance. For those that choose to do all of the work in-house, our group noted that it’s important to remember city, local, transit, and county taxes are also applicable.

Voluntary Disclosure Agreements (VDA) – Companies who owe back taxes in a given state can proactively disclose this fact, and in return receive certain benefits. For example, a company’s lookback window could be three years instead of unbounded. Additionally, there could be an abatement of penalties or a reduction of interest obligation.

Be prepared for probing calls from state regulators. In some instances, these probing calls can result in a VDA denial. Again, being proactive is a better stance.

Other resources – Unfortunately, there doesn’t seem to be a regularly updated resource for understanding different states’ approach to SaaS tax. However, this map – published by the Tax Foundation in January 2013 – is a good starting place for a snapshot view of policies.

This is a complex topic that continues to evolve in spite of the relative maturity of the SaaS market.  If you have additional resources, please pass them along or add them into the comments!

A Mighty Swing

News has now spread on Aereo’s filing for bankruptcy. While folks in venture generally don’t talk about their failures, this is one I’m exceptionally proud to talk about.

We are in the business of backing innovation and taking big swings. Companies that can be change agents for their industries. Aereo is the very definition of that. Long before Aereo stood in front of the Supreme Court of the United States, the Company ignited conversations about the future of television and its delivery at a time when these services remained fixed, bundled and costly.

Since Aereo’s launch and first victory, we’ve seen cable companies introduce “TV Everywhere” strategies, networks announce over the top mobile apps and unbundled streaming options, and even the FCC take dramatic steps to define OTT players alongside cable and satellite companies. Can Aereo take credit for all of it? Probably not. But I think it’s fair to say they accelerated many of those discussions and helped re-shape an industry perspective.

While that impact may not be found financially, it is felt in the hands of consumers everywhere. For that, we at FirstMark are exceptionally proud to have partnered on this journey with Chet Kanojia and his incredible team. And as I’ve said before, we’d do it again in a heart beat.

Thanks and Congrats Aveksa!

Today is one of those wonderful bittersweet moments in venture.  When a team you’ve worked with for many years and is firing on all cylinders gets acquired in a fantastic exit.  This is the case with the announcement of EMC buying Aveksa this morning.

Aveksa builds enterprise identity and access governance software.  What does that mean?  Well, in lay terms, their software ensure that the right people have access to the right data and applications at the right time.  It’s a core security function and one that is quite technically complex to solve.  And in today’s world where anyone can spin up an application with an email address and password, it’s one that’s coming under increased scrutiny.

We’ve known Deepak Taneja, the founder and CTO of Aveksa for many years.  My prior firm had backed Deepak’s last company, Netegrity, where he was CTO and VP Engineering.  Netegrity pioneered the web-based SSO market and built into a $100MM+ business before being acquired by CA.  We were of course delighted to partner again with Deepak when he founded Aveksa.  As part of that, Barry Bycoff – the former CEO of Netegrity – also joined Aveksa’s board as Chairman and we partnered with CRV to co-lead Aveksa’s Series A.

Along the way, we were joined by FT Ventures (Liron Gitig in particular) and were quite fortunate to find Vick Vaishnavi, who joined as CEO of Aveksa in late 2010.  He’s an incredibly accomplished individual, having been VP of Marketing with Bladelogic from its early days through going public and eventually at BMC when it was acquired for $800 million.  He brought together a veteran team and drove the business to 100% year over year growth.

This is a great outcome for us as shareholders and for the employees of Aveksa.  I’d like to thank the entire team, most of whom are with us today from founding and some who are not, and the Board & co-investors I’ve worked with over the years.  It’s been a thrilling ride that I’ve been privileged to be a part of and building Aveksa proved that creating complex software for the enterprise can still be sexy.  I hope to work with you all again in the future!

APIs First

Lots of discussion about whether a service should be “mobile first” or “web first”.  I tweeted it actually should be “API first”, and I got a lot of reaction to that comment and asked to expand.

First let me clarify.  I believe mobile IS important and a huge emerging channel.  Source of traffic has shifted dramatically and I don’t have my head buried in the sand in that regard.  Across many of my companies, mobile origination (tablet included) comprises anywhere from 30-50%+ of traffic.  I recognize that access patterns have structurally changed.

When I say API first, I mean that an idealized service needs to start with a core infrastructure with robust APIs that is tapped into via any number of “front ends”:  web, mobile, and even 3rd party ecosystems.  If you look behind many “web first” companies today, including in our portfolio, you’ll see a very clean architectural split between the front end and the back end.  The back end exposes a range of services that allows the front end to innovate independently and be re-purposed in interesting ways depending on changing business needs.  The rate of change on the front end is usually a LOT higher than in the back; the scale and stability requirements on the back are far more demanding than on the front.

“Mobile first” companies really are just a front end selection accessing a solid API driven backend infrastructure.  The use case, the logic, and what the app is optimized for may be a subset or different than Web, and I think this is what Fred Wilson and others are focused on.

But as I look at the world, while point of entry may vary, I believe having all three elements of web, mobile and 3rd party are going to be table stakes in the future.  You CANNOT be one only.  Users want different experiences for their different point of engagement.  Mobile is about speed of access, much more transactional and timely, very much about getting something done.  The web is great for researching, deliberating, and exploring.  Both are different aspects of the same service, and I’d want both as a user depending.  Finally, enabling third parties is a realization of the web services and SOA manifests from the late 90s that allow for programmatic distribution and can launch powerful new economic models.

Facebook has already shown us the above and what a powerful, mature, winning service looks like.  They have their core site, their massively used mobile applications, and their various graphs 3rd parties access which gives them tremendous power, platform extension, and plata.  Instagram, normally cited as the poster child for “mobile first”, recently announced they intend to move consumption to their core web site.

So to wrap up, sure, there might be some apps that are best started purely in a mobile context.  But I’d bet 99% of the services out there will have to incorporate all three elements and that starts with building an incredibly solid foundation.  API first, front end second, all screens third.

What Changes the Second Time Around?

It’s been a while since I’ve blogged but I’m trying to get myself back on it again. I thought I’d kick off on the backs of our seed investment into appRenaissance announced today.

The CEO of appRenaissance is Bob Moul, whom I had backed in his last company Boomi in 2008. They were a pioneer in the cloud based integration market and Bob led the business to a great exit in 2010 to DELL. Bob left DELL a year later to jump back into the startup world. He eventually caught the mobile bug and joined appRenaissance as CEO earlier this year. When I got the call, it was a no-brainer and we were delighted to partner together again. It got me thinking, what changes the second time around?

1. Price and terms get figured out quickly. Seasoned entrepreneurs know the game; they know the pros and cons of too high/too low; they know the danger of running out too quickly or overcapitalizing; they don’t get sucked in by the hype in the echochamber; you don’t have to unwind all the misconceptions that exist out there. There is a tremendous clarity that allows us to virtually waste no time in coming to a handshake. Whether it was Bob Moul at appRenaissance or Chet Kanojia at Aereo, the conversation took a total of 10 minutes and we were onto building something great.
2. Don’t need proof because the trust is there. For first time entrepreneurs, generally people like to see some evidence of execution. We want to see what you’ve been able to accomplish, before and now. The relationship is so new that it’s hard to take people simply on their word. We want to see it in some numbers somewhere. The second time around, we already know what you can do and have done before. We’re glad to take early risks blindly because the trust is there.
3. Neither side worries about protecting outside case scenarios. You know the ones I mean… Spending a few weeks defining “Cause” and how to get a ladder of severance lengths based on that. Taking great pains to ensure you approve budget because someone might set one at zero and pay themselves insanely. Having to define exit thresholds and multiples because both sides worry about blocking (or not accepting) an exit because someone didn’t think they made enough money. In general, we never get hung up on the above, but they are real and these are the outside cases that strangers might try to protect. The second time around everyone focuses on the core issues, dealing with things that set up good governance and good mutual accountability, and knock them down easily.
4. It’s a lot more fun. If you’ve had a good outcome with someone, it’s likely the second time, an entrepreneur will be thinking bigger, focused more clearly and will want to build longer. Bob’s goal now is no less than to build a big public software company based in Philadelphia. We love BHAGs like that – it clarifies the mission and energizes all around.

Since starting FirstMark in 2008, I am getting my first wave of entrepreneurs coming back for our second time together, and it’s fantastic. We’ve made it a point to build early, deep and longstanding relationships that make us a place to go again and again. They serve as the best references for new entrepreneurs (first time or repeat) we endeavor to work with. And I look forward to doing so in the future with the many incredible first time entrepreneurs I’m so privileged to be involved with now.

A Reflection on Boomi

This was a long overdue post, but it’s been a busy year.  Fitting this comes as we head into Thanksgiving.  Our investment in Boomi came at an interesting time.  There were plenty of scars from the legacy integration 1.0 and EAI worlds.  Those companies were marked by significant services implementation relative to license sales to deal with unique customer environments.  That made integrations complex, costly and brittle.  Companies like Grand Central, Bowstreet, and others had all tried to ride the Web services, SOA, and interconnected enterprise wave in the early 2000s.  Most were way ahead of their time, leaving lots of dead companies on the road of venture capital.

We believed Boomi’s timing was different.  The emergence of cloud compute services and the growing maturation of SaaS was a stark change from the past.  Both were important backdrops to answer the question “what had changed”.  We’ve had a thesis on how the cloud would require the re-writing of various middleware services.  While the team had a long history in EAI, they decided to bet the farm on the cloud in 2007 and wrote an innovative forward looking platform from the ground up.  They launched in early 2008, and we invested in the summer 2008 on the backs of healthy customer activity.  The business wound up growing very rapidly 300%+ CAGR, continued to launch new innovation upon innovation, won major awards, struck some good strategic partnerships, and eventually got purchased by Dell in an outstanding result for us as investors and for the employees.  From the outside, it was how you’d script it.  But there were definitely things we learned along the way.  Below are a few of them:

•         SOA and Web services (WS) are foundational, not competitive with integration.  Many had a view that as a result of the maturation of Web services, integration was built in and no longer needed.  In fact, turns out WS were foundational to doing integration in a flexible, repeatable manner.  It allowed us to connect more easily to systems, but you still needed a platform to orchestrate, move, transmute, and connect these WS ports.  We believe we are finally, after a decade, scratching the surface on how SOA will empower and impact applications going forward.

•         It takes time to find your sweet spot in the pyramid.  Boomi launched with incredibly disruptive pricing, which led to a lot of customers quickly adopting.  Early on, it turns out many were very small businesses only looking to connect two low end applications, where the value of the platform was less obvious and there were simple alternatives in the “point to point” world.  The value of an integration platform grows non-linearly with the number of points connected.  We pivoted to focus on companies with slightly greater needs, where our platform value would be clear and our innovation led to high stickiness. It takes time to tease out who the *right* customers are for a new category product.  Once we understood that, it helped clarify decisions around product roadmap, hiring, sales model, etc.

•         Don’t be afraid to raise prices.  Related to above, low price, high quantity led to a lot of early customers, but it didn’t scale exactly the way we wanted or attract the best fit customers for our product.  But it led to a lot of buzz.  As we realized our best customers were a little further up the pyramid, we worried that increasing pricing would also mean losing the very small business segment and perhaps impact buzz.  We spent a lot of time thinking about the tradeoffs, but decided it was more important to align with our target customer.  We increased prices three times and the business didn’t skip a beat (in fact inflected upwards).  If you find your spot on the pyramid, align all parts of the business to it.

•         SaaS delivery model changed everything.  Unlike the legacy world, which was plagued by high services and one off implementations, true SaaS allowed us new functionality and velocity the market hadn’t seen before.  We could do exciting things like using multi-tenancy to figure out what most people do when connecting applications, and auto recommend process maps.  This eliminated 90% of the manual work in integration.  Our platform could be opened up, allowing people to build connections and make them available to the entire community.  We could get reasonably complex integrations done quickly and reliably.

•         SIs say they love SaaS but it’s hard to break economic incentives.  We worked with a number of larger SIs who individually loved what Boomi was doing, but collectively found it difficult to leverage the product.  It broke the model of “billable hours”.  “Easier to configure” made for efficiency, but not more revenue.  Some newer more progressive SIs, like WDCi out of Austrailia were great, but bigger shops found it hard to change.

•         Indirect channels are hard to predictably scale early on.  In addition to SIs, we also worked with dozens of ISVs who were go to market partners for the Company.  We began to see success but that came after years of effort.  Mark Suster has a great perspective that fits our case pretty well.  No one could care about our success as much as us, nor did it matter that much for others versus us.

•         Conviction is important.  When we first invested in Boomi, we planned to split the round with a co-investor and introduced the Company to a few shops.  Most folks could not get there, so we decided to write the entire check.  After the market collapse in 2008, we told the guys to just focus on the business and be smart with cash, which they did a great job of.  There was constant inbound poking given the profile, but mostly off and on distracting conversations.  We decided to write an additional check so the team could focus entirely on the business.  And it was ever so rewarded!

Looking forward, we’re always sad to see a market defining company go.  The team did an outstanding job and I’d work with them in a heartbeat.  We are glad to have been a part of it.  We think there continues to be a huge opportunity in cloud infrastructure software.  The strategic interest in Boomi underscored that.  Dell has a fantastic opportunity to own one of the cornerstone building blocks for public or private cloud offerings, and exploit that as a real differentiator versus others out there.  Meanwhile, we’ll go back and look for the next great company to back!

Buy Me Or I’ll File

The 3Par saga is finally over, and the Company with the larger resources and most similar channel won.  HP is buying 3Par for $33/share or $2.4B in value.  This is over 3x where the Company’s stock was trading before the battle begun.

3Par is a classic example of why many private companies go “on file” (meaning, file their S-1) to drive an M&A process.  If you are a unique company with technology and sufficient scale to go public, that should be a pretty desirable asset.  But many times you need to create a compelling event to get buyers to take a process seriously.  By filing an S-1, you are telling a broad audience that you intend to go public.  Once public, there are a whole new set of fiduciaries the Company becomes obligated to and new set of disclosure obligations.  For example, in 3Par, all bidding happened formally and publicly.  Dell had no ability to lock the deal up and drive it to a close.  Their foresight and brilliance tipped others into action.  We saw the same with EMC, when they swooped in on DataDomain and took them away from NetApp. 

If either of these companies chose to buy 3Par when it went public in November 2007, they would have saved over $1.8B!  There are many companies on file today that don’t really want to be public.  It’ll be interesting to see if these recent public battles spark others into action sooner.

Purpose!

I was introduced to a great video around motivation by Brad Feld’s blog.  If you haven’t watched it, it’s worth 10 minutes of your time.  Much of what Brad and the video highlights is very relevant.  The primary idea was debunking the notion that pay and performance are linearly correlated.  While true in mechanical tasks, the research demonstrates that for anything requiring cognitive engagement, if pay gets de-coupled from purpose, outcomes are markedly inferior in spite of higher reward.  The talk is riveting, and I thought I’d offer a few suggestions based on what I’ve seen from our best executives.

First, create a purpose!  Many companies I meet with mistakenly assume it is so self-obvious that it is never made explicit.  And yet deciding those few words can make all the difference in the world.  Once articulated, the great thing that happens is those words can then be printed and shared over and over across a Company.  It allows purpose to be infectious and align an organization.  “Is everything I am doing consistent with our purpose?”  When everyone thinks with a higher goal in mind, it helps create a consistency of outcome.  Companies like Zappos are a great example of this.

Second, make sure you define a purpose in an aspirational way, not functional.  Purpose to me is not something that gets achieved, it’s a direction.  For example, it’s not “we want to build the best online marketing software” but “we want change the way people discover and interact online”.   Instead of “we will be the leader in online multi-player games” but “we want to revolutionize the experience, distribution and delivery of games to online audiences”.  Admittedly I spent 15 seconds thinking of these examples, but the idea is stay away from purpose that does not appeal to a fundamental emotion or create a cause of action.  The term BHAG comes to mind.

Third, find ways to reinforce the purpose and make accomplishment tangible.  Our best companies create exposure and reinforcing loops to show how individuals and the company support the mission.  Developers get introduced to customers who rave about how a new feature has shaved an hour off of their day.  Metrics are aggregated that frame how their engagement and excitement compares to other things out there.  Spontaneous community activities are highlighted and ‘shout-outs’ to individuals go company wide.  Beyond incentive compensation, people need feedback on a regular basis that they are indeed contributing to and achieving purpose.

Our best companies and leaders have a sense beyond themselves.  They create ideals that people line up to get behind.  When people believe, they will go through walls to create outcomes.  And when everyone is willing to break through walls, usually you break through mountains.  This is hard to do and requires focus to make happen, but remember even life is not that interesting without PURPOSE!

Love & Flux in a Time of Seed

I was at a panel earlier this week, when a question was asked from the audience.  “Are we in a seed bubble?”

Well, between the rise of super angels, the proliferation in micro-cap funds, and a shift in some LP interest towards the seed stage or emerging managers with small funds, it does not take a lot before we see significant changes in the available capital for seed.  Combine that with how capital efficient companies are, and you get seed stage activity at a level that did not exist before.  Admittedly, the fact that these companies can achieve material traction with much less money is a driver for the phenomenon.  But divide more dollars in the asset class by fewer dollars required per company and the output is many more companies.

What happens to those seed companies?  Typically, if a company does a good job executing on their seed round, by being capital efficient, they can quickly raise a Series A round of capital.  Some don’t need it, but generally in an era of easy “me-too”, expanding to all markets in parallel or staffing up quickly to feature differentiate usually necessitates venture capital.  The problem is that the venture industry at a macro level is in a not so healthy state.  LPs are having their own macro difficulties, and investments in the asset class are coming down materially.  Many funds from the prior climate are actively reducing fund sizes, by choice or otherwise.  And we in venture believe this actually is a good trend (at least those of us performing!).   

What does this all mean?  Combine the increasing number of seed companies with decreasing venture capital dollars, and you potentially have a tough situation.  Not every seed company that does “well” will have the opportunity to be fully capitalized.  There are only so many times a seed investor can tell a VC “no, no, THIS is really a hot deal”.  And so the bar will go up dramatically.  This is a good thing in that much better companies will get funded beyond the seed.  And in many respects the bar for a Series A deal these days will start to resemble a Series B deal.   But it also means lots of failure.

For entrepreneurs, a few things to think about.  First, think about the composition of your seed round.  Take the time to build the best network around you for information flow.  Create a good mix.  Make sure you have a strong group that can be your advocate and can give you credible advice about how to navigate the market.  Second, work actively with your seed investors to define real value creating metrics and what ‘clears the bar’.  It used to be 100K uniques was interesting, then it was 500K, six months from now it might be much higher.  Having institutional money as part of that syndicate can be helpful as we are actively in the transaction flow of real companies graduating from the seed to A and beyond.  Third, make sure you have the capital to achieve those objectives.  Don’t just take $1MM because that’s what is “typical”.  Map your capital to milestones in a disciplined manner.  This is not for investors, it’s to make sure you can grow your company seamlessly, keeping fundraising tasks to a minimum, and emerge owning a huge chunk of your business!

Don’t Ignore the Obvious

My partner Larry Lenihan recently passed me a great article in Wired on the neurocognitive basis on which people absorb and discard information.  The author used the famous case of two scientists who built very sensitive radios to map the emptiness of space, and kept hearing a persistent noise.  They spent years tuning their radio telescope, clearning pigeon poop off the dish, blamed it on nuclear fallout.  Eventually and reluctantly, they accepted their equipment could be right and sought an explanation from more diverse sources.  They wound up winning the Nobel prize in physics in 1978 for discovering the cosmic “noise” associated with the Big Bang. 

 There were lots of lessons to be taken away for all participants of a startup.  Much of it involves overcoming one’s own personal biases to get to real insight.  Some examples: 

• Seek diverse opinions early on an idea, rather than hoarding it for fear of being stolen.  The constructive dialogue process generally sharpens, not dulls.
• When hiring, focus on the references (particularly ones not provided by the candidate) and listen to what they have to say.  Don’t fall in love with a candidate in advance and use that bias to filter out the lukewarm language.  It usually means there’s more behind it they are not saying. 
• Continually test and seek feedback.  Try to ask for the check as early as possible, because that is when you learn whether the market truly values what you implicitly believe is valuable and are spending resources building. 
• In fundraising, don’t ignore the “nos”.  Many may not get it, but there could be good lessons learned in other situations that one should be mindful of and avoid.
• When stuck on solving an issue, try to bring in completely fresh perspectives that aren’t stuck in the weeds.  They can look from the outside, borrowing concepts from other disciplines even in the technology space.

 Overcoming mental blind spots has become a hot new area around improving “Executive Function”.   The more we are aware of the bias, open to hearing issues, and resolving in light of them, the better the businesses we build will be.

Practical Tips from FirstMark Capital’s Online Marketing Summit

I did a post a few days ago around the high level themes from our Online Marketing Summit called “Stop Selling, Start Giving”.  There were enough very practical tactics that emerged from the event that I thought I would share some below.

SEO: 

• The best time to think about SEO is when building a new site.  When using any good CMS system, such as Drupal or Joomla, be sure to use their SEO plug-in modules.  It will make it very tough to not have SEO on the site. 
• Links are very important, particularly ratio of inbound links to outbound links.  Also, the deeper and more specific you can have links to the site (rather than just all to the homepage) that will improve the SEO of the site and pages.  Make sure your content is structured in such a way that incents people to point to deeper pages.
• SEO is a process involving content creation, engineering head count, links, technology, and budget.  Create commitment to SEO in the organization.  Hiring one person cannot change an organization or generate real SEO value.  Consider allocating 10% of engineering time to SEO work.  The best practitioners have everyone in the organization focused and thinking about it.
• Resources:  SEOmoz.com, Conductor.com

SEM/PPC

• Before you spend your budget on an SEM campaign, be sure to take 10% of it FIRST and do a test run.  You can save yourself some major embarassment in case something was not set right and to further tweak. 
• Be very careful using BroadMatch – you could spend money in a heartbeat on terms that are not related to your product or service.
• Keyword research is critical.  Lots of tools out there can help, but also thinking about negative keywords, plural vs singular, etc, are all ways to create variation. 
• Resources:  Clickable’s free guide SEM best practices and tips

Community

• Create a community and empower it to set directions – a censored community is not one at all.  Manage but “with a light touch”.   Allow users to moderate content.
• Recognition is key for community growth – tiered structures, badges, experts, rewards (virtual or physical) are great ways to accomplish this.
• Transparency is critical – if you have an issue, publicly engage the community and tell them what is going on.  Building trust is paramount to a vibrant community.
• Measure the community –  post activities, engagement, session lengths, etc.   The numbers will tell you if your community is active and thriving.  If it’s not working, find out why!  It’s usually something you did.

Email

• Email is NOT for acquisition, it is for retention! 
• The FROM and SUBJECT alone determine if someone opens – the questions they are asking are “DO I KNOW YOU?” AND “DO I CARE?” respectively.  Answer those questions well.
• Build your lists organically by providing VALUE to users such that they want the information rather than a marketing message.  Use things like questions that your customer service receives as material for future newsletters.  You dont need dozens of articles – a few targeted ones that serve a purpose and give value to customers is better.
• Create links back to specific pages on your site so you can track activity and users interests. 
• Make sure you have a sign-up form on ALL pages of your site.  Customize the thank you note when someone does sign up – show genuine appreciation for signing up.
• Most people have images off in their email clients – dont have a huge picture at the top or users will see a big X instead of a message in their preview screen.
• Testing is key – treat email just like PPC.
• Use the word “Feedback” instead of “Survey” – people are much more willing to provide feedback than take a survey.  One improves their life, another takes time from their life.

Marketing Automation

• If you can read the “Digital Body Language” of how customers are interacting with your site, content, and marketing activities, you can calculate how likely they are to buy and where they are in sales cycle.
• Lead scoring is critical to understand when marketing activities transition to sales type of activities.
• Separating FIT of buyer from ENGAGEMENT of a user is critical.  A key decision maker doing a few things online and a summer intern doing a lot online should not have the same lead score.  A CEO doing A LOT is the ideal.  Segment those rigidly and pass on to sales things at the closest intersection to improve MQL close rates.

Integrated Marketing Approach – Case Study of Omniture

• Marketing commits to generating 35-80% of sales accepted leads, and in closing 35-40% of deals in a quarter.  If you do not know what number you are responsible for, you are not strategic.
• Dont do live webinars – record and push it out there – allow your customers to sign on when they can, fast forward to what they want, and interact as they wish.
• It’s hard to find online marketing savvy folks.  If you cant find someone smart, hire an inexperienced, smart person and send him/her to get certifications:  DMA, AdWords, etc.  Make sure they have gone through the formal trainings – well worth the investment, and smart people without legacy biases will get this system.
• Map your marketing process to a sales process – someone looking deep on product page is much further in a funnel than someone downloading whitepapers.   Know that and automate.
• Sample mix of budget:  25% Site and Content, SEO 15%, SEM 15%, Email 20%, 3rd Party Emails 10%, Display Ads 5%, Newsletters 3%, Tradeshows 7%.

John Deighton’s definition of Interactive Marketing:  “The ability to address the customer, remember what the customer says and address the customer again in a way that illustrates that we remember what the customer has told us.”

Any other suggestions, please post below!!

Stop Selling, Start Giving

FirstMark Capital yesterday hosted an Online Marketing Summit for our portfolio companies and friends in the community.  The goal was to bring together the latest thinking across a variety of functions (SEO, SEM, Email, Community, Social, Automation, and others) and to improve the overall fluency of our companies regardless of their field.  If I were to summarize everything I learned at the event, it was to “Stop Selling, Start Giving”.

The Internet has democratized customers’ abilities to learn about new products, instantly provide feedback, and share their experiences with others.  The traditional model where sales controlled the product message to buyers, carefully built relationships, and used those relationships to close deals has been permanently broken.  One way marketing strategies can now be easily sidestepped by a user that self-selects how to use products and research decisions on his or her own.  As a result, marketing’s role has changed to find buyers when they are ready to make a decision based on their OWN actions.  Steven Woods from Eloqua calls it “Digital Body Language”.  By reading the Digital Body Language, sales can step in at an appropriate and desired moment to facilitate the close of a deal at the right moment of intent.

What does it mean to “Stop Selling, Start Giving”?  By that, you should try to begin the dialogue with a customer with a value proposition and an insight that addresses a problem they have.  If they don’t have a problem, they don’t need your solution.  If they do, actively help them understand the PROBLEM better, not your PRODUCT better.  One tactic could be a whitepaper, another could be giving away your product for free initially, another could be hosting a community forum where experts comment on industry issues.  In addition, by actively participating in the customer pain and facilitating their dialogue, you gain a precious opportunity to subtly influence and learn from the dialogue.  Transparency exists whether you want it or not – embrace it!

By the act of giving, you’ll begin to engage a prospective customer in a series of activities.  Each of those activities can be measured online and used to decode where a customer is in their buying process.  Are they just exploring the web site?  What sections?  Have they downloaded a couple of specific whitepapers?  Now moved to using the product?  Asked for some help?  These data points can be mapped to a buying cycle where you can appropriately insert yourself to a sales activity.  Done well, you can tie all of these data into one continguous funnel that starts with first contact at the top and closes with a sale.  But it all starts by giving, not selling!

Zappos & Amazon – Happy News For All

I had been asked a few times over the last week about my thoughts on the Zappos transaction.  I think this is a great story for innovation and startups.  Zappos started in a space many believed you could not transact online: selling shoes without people trying them on… Of course, as the world has grown increasingly comfortable transacting on the Web, that changed pretty quickly and Zappos took off.   With their focus on customer service and company culture (can watch a video by Tony Hsieh on that here), they were able to build sustaining brand advantage.

Ultimately, I think Zappos could have gone public, but Amazon stepped in and paid over 20x+ reported EBITDA of Zappos.  That’s a serious multiple, healthier than the public markets now.  And of course, in an online business at this scale there are significant capex cost, so I’m sure if you looked at cash flow, you get an even bigger premium.  Zappos built a dominant brand in a category, and Amazon stepped up and paid a premium to get the company.  To me, that’s a textbook entrepreneurial story.  I think you will continue to find next generation e-retailing companies thrive, but with an innovative new spin.  Gilt just raised money at a reported $400MM valuation, and had multiple bidders competing to get in.  There are a whole generation of companies pushing the ‘mass customization’ or ‘personalization’ theme, and doing well.  It’s all about finding a novel approach, attacking it quickly, and building scale at a brand level before someone can catch up.

Marketing is the New Sales

Many have written about the rise of highly capital efficient companies, the growth of SaaS, the penetration of technology into the SMB community, and the new requirement to deliver value to customers at the time of purchase.   Each of these strategies has radically altered the sales process.  No longer are armies of sales people sitting in customers’ offices or spending endless hours over dinner trying to forge relationships they can lean on in the sales process.  Instead, customers are “pulling” solutions they are interested in, trying them out for free early on, and selecting products that meet their needs.  If the best way to do sales is to have customers “declare” their interest, then one needs an exceptionally broad funnel to ensure productive sales activity.

As a result, marketing in this new era is undergoing a rapid transformation.  Marketing is no longer about softer concepts like brand building and trade shows; no longer simply providing the appropriate message and collateral for the sales organization; no longer sitting with industry analysts, hoping for positive coverage.  Instead, it has become a much more active, tactical, and quantitative function.  Done right, it becomes a highly integrated and critical part of the overall funnel. 

The next generation of marketing leaders will be fluent in online acquisition channels and implementing a real time, transparent, measurable system.  The areas of spend are highly fragmented: SEO, SEM, Email Marketing, Affiliate, Social Media, Community, Video, and on and on, balanced with the traditional channels of PR, magazine and trade shows.  Quantifying cost per lead, customer acquisition costs, conversion rates, and value per customer across each of these channels requires significant discipline.  Architecting follow up in a highly automated manner and driving to increasing levels of qualification becomes key.  Webinars, emails, and free trials are scalable ways to move potential customers along and require minimal touch.  Site activity, logins, and usage inform how much deeper customers are getting. 

The challenge is that many of these channels have only been around for a few years at most.  At FirstMark Capital, we are trying to support our CMOs make the transition by sharing the nuggets of best practices across our portfolio.  Luckily, via companies like Clickable, Conductor, and others, we have some of the leaders in these areas within the portfolio.  We are also organizing an annual Online Marketing Bootcamp for our portfolio companies and friends of the firm to augment organic knowledge with leading experts in the field. 

If you are one of these types of CMOs, we’d love to hear from you.  We have lots of places you can be used!  🙂

Jeff Bezos at Wired: Disruptive By Design Conference

I attended the Wired: Disruptive by Design Conference earlier today at the Morgan Library in NYC.  One of the best sessions was of course with Jeff Bezos, CEO of Amazon.com.  I have an incredible amount of respect for Jeff, not only because he stayed true to his strategy in spite of an incredible amount of pressure during the bubble bust, but also because of the spectular innovations that have come out of Amazon over the years.  The Kindle has revolutionized the e-reader market and launched Amazon into a consumer electronics company.  Amazon Web Services of course has transformed Internet economics from fixed costs to variable ones, and unleashed a wave of new companies to boot.  Jeff did not disappoint, and I thought I would share some of his thoughts below.  My favorite from below – “The trick as an entrepreneur is to be stubborn on the big things and be very flexible on the details.”  Enjoy, and feel free to post any other good ones you have from Jeff. 

On the economics of e-books and the Kindle: 

• A text book is re-sold 5 times over it’s life, which is why they cost so much.  With digital books, publishers have the opportunity to sell that 5 times to consumers.   The price can now come way down.
• Historically, we have never made money on bestsellers.  We make money on the mix.
• For books where we have both physical and e-book inventory (300,000 books), Kindle unit sales are 35% of the physical book sales.
• “We humans do more of what is made easy”.  You do more when you reduce the friction.  Making buying books so easy makes people buy more.
• Reading is an important enough activity to have it’s own device.
• On multi-function devices versus signle function:  “I like my phone… I like my swiss army knife, but I also like my steak knives too.”
• “The physical book has had a great 500 year run, but it’s time to change”
• “Our vision is to have every book ever printed, in any language, available within 60 seconds.”
• On Google’s pending deal with the US book industry:  “It doesn’t seem right to get a prize for violating a large series of copyrights”

On staying true to the path and entrepreneurship:

• “We always noticed some of our harshest critics were our best customers.  Told us we must be doing something right.”
• Regarding the run up in the bubble: “I always told our employees not to feel 30% smarter when the stock went up by that amount because one day it will go down by the same.”
• “One of the differences with founders and professional managers is that the founders care about the detail of the vision.”
• Regarding vision and strategy:  “The trick as an entrepreneur is to be stubborn on the big things and be very flexible on the details.”
• “If you disrupt something, you have to be willing to be misunderstood for long periods of time.”
• Regarding products that seem very different:  “A question people at large companies don’t ask enough is “Why not?”” 
• “I wouldnt know how to respond to someone if they said, “We cant do this because it’s not in our knitting.'”
• “The two things we do is work backwards from customer needs and work forward from our set of skills.  AWS is an example of us working forward from our skills, while the Kindle is an example of us working backwards from customer needs.”
• “Many companies believe learning a new skill is akin to leaving your core competency.”
• “Errors of comission are over focused on versus errors of omission.  People over dramatize how expensive failure is.  You never hear of a company getting criticized for failing to try something.”
• On trying different ideas:  “If you are in the investment phase and you stop doing it, the only thing that happens is your profits go up.  How hard can that be?”
• On mistakes:  “We launched Auctions, no one came.  We licensed Google’s search and launced A9 and no one came.  A year after we shut it down it was still my mom’s homepage.”
• Citing another quote in response to why they didn’t better service and if it was deliberate or not: “Never attribute to conspiracy what can be explained by incompetence.”

It was a great session and Jeff had some great lessons.

LTV: Another Metric in SaaS?

I recently had an interesting conversation with a very smart hedge fund buddy of mine.  We were of course talking about investment ideas, given many of us were holding either cash or gold, and I threw out Salesforce.com.  It is generating 15-20% free cash flow margins, growing revenues at 30%+, with a solid recurring base.  This led to a discussion of valuing SaaS companies.

As venture folks trying to build companies, we tend to focus on operational metrics like Annual Contract Value (ACV), Monthly Recurring Revenue (MRR), Average Selling Price (ASPs), and Churn.  Both Byron Deeter of Bessemer and Will Price formerly of Hummer Winblad have done very nice posts here.  My friend’s perspective was entirely different as a public market buyer.  He looks at everything through the valuation lens.  He said the metrics above are all interesting, but he and his peers tend to focus on Lifetime Value of a Customer.  Essentially wrapping many of the components above to look at the DCF value per customer.  It is very similar to how analysts look at cable companies on the overall value per subscriber.  An obvious point he made, but framed from an entirely different angle, was that small changes to churn assumptions would lead to drastic changes in the overall valuation and associated multiples of a company.  While one can focus on the revenue or FCF multiples, it’s really the LTV that he cares about.

[UPDATE: Many searching for specific LTV calculations come to this site – a great summary of the formulas to use can be found here by Joel York of Chaotic Flow].

As a venture investor, I had never really thought about the public market perspective on my companies.  But it got me thinking about adding it to the key list of metrics our SaaS CEOs think about, because someday, we hope they will be selling that LTV metric to the Street.  Its component parts are made up of all the metrics we track, but creating an explicit metric often generates focus, and it’s probably one to think about early on in building value.

What do you think?

Entrepreneur’s Guide to Surviving the Credit Crunch

Given the events of the last few weeks, there are many provocative questions being asked about what the subprime implosion and subsequent bailout mean to all of us.  Will the bailout bring liquidity back to the market?  Are we descending into the worst recession we have seen since the 1930s?  Is the US secretly a socialist regime shrouded in capitalist clothes?   Amongst all the questions, very few are oriented towards the startup that has no leverage and is still building product or traction into the market. 

While I’m not here predicting the “bread lines” scenario, for most entrepreneurs and even us VCs, our companies are our lives.  The last time around, many “whistled by the graveyard” refusing to believe things were different until it was too late.  It would be irresponsible not to consider a tougher environment.  The following are things to consider for any entrepreneur beginning to prepare for upcoming market volatility:

1.   Cash is king once again, and is all that matters.  Preserving, extending, replenishing it.  If you have less than six months of cash, you need to seriously evaluate how to replenish your balance sheet.   Venture is generally the last industry to be impacted from market implosions given the long term nature of LP capital commitments and horizon for our investments – raise your money now if you can.

2.   Planning to hire a lot more people?  Especially sales folks?  Slower, more responsible growth will be cheered, but running out of cash will not generate sympathy.  Rather than hiring a bunch of sales people, who may spend months to get productive and still be pushing on a rope, keep the team lean until you feel that your customers can feel the bottom.  People do not make any decisions when they are worried about their own jobs.  No point subsidizing commiserating Happy Hours.

3.   Focus resources on a great, specific product.  In a tough market, large companies are cutting wholesale.  R&D groups are in disarray or not as productive because they too are worried about their jobs.  Smaller companies have finite resources and are all playing the “last person standing” game.  Building a narrower product that is incredible at one thing and working outward is better than building a broad set of functions in parallel.  Get to the 10x customer value proposition (3x improvement at 1/3rd the cost) and start selling as quickly as you can.  This will help you leave competitors in the dust.

4.   If you have venture investors, ask them how much they have reserved for this investment.  All responsible venture firms create budgets for how much capital a specific company will need over its life.  It’s how we know how many new investments we can make.  If there are no other investors out there, your existing investors will be your support structure.  Their summed reserve amount is the most capital you can plan on being available to you.

5.   Work even closer with your investors to define value creating events.  No VC will simply hand over all that reserved cash.  Start early, work with them to adjust near and longer term goals to realistic levels, and document them, so that when you visit the partnership having accomplished your objectives, they’ll have your check ready to go.

6.   Check in with your local banker.  Many of the emerging growth banks specifically stayed clear of any credit derivatives or subprime mortgages.   Their balance sheets are strong and leverage relatively low.  This market could be an opportunity for them to grow share.  The stronger the relationship you build now, the more likely they could be a supportive source of venture debt or capital.  

7.   Maximize any existing space and avoid signing new long term liabilities.  This benefits you in a few ways:  first, you avoid things like security deposits that tie up cash that can be used for operations; second, the commercial markets could be affected just as much as residential ones and you could negotiate a better deal after the ripple effect hits the economy;  third, it can foster a “cash is king” mindset amongst the team.  Everyone is in this together.

8.   Try to do deals where you get paid upfront, and avoid doing deals that require significant cash upfronts.  Again, cash is king.  Better to use cash for business deals rather than security deposits (number 6).  EVEN better to structure a win-win partnership that allows you to operate longer, rather than letting someone else carry your cash on their balance sheet.  If the only deal is an upfront cash deal, hold out a little longer.  If someone else jumps in now, you’ll be there when they go away.  If no one else does, people will really begin to feel pain and you might be able to structure the “death blow” deal against a competitor or lock up some invaluable web inventory for a song.  The flip side is if you can get money upfront, that is worth a lot!  Whether that’s prepaid inventory, annual billing terms with cash paid upfront, or non-recurring engineering that actually subsidizes your team, keep all the chips in your corner you can. 

9.   Quantify marketing and shift it towards DR (direct response).  There is a reason why in recessions, even before Google, brand advertising pulled back but DR grew – it has a defined ROI!  Examine all “goodwill” oriented marketing costs.  Paid search, display advertising (esp with its recent contraction), email marketing, webinars, and other forms of spend can be a much more efficient way to generate leads or acquire customers.  All of them are measureable – what better way to know if your cash is well spent?!  In addition, many ad networks will do guaranteed placement or conversion deals in tough times IF YOU HAVE THE CASH.  This is the Internet era, don’t let marketing spend a dime without knowing what you get back.

10. Start thinking about potential HR upgrades!  Tough markets mean top candidates are much more available than normal.  Think about swapping out B- employees for A+ folks.  Every person in a tough market has to contribute – sharpen the blade and drive productivity!

Got any other tidbits?  Feel free to post them here….

The Entrepreneur’s SEO – “Startup Exit Optimization”

I was chatting with a start-up CEO today, who had received some early inbound interest from a potential acquiror.  Without any discussion of price, he asked me innocently enough, “Should I think about it?” 

I started thinking about the positioning of the Company and the phase, and offered the following.  I think most start-ups go through several brief natural local maxima, to borrow a calculus term, over its life (3-6 month windows of time over a 5 -7 year life) .  Those maxima are periods where, on a risk adjusted basis, it may make sense to exit early.  The trick is to recognize whether you are there or not, so as to know whether you are value maximizing. 

To be clear, this is not a post advocating early exits.  Heck, as many other people have observed, as a venture investors generally try to swing as big as possible across a portfolio of companies.  As a maximizer of *company* value, however, you have to be cognizant enough to realize when you are on one of these plateaus, pick up your head to look around, and see if someone might be looking at you through binoculars from afar.   You’ll always have to be “bought not sold”, and many people move from valley to valley never getting to a peak, but if you do, recognize it, assess it, and make an informed decision. 

Generally, I’d say an acquisition is value maximizing if it occurs in one of three periods: the “concept” pop, the “growth” pop, and the “IPO” pop.  In the “concept” pop, a company is acquired primarily for its radical vision or strategy, with no correlation to financial metrics.  (This is not in the context of a bubble.)  Think of a Series A company that seems to have a laser sharp vision for a particular space that many other people haven’t begun to understand.   The Company usually has visionary management, early mindshare in a rapidly evolving but undefined/unstable space, and the early positioning (and PR!) to objectively call it a “thought leader”.   In a normalized market, it’s probably just getting to revenue.  The multiple is the highest at this stage b/c the denominator (revenues) is low; conversely the acquisition price is also the lowest because the acquiror has no reasonable financial grounds on which to pay the price.  They just know this could disrupt, transform, or catapult their business and want to be on the ground floor.  This is usually the $50-100MM exit. 

The next major hill is the “growth” one.  This would be a Company likely past its Series B, generating $10-20MM in revenues, has clear market leadership by virtue of tangible numbers like customers/partners/ASPs, and a fully built management team.  In this case, a Company has built hard technology that works, has perfected how its sales machine works, and now is adding fuel to the fire.  It’s probably growing at unsustainable longer term rates of 100-200%+ but can project wonderful visions of grandeur.  Competition exists from a raft of “me-too” startups, but also in the marketing from large vendors as well.  From an acquiror standpoint, you can start putting loose financial multiples to the Company and assessing sales channel synergies.  While the multiples begin to come down relative to the first hill, only a fool would give up what seems like a rocket ship, and so the absolute dollars go way up.  Exit values are usually in the $150-300MM range.

The last major hill is the “IPO” hill.  The IPO hill is the company that has not only done all of the above, but has managed to stave off ALL competitors, large and small, and built a truly defensible position.  The Company has not only done that, but also met the inter-steller, global galactic, worm-hole inducing bar to go public by filing its S-1!  An acquiror at this point would be capitulating that they will not beat the company at its game, and moves in to take it out before it goes public.  The multiples here have to come way down and likely tie to some notion of “accretive” (within 2 years) for the acquiror, but again the absolute number is much bigger.  The universe of buyers is also much smaller given the magnitude of the exit.  This is usually the $400MM+ purchase. 

Why look to an “exit check” at each of those hills?  Well, typically, those hill peaks are followed by valleys of varying depth and visibility.  Doing a little more wont change the exit outlook; in fact, it’s more likely to cause you to be “in discussions” while on some kind of a non-optimal slope.   And while there are always larger, more lucrative, adrenaline producing hills ahead, you have to be fully prepared with better equipment, maps, resources, and a better set of lungs, while finding enough sustenance and staving off nipping animals, before emerging on another peak again.  In start-up terms, that means making sure the product works, figuring out sales cycles, successfully deploying at customer expectations, rising above the noise of ever present competitive slideware, maintaining price points, expanding the available market, raising venture capital (aka, dilution!), hiring and retaining great people, building appropriate regulatory and compliance infrastructure, and so on.  All are manageable issues, but companies inevitably move downward from a plateau when getting into the weeds of execution.  The numbers bear out how many make it through to the next hill.   

[As an aside, it’s why VCs love guys who have “done it before” – their lungs and maybe wallets are usually stronger to go the higher distances.]

How do you know you’re leaving one of these hills?  I’ll save for another day if there’s interest…