VC Secrets Revealed

An Interview with Ann Winblad

BIO

Ann Winblad is the co-founder and a Managing Director of Hummer Winblad, a VC firm in Silicon Valley focused on software. Ann began her career as a programmer and, in 1976, co-founded Open Systems, Inc., an accounting software company, with a $500 investment. She operated Open Systems profitably for six years and then sold it for more than $15 million. Prior to co-founding Hummer Winblad Venture Partners in 1989, she served as a consultant for clients such as IBM, Microsoft, and Price Waterhouse. Ann has co-authored the book “Object-Oriented Software” and written articles for numerous publications including Red Herring, CIO Magazine and Forbes. She has served as a director of numerous start-up and public companies and, as of 2007, serves as a director of Voltage Security, Krillion, Star Analytics, and Mulesource. She is also a member of the Board of Trustees of the University of St. Thomas and is an adviser to numerous entrepreneur groups. Upside Magazine has named her one of 100 most influential people in the digital age and Vanity Fair placed Ann in the top 50 leaders of the New Establishment. Business Week called her one of the top 25 power brokers in the Silicon Valley.

Interview

Forum Link: Can you lift the veil of mystery and tell what venture capitalists actually do?

Ann Winblad: We do our job as company builders. We specialize in software, so we build root knowledge about the sector. What you need to do to build the right business model around your software invention.

Most venture capitalists are established players. We also open our Rolodex to you for two things: one, for your hiring, and two, for key strategic business partners. All in all, our job, once we give you money, is to help find every unfair competitive advantage that we can bring to the table.

We also ask for a commitment from you to grow, versus just to build a little company. We’re committed to helping you building a big company. We don’t run your business. We invest in people who we believe have the capability to lead, strategize and manage. We function as your coaching staff. We don’t shoot the baskets or toss the football. We’re on the sidelines, but there are timeouts. What do you see the competitors doing? Are your strategic assumptions still valid? If you’re watching from outside of the business, what do you see as the strengths and weaknesses in the strategy? How do we win? This is what we try to offer through our experience and our network. You also join a portfolio of companies that are also growing.

Forum Link: At what stage do you think a company would be ready? What stage is a good time to approach a VC?

Ann Winblad: That is a decision that each entrepreneur has to make. If you believe you are going to have a large company, you probably will need some capital at some point in time. You should allow yourself some time to find the right VC for you; one that you can build a trusted relationship with. If they are going to be on your coaching staff for a long period of time, you want the best coaches. You want someone that you feel you can trust and you want someone who you believe can bring you these unfair competitive advantages.

Some companies come very early to venture firms. I’ll give you a good example. We funded what today is known as Hyperion and it was two guys. They had not written the product yet, but they saw a real need to move from the old decision support software to what we have today in the business process management software. So, Jim and Bob came to us, and we funded two people right at the starting line. Ultimately, a company called Hyperion emerged and at the end Hyperion was acquired for over $3 billion by Oracle.

We also funded a company called Omniture. They had pieced together some financing along the way from small angel investors and strategic investors, but suddenly their business was growing and they needed to have an institutional investor. We funded them a few years ago; they are now a public company with just under a $2 billion market cap. These are examples of two companies seeking venture capital at very different stages.

When you think you’re performing unnatural acts you probably need money, and if you need money then you should probably talk to a venture capitalist early to find out “is this the right stage that venture investors will consider funding you or not?” I call that the socialization process. You don’t want your company to go too far, where you end up rubbing sticks together to get dollars, or you have to do consulting to go get the software revenue, because you can’t afford to hire the salespeople to sell it. It is never too early to talk to a VC. Just pick up the phone and say, “I’ve got a company that I’m working on,” or “I am a young company and I’m not sure if it’s the right time to raise venture capital, and I’d like to just have a cup of coffee and talk to you about this.”

Forum Link: So there really isn’t any bad time to approach a VC. At the least you get some advice.

Ann Winblad: Yes, and if you’ve never approached a venture capitalist, you might want to ask, “What do you want to see? Do you want to see a formal PowerPoint pitch? What needs to be in that pitch?” We can provide you that help as well. You might say, “Am I going to be a big enough company for you? How far along do I need to be?” Some companies come to us at the invention stage when they haven’t really figured out how this might be a business. We’d like you to be a little past the invention stage. See us when you might not have all the answers but you’ve thought about what you might have to do to create a substantial business around your invention.

Forum Link: Whether the company is an ongoing business or it’s just a couple of experienced people starting one, what is it that you would like to see from someone coming to talk to you?

Ann Winblad: Well, I can relate back to the Hyperion story. Warren Buffett, who is the best investor in the universe, says the market bats last. We’d like you, even if you have not built your product, to understand who might be your customer. The first thing we look for is have you gone out and asked the market whether they’re going to swing their bat at your product. We don’t need you to have sold the product, but we need to validate it with the customers, to make sure that this is something that you can build into a company. You need to answer the question: Is there an unmet market need?

Forum Link: How large would a company have to want to get before you were interested in investing? How large should the enterprise want to become to get the average VC interested?

Ann Winblad: If the total available market is less than $1 billion, it’s hard to understand how you can build a scalable company. If you’ve got a total available market of $100 million of unmet market opportunity, you’re not going to get all of it. You’ve probably got a $20 million company in the making. It’s great for a start-up to get $20 million in revenue, but in the total available market, it has to be at least a $1 billion available market. If you’ve got all the customers, would there be $1 billion in value there? Not in the first year, it certainly takes awhile to build a company from zero to even the first $20 million in revenue. We’re not asking you to have your revenue ramp be super rapid; we just want to know that the unmet market opportunity is substantial. You can execute over time to realize the opportunity.

Forum Link: I would like to ask you about funding scenarios, from the very, most basic sweat equity, all the way to IPOs. Can you briefly outline the pros and cons from the perspective of an entrepreneur of the major ones?

Ann Winblad: I started a software company called Open Systems in the late seventies with sweat equity, mostly because there weren’t any angel investors around, and there was no venture capital for software at the time. I had to earn my capital through building the company with no salary and then selling a lot of software. Those scenarios still potentially exist, but they’re few and far between. One problem is that if the competition for talent is severe, most great people won’t come and work for free. Secondly, it is really hard to get to scale based on sweat equity. But it certainly is getting cheaper and cheaper to start a company with a couple of people in a garage, so if you can afford to go without your own salary for awhile, you’ll get a lot of extra credit for sweat equity start-ups. But it means that you’re in a unique position where you don’t need a salary, others don’t need a salary, and you can just hunker down for a while.

Over time, angel networks have become easier to find and more professional. We do strongly recommend that if you think you are finally going to do an A-round of investing, that you really talk to your legal counsel and say, “If we take this angel round, how would we construct its evaluation [and] percentage ownership to accommodate a venture round later?” Think ahead, but if you’ve got money at your disposal to get going with the idea and you’re not feeling like you’re ready to talk to institutional investors, there is absolutely nothing wrong with taking money from angels or individuals, as long as you don’t constrain your capital structure for later institutional rounds. There is a big benefit in getting the right lawyer who has done venture rounds, even when an angel round is a good recommendation.

In venture rounds, every round is different depending on the capital needs of the company. We’ve done A-rounds that have ranged from $500,000 to $13 million. What we try to do is what every good venture person does; we sit down and say, “What are your capital needs, and how do we give you enough money at this A round that by the time you need more money you’ve mitigated substantial risks?” We exercise an understanding of how much money you need to build even greater value, so when you raise the next round, it’s less expensive to you. In the following rounds, the choice of your investors can become much more strategic, because you’ve already proven yourself. You have much more choice in who your investors are, because you are going to the market with less and less risk over time. That is, if you performed well while spending your A round.

Forum Link: What is the process that you typically follow when considering an investment in a company?

Ann Winblad: We try to, first of all, to take as many meetings with great entrepreneurs as possible. An A-round investor cannot try to out-guess where innovation will occur. We are the opportunists; the visionaries are the entrepreneurs. The intellectual capital really drives the first part of the decision. Can the founders articulate their business strategy, or at least their strategic assumption? Can you at least convince us in that first meeting that it is worth taking a deeper look at the market opportunity and the product offerings themselves? If that happens, then we go through a due diligence process where we talk to potential customers, we check out personal references, we may even have some of our partners actually look at your product’s code to make sure that the company understands commercial software development. We also talk to potential partners in the industry to see if there is an opportunity to help this company to get a foothold in the software market. That process does take some time. Most venture capitalists give fast nos and slow yeses. We really want to make sure that this is an investment that we can stand behind and value as well.

Forum Link: You suggested that the best way to find out whether you need financing right now or not might be just to contact a VC and have a chat with them. How easy is that to do? How do you present yourself when someone doesn’t really know you?

Ann Winblad: Most entrepreneurs we don’t really know. Starmine, one of our investments, which is being acquired by Reuters, was an example of one of those companies. Liquid Audio is another. Gerry Kirby walked in one day, and it eventually became a public company. Good early-stage investors will try to take as many meetings as they can. If you go to any of the websites of venture firms, all of the email addresses are on there. There’s nothing wrong with sending an email directly to us; we will read it. Just don’t send it to the entire venture capital industry. Start by getting meetings with two or three at first. If you have a lawyer, ask him “Could you make introductions to VCs for me?” If you have a colleague who is successfully funded, go to them. Give them the pitch and say, “Which VCs do you recommend?” It’s really the classic social networking with people who have already gone through the gauntlet before: your accounting firm, your colleagues, and if you don’t have any of those touch points, just go right to our website and send us an email.

Forum Link: How many teams seeking financing do you typically see in a week? And how many on average do you finance?

Ann Winblad: There are probably about 20 new companies a week we meet with in our shop. Sometimes we don’t fund these companies, sometimes we do socialization. A typical early-stage venture fund will fund, at max, 10 new companies a year. So the filter is pretty high in an early-stage.

We try to make these meetings valuable. You get to hear our thinking about your business, what we’ve learned over 20 years as software investors about the category you’re in. So, if you do the venture process right, the meetings will have value for you even if you’re not funded by the VC.

Forum Link: Having successfully started your own business, is your background as an entrepreneur helpful in working with new ventures?

Ann Winblad: The most helpful thing that anyone who’s been a CEO of a company – and five of our seven partners have been CEOs of one or more start-ups – is that we know how hard those jobs are. We know how challenging it is to build a company, and what incredible requirements are put on the CEOs. We’ve been in your shoes. We know what it’s like to be in a highly competitive market of software, but we also know how to win because we’ve had the experiences having very successful outcomes, doing all of the hard work that you have to do. Every person’s job is different, so we don’t try to think that any of our executives are us, but we do have a really good feeling about how hard it is to build companies from scratch and what it takes to build successful ones.

Forum Link: What is the balance between using mathematical models as opposed to just a gut feeling when deciding on an investment?

Ann Winblad: Well, we don’t use mathematical models very much. There are a few overlays we can give to your business plan. We can look at the route to market and say, “Will you achieve software economics? Is this going to be an 80 percent growth margin business?” So you can at least achieve quality business models adapted to that. That’s mathematical overlay without a lot of modelling.

Talking to customers is not a mathematical overlay. We have to listen carefully; even when we love the potential of the company and the people behind it, we have to make sure that we seek the unvarnished truth about the reality of the product when it might hit the marketplace. So, we have to say, “Okay, what did the potential customers really say? Did they say there was going to be a budget next year or not?” Sometimes we hear answers that are very disappointing and we have to turn down an investment. So, it’s not guts, it’s hardcore due diligence. There’s not a lot of mathematical mixture at the A-round. When you get to the later rounds the numbers tell the story.

Forum Link: Right, when you can measure performance and analyze.

Ann Winblad: Are you maintaining your pricing? Is your pipeline building?

Forum Link: What are some of the lessons you have learned from working with Napster?

Ann Winblad: We learned the market’s backlash. Truly we were on the leading edge of peer-to-peer being a disruptive innovation element. We learned that the market forces can sometimes be stronger than the disruption of the innovations, and this time they were. There were stronger market forces to stop than even extraordinary consumer demand. The learning there is that the market bats last and the exogenous forces cannot be ignored.

Forum Link: Could you explain the difference between a trend and a disrupter?

Ann Winblad: By the time something has become a trend, it’s too late for us to invest. Really, disrupters appear under the surface for long periods of time. Disrupters really are these core market change ingredients. Early on they’re extremely disruptive. The critical ones have disrupted not only from a technology standpoint, but from a business model standpoint as well. Usually there are some key breakthroughs by one or more large or small players that change the ingredient mix in a market and create this disruptive milieu that we talk about here.

Forum Link: Is there a way that you suggest one could spot a disruptive technology? Can people sharpen their sixth sense into finding such things, or being more attuned to them?

Ann Winblad: That’s what we have to do. We meet a lot of companies. We meet a lot of innovators, not just the companies we’re going to fund. We keep taking 20-30 meetings a week. We see the glass half full rather that half empty. It takes seeing things that could work and could translate into a significant value proposition to the marketplace. It takes having the dialogue with the buyers, the large customers, to say, “Hey, we’re seeing some new innovation trends. How quickly could you absorb these?” It’s not so much a sixth sense, as being able to live it and recognize patterns. That is what our job is.

Forum Link: From your experience, what makes a great entrepreneur? What are the characteristics of someone who is a natural and is going to be successful?

Ann Winblad: We look for natural athletes, not necessarily the best resume, but the natural athlete. You’ve got to have a really sharp mind because you’re always thinking on the job. You’ve got to be able to be a great communicator. Communicate for fundraising, recruiting, customers. Everything to hold a company together and sustain it requires you to be able to succinctly communicate your unique strategy, and your competitive advantage. You also need to be a great collaborator in the software industry. None of these companies can operate alone. They really operate in tandem with their partners, with other market. You’ve got to have a lot of intellectual and physical stamina. These are hard jobs.

Forum Link: What is your definition of entrepreneurship?

Ann Winblad: My definition of entrepreneurship, in software, is the amazing opportunity and the very efficient way we have here, specifically in the United States, to allow ideas to transform into companies. If you ever read those fairytales about spinning straw into gold, this is the closest it’ll ever come. It rewards highly the strong intellectual stamina, and the backing of that intellectual stamina with the physical one. It’s the ability to take that and transform it into a company or a proven value proposition for the marketplace. That’s what entrepreneurship is. Not just the confidence, but the framework that we have to allow that to transpire.

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