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.

Thank God We Just Missed Our Revenue Projection

"If you are lucky your high-growth software company will one day miss its revenue projections by a long shot." After you have read this statement.......you will likely conclude that the author is crazy...and you might be right...BUT...I have seen supporting evidence for this sentiment many times over....let me explain.


After a period of sustained revenue growth...all the investors are smiling..." we are going to be rich again" they say. Near the end of the fiscal year...we clamour for next year's financial forecast....how much bigger is this thing going to be and how much richer might I become? The forecast is then produced...it is presented to the board and is spectacular...it makes perfect sense...in fact it even looks conservative. At this point, we are very smart.



The something unexpected happens. The first quarter comes in a little under budget and the second quarter comes in way under budget. Deals seems to get delayed and smaller...prospects are asking a lot more questions...and getting calls returned by them seems to take forever. The prospects then let you know that they are looking at several alternatives and are trying to figure out if yours is right for them. This all sounds so new for a company that seemed to have such clear sailing for the past two years.

Investors become concerned. A mild panic surfaces in the Board meetings..."What is going on here?" However...what looks like trouble is really a clue that investors are entering the playing field they dream of.

What has happened is, in a word, "competition.." Once the market becomes confused it is generally a sign that competition is increasing and thus that others see market potential for a technical solution. It means that this subject is becoming important to a large number of people. The good news is that if you have been in the market for a couple of years before this heating process occurs...then you likely have a great leg up on this competition from a competency perspective and your job then is to show the customer why his needs will eventually require the maturity of your solution. You just have to have enough antacid medication to endure the revenue speed bump for which you didn't predict the timing.

If the revenue speed bump doesn't happen...it is likely, in my experience, that your company will not become a big thing...so....bless the speed bump and don't curse it...