By: Peter Cohan
Why do big technology companies like IBM and Oracle have trouble sustaining rapid growth that drives up the value of their shares? In a nutshell, they’ve lost that startup feeling.
In recent interviews with four startup CEOs and a few of their investors, I’ve observed that despite not being required to report quarterly financial results to the public, the dance between startup CEOs and their investors reveals useful insights for these tech giants about what that startup feeling means, why it is so important, and where they might look to acquire some of the growth that these startups are enjoying.
IBM and Oracle surely are in need of growth. After all, IBM has suffered a 5.1% annual rate of revenue decline in the last five years while Oracle has been eking up at a 1.4% rate since 2014. And their shares are lagging — IBM stock is down 3% through July 13 this year while Oracle has risen a mere 3.7%, according to Morningstar.
These startups only get funded if they have what these big companies need. That means a big market, unrelieved customer pain, a great management team, and the ability to get and keep customers without spending too much money
As I described in my book, Startup Cities, startups whose CEOs are marathoners — e.g., founders who lead their companies from idea to huge public company — go through four stages of scaling — each of which requires different sources of capital. Here are the first three stages and how four CEOs are raising capital for each.
1. Winning the First Customers
A startup’s first customers and investors are likely to sign on because of personal relationships with the founders, and stay because the startup makes them better off.
That’s why the first stage in scaling requires a startup to fit its product’s features to benefits for which a customer is willing to pay.
Edgard Capdevielle, CEO of Nozomi Networks, a San Francisco-based supplier of cybersecurity solutions for industrial control systems — raised $22.5 million. Cofounders Andrea Carcano and Moreno Carullo got Nozomi’s first customers this way and won initial capital from a government-funded competition.
As Capdevielle explained, “Our first two to three customers were willing to serve as design partners, Those early customers were suffering the most pain and were willing work with us to build a product that would relieve their pain — thus achieving product/market fit. We got our first funding with help from an EU sponsored award for the most innovative solution — which we developed for Enel, an electric utility.”
2. Building a Scalable Business Model
The second scaling stage is to design business processes that will make the startup’s costs drop and value of its product to the customer rise as it grows. Startups with scalable business models lower their costs to acquire new customers as they get bigger.
What’s more, a scalable business model increases the lifetime value of that customer because the startup adds valuable product features and provides excellent service — so the customers keep using the product, keep buying more from the company, and recommend the company to others.
If they’re growing fast enough, many investors are willing to swap cash for a stake in a startup even though it does not have a scalable business model. But such a company could be vulnerable if the venture capital market freezes up as it did in 2015.
Nozomi — which competes in the industrial cybersecurity market (which is expected to reach $23 billion by 2023) raised its Series A round just as it saw a big spurt in growth. “At this stage, investors were asking: Do customers want the product? Is the market big? What are the pain points? Are there competitors? At this point, we were seeking funds to keep growing and to refine our business model. We were trying to figure out where the elbow in the hockey stick would be,” said Capdevielle.
Eyal Grayevsky, founder and CEO of San-Francisco-based Mya Systems a conversational AI recruiting assistant raised $32.4 million.
Mya — which competes in a segment of the $30 billion (expected 2025 revenues) HR software market — is nearing the tail end of stage 2. As Grayevsky said, “I started firstjob.com, a recruiting platform, in 2012 — we pivoted In January 2016 to Mya which focuses on high velocity recruiting. There was pain on both sides — big recruiters like Adecco were trying to become efficient at processing millions of applicants a year each of whom wanted better communication on the status of their applications.”
Mya solved that pain and investors piled in. “Our AI-based service was much more efficient — leading to 91% average conversion rates. We signed up four of the six largest staffing companies and 30 of the Fortune 500. We raised our Series A in March 2017 after trying since 2013. By 2016 we had revenue, clear evidence of market demand, highly-referenceable customers, and industry wide recognition that we were a leader.”
By July 2018, he said, “We had grown from 7 to 60 people, had 80 customers, and were developing a scalable business model moving more to self-service to help us support thousands of customers.”
General Partner, Santi Subotovsky of Emergence Capital, a Mya investor, said in a July 10 interview, “I want to work with companies whose founders are in it for the right reason — not to get rich but because they believe passionately that the world would be worse off without the company’s product. Mya is focusing on the right customer — high velocity recruiters who say they can’t run their business without Mya’s product.”
3. Sprinting to Liquidity
This third stage is often referred to as pouring gasoline onto the business. At this stage, the startup is rapidly expanding — which gives investors hope for achieving liquidity through an acquisition or IPO. Venture capitalists and institutional investors like to invest in a startup if its revenue is likely to reach $100 million, a common benchmark for going public.
Nozomi was ready to sprint to liquidity when it raised its Series B round. The questions it had to answer are relevant to all founders. As Capdevielle explained, at this point, investors ask “If I put more gasoline into the tank will more revenue flow in? Can we land and expand? Have you gained a marketing identity? Do you have reference accounts? Can you market cost-effectively? Can you sell through channels and partners?,” Capdevielle said.
Alex Rinke (interviewed June 21), is CEO of Munich, Germany-based Celonis, a supplier of AI-based process redesign software — an $850 million market (2016 revenue) — which raised $77.5 million. Celonis, which was founded in 2011, has grown quickly — up 5,000% in the four years ending June 2018. Since September 2016 it has added Merck, Lockheed Martin, ExxonMobil and Uber to its list of customers. In June Celonis raised $50 million in Series B funding from existing investors Accel and 83North, which valued the company at $1 billion.
Chen Amit and Oren Zeev (interviewed July 6) are CEO and lead investor, respectively of Palo Alto, Calif-based Tipalti, a provider of accounts payable software competing in a $1.9 billion (expected 2025 U.S. accounts payable software market), which raised $60 million.
Tipalti, which was founded in 2010, took a long time to reach the point where it was ready to sprint for liquidity. As Amit explained, “Our VP of marketing, hired about three years ago, helped us generate strong interest among potential customers — which we call inbound leads. We used to get 95% of our leads from direct sales calls — so-called outbound and 5% from inbound. Now 70% are inbound and 30% are outbound.”
Zeev said, “At the seed round, I look for the size of the opportunity, the strength of the founder, and the value proposition of the product. When you get to later stages in a company’s growth, you can get data on the customer churn rate, the lifetime value of the customer, and the cost of customer acquisition. We assume a Tipalti customer has an eight year life and only 1% to 2% churn.”
Big tech companies should be running their businesses the way these startups do. Unlike IBM and Oracle, they can’t take their investors for granted. If these big tech companies can’t change how they manage, they might at least acquire these fast-growing startups.