Where is the Money Coming From?

Early-stage software company investors are regularly trying to calculate velocity and change in velocity of their portfolio company investments. Is this getting harder? Is this getting easier? Is the market opening up? Is it flat-lining? What? What? What?

In Geoffrey Moore's "Crossing the Chasm"...the author identifies the period in time during which companies and markets expand into what he calls "Majority Markets" The period of transition into the Majority Market is where investors learn that they are (a) going to do well, (b) going to go broke, or (c) somewhere between (a) and (c). This period of time can be excruciating. A pretty good clue one may use in answering these questions is derived by asking another question: "Where is the money coming from?"

Lets say for example your company makes virtual sponge-covered chocolates ("VSCC's"):

• Later Stage - If your portfolio company is approached by a prospect that has a line-item budgeted amount for VSCC's and you see this with some frequency then you may be on the road to investment glory. The reason is that the prospect is educated enough in the market to have internally thought about and lobby for a budgeted amount for your item - he knows he needs it. Many many times the budgeted dollars are from within the IT department.

• Middle Stage - If your portfolio company is getting money from a combination of operations and IT budgets - this is a little earlier stage endeavor but you are on the right path. In this context..operations has recognized that it needs to do something better and has been allocated a "do something better" budget. Some of this is then pushed over to IT if it is deemed that a software solution can help the "do something better" project.

• Earlier Stage - If your portfolio company is, on average, getting money from operations only and IT is not really allocated money and thus responsibility, it generally means that operations is test driving the "do something better" software solution and hasn't started pounding the table for IT to get involved - maybe. This is a tougher spot to be in because your portfolio company is trying to sell something that operations is not yet sure it needs. Operations is speculating and allocating money to support speculation is hard to do and generally comes in fairly small buckets.

The net of the migration from the earlier-stage scenario to the later-stage scenario is that sales and marketing costs as a percent of software license revenue should begin to decline materially. If you are in the stage where money is coming from a line-item budget and sales and marketing spend is one dollar (+) for every one dollar of license revenue (bookings not GAAP)- you may be in the middle of an investment nightmare. Otherwise you've got something that may be economically scalable and an investment money maker.