Unlike the dot com era of the nineties, Web 2.0 enables entrepreneurs the ability to engage in two very different paths:

• Create a traditional nineties-style, high-growth, venture-funded technology business.
• The second option for starting a business that has burgeoned is the rebirth of the traditional entrepreneur’s self-funded small business.  The Web 2.0 era affords entrepreneurs the ability to have a technology business that rapidly develops product, with that product being sold to meet clients’ needs.

Although these two options are laid out as extremes and are both worth discussion, I am going to discuss the underlined nuances of the second option.

Building a business: First, I am defining a business as a revenue-generating, profit making entity. Although this definition may seem pretty obvious, there are plenty of businesses today that break that model – YouTube.com, FaceBook.com, MySpace.com – you get the idea. In spite of these examples, the beauty of a Web 2.0 era business is that the level of capital required to build a technology-related business has declined to rival the capital requirements of starting ANY small business in the pre-dot com days. And contrary to the above Web 2.0 examples, entrepreneurs can immediately engage on a path toward profitability.

Unfortunately, the message of this new reality hasn’t gotten the wide-spread distribution it deserves. Entrepreneurs are still making their rounds to the VCs looking for bubble-level cash investments in hopes of being on next year’s cover of Business Week. And VCs are still funding business plans without clearly-defined paths to profitability, in hopes of landing the company that ends up on next year’s cover of Business Week. The model from the nineties that you can build a business AND lose money should have burst with the dropping of the year 2000 Waterford crystal ball in Time Square. My all-time favorite quote from the nineties is “we’ll make up for the loss on volume” – which they did a few months later by shutting their doors.

As recently as the past month, I heard advice given by a VC to a Web 2.0 start-up was to defer actual sales opportunities and focus on building product and brand. This scenario results in a cycle of dependency, where the entrepreneur becomes ever more dependent on funders to keep their lights on. And the funding partners, instead of having a portfolio of businesses, has a portfolio of products. This may not be a bad deal for the investor if they are looking to roll up product, but it can be a risky play for the entrepreneur.

Therefore, in starting a business, I recommend that entrepreneurs have clearly defined personal and business profitability goals that they model and make sure that these goals are in alignment with their funding partners’ goals. Worse case scenario, if they don’t hit it big on the cover of Business Week, they end up with a profitable business.

Rapidly developing product: Secondly, the era of Web 2.0 enables entrepreneurs to rapidly develop and market new products. In the Dot Com era, at a minimum, it took over $500,000 to develop prototype products. Nowadays, with combination of Web 2.0 technologies, open source, and off-shoring, entrepreneurs can develop mature product for a fraction of that price. Gone are the days of the big bang product launch – we are seeing more and more businesses rolling out as “Beta”, thereby setting low expectations, and getting preliminary reaction from the user community, and ultimately paying customers. 

After an initial beta, or proof of concept, it is desirable to then build what you can sell. It is amazing how many entrepreneurs have great ideas and begin developing their beta product – without ever having put a design prototype in front of a potential client. Some entrepreneurs have told me that they would like it to be closer to final before showing; others are afraid that they will be giving away their intellectual property. Nonetheless, my experience is that there is nothing like good old fashioned client feedback to help speed a product to market and to ensure that entrepreneurs build what they can sell.

Sold to Meet Clients’ Needs: Finally, selling a product that meets immediate clients’ needs is perhaps the most important aspect of starting a Wed 2.0 business. If you have 1) committed to making a profit and 2) committed to a rapid, client-centric development cycle, then 3) the entrepreneur needs to sell the product to the clients that informed the development cycle.

These three integrated steps makes it possible to start a web 2.0 business via bootstrapping your way to profitability. As an investor and entrepreneur, I am not making a judgment between bootstrapping versus outside funding. I am simply drawing the distinction between the two extremes.

In thinking about the options as extreme examples, the main issue that comes up through this process is the entrepreneur’s desired growth rate and perceived risk tolerance. Taking this organic, methodical path generally means a slower growth rate, but also minimizes the amount of outside capital requirements and medium-term risk. I consider the organic growth route to be less risky since more of the control is in the hands of the entrepreneur and the decision to keep the lights on is a decision made between the entrepreneur and the customers.

If the entrepreneur takes outside capital, even if the business is going according to plan, the plan could include another round of funding. And if that is the case, and the funding dries up, due to circumstances outside of the entrepreneur and their current funding partners’ control, the business shuts down, or at least goes through a significant, uncomfortable transition.  

The pros and cons of bootstrapping versus outside seed funding is a topic that spans many critical areas in starting and running a small technology business (and keeps many entrepreneurs and investors up at night). Therefore, I will be spending some more time on this issue in future blogs and sharing with you my discussion with other investors and entrepreneurs.

Welcome to my blog – my first entry in my first blog. I have been very excited to become an active voice in the greater community, sharing information related to marketing and the media in the high-tech entrepreneurial space. I had the opportunity to attend the Word of Mouth (WOM) Marketing Conference this week in DC on December 11-13 and am now even more excited to start this blog! I’ll be letting you know all about the impact WOM is having online and offline in future entries.

But first, I’d like to get to know my readers, and I’m certain that you’d like to know something about me as well. I’ll cover the earlier part of my career so you can understand how my background in computing and in marketing and media has come together. This entry is going to be longer than usual. I promise future ones will be shorter.

The Early Days

I started my career at AT&T back when it was the big behemoth – the mother of all telephone companies, fondly and many times, not so fondly, named Ma Bell.  Alexander Graham Bell was a technology leader in his day and set in motion a communications revolution. By the time I joined AT&T it was the largest employer in the nation and in New Jersey and was a monopoly.  I laughed when I was told about the golden handcuffs.  The theory went that once you were lucky enough to be anointed as a Ma Bell employee, you would be well-taken care of and stay there throughout your career.  I was so certain that this would never apply to me that I didn’t sign up for the 401K plan until six months after I was eligible.

 My first job at AT&T was a computer programmer, an entry-level management position. AT&T was a powerhouse company, and they wanted every programmer to get the same training – whether or not they had previous training or experience working in the field. They had high standards and often began a training class with all experienced programmers. Since I was largely a novice in this field and still made the cut, I felt fortunate. Those first three months were grueling. Every exam was a pass or get fired experience. This was my first venture into the technology world of computing, and so, from the very beginning, even though AT&T was voice-centric, my experiences were data-centric.

I was always interested in advertising and marketing and was fortunate to work on the company’s business marketing system.  Thus, I was able to be a techie and yet deal with marketing data. Every Bell Operating Company (BOC) in the nation had to send all their business customer data to headquarters each month to Marketing. The systems consisted of JCL running many huge programs, primarily in Cobol, strung together. The programs that were sent out by headquarters did not include the source code - they were sent as object code or executable modules. The operating companies got creative and would intersperse their own programs into the system. This sometimes created havoc.  (Note: most PC or Mac users are still just running programs and don’t have access to the code – case in point – I’m writing this in Word, a Microsoft proprietary program or application.)

During these years, very few people knew much about computers and programs, and systems analysts (which I became) were highly regarded.  To the average person, this was like a huge black box. And people in the industry worked hard to keep it this way. One of the ways was using jargon, which made everything seemed more serious, difficult to learn, and, well, elitist.  I mention this here, because there are a couple of themes I will come back to:  you’ve got the experts working very hard to maintain an aura of awe around them, and you’ve got lay people who are always playing catch up. You’ve also got the hockey stick learning curve that highlights the gap between the techies with the everyday Joe or Jane during the product introduction period.  Once people get over the hump of having to learn something new, they often embrace it full-tilt, sending the techies off in a race to come up with the next major leap. Today, the pace has accelerated dramatically!

I was also fortunate to be exposed to Unix, which was created by two Bell Labs computer gurus, then given away to universities and others. Not only did we run small Unix programs (shells), but used this to store source code and the many iterations of changes, updates and fixes for all our systems’ programs.  Although this was the heyday of mainframe computing, Unix ran on mini computers which was really, in my view, the forerunner of the PC.  In fact, Microsoft borrowed a lot from Unix to come out with their personal computer operating system, DOS, making it understandable to me from the start and giving me a leg up on understanding personal computing technology. 

I know how antiquated this all sounds in today’s world of technology and nano technology, but we were at the cusp of massive changes that would take place in the industry.  Many people today look at pre-post Internet as a major sea-change, and it was. However, in the mid 1980s the shift to individuals having their own computer and running programs was also a major change. People could control their own data, their own technology and their own learning.

Well, we’ll find out soon enough. I am a co-founder of iBelong Networks, which has developed and supports the social networking platform that hosts the Amplifier Network. When Jonathon asked me to blog as a part of the entrepreneur section of Amplifier Network, I was very excited – not because I feel I have so much to share, but because I feel I have so much to learn. As this is my second startup, I consider this a masters degree program in entrepreneurship – and this forum will afford me the opportunity to sit down with some of the region’s most successful entrepreneurs, discuss lessons from their experiences, and determine how these lessons apply to my day-to-day hurdles in starting and running a technology business.

Over the course of the next few months, I will explore the topics that are top-of-mind to me and other entrepreneurs in starting, growing, and running a technology business. These topics include:

• Choosing the right business partner: This likely is one of the most important decisions an entrepreneur will make. Starting a new business has many ups, and many, many downs. And going through this experience with the right partner helps in making the right decisions, putting things in perspective, and providing motivation. In this blog, I will talk to established entrepreneurs to learn their process of choosing their business partners and the results – both the good and bad.
  
• Hiring top performers: As a small, rapidly growing business, sometimes it seems like we can’t hire fast enough. But it is my feeling that making the wrong hire is an even worse fate. In tight job markets, such as the Washington, DC area, hiring the right people can seem nearly impossible. I’ll be asking top entrepreneurs in the region to discuss their processes for hiring and retaining top talent. I’ll also ask them to share the repercussions they experienced when making the wrong hires.
  
• Optimizing the alignment of the sales and product development cycles: In a start-up, product-oriented company, it is critical to foster innovation and develop products that meet clients’ demands. And although much has changed between Web 1.0 and 2.0, particularly the dramatic decline in the cost of taking a product to market, most start-ups still invest heavily in their first round of product development prior to actually getting their first customers. But there are many paths to product development. By aligning the product development and sales cycles start-ups keep the need for funding down – you’re building what the client is willing to pay for. Of course, not all successful companies have taken this route to profitability, but I will be talking to other entrepreneurs about how they have managed this process and their point of view on taking product to market.
  
• Bootstrapping versus outside seed capital: Bootstrapping a start-up has many advantages and several disadvantages. The key advantages include encouraging the founders to develop a business model that includes revenue early in the life of the company; keeping the company focused on meeting immediate client demands; minimizing frivolous spending; and increasing valuations before seeking outside capital. The disadvantages include potentially starving the company; angering current customers due to inadequately-funded customer service; or taking too long to get product to market and losing market opportunity. Although there is no one right answer in choosing a funding path, I would like to learn from other entrepreneurs who have tackled the question of how to fund their start-ups and the ongoing costs.
  
• Finding the right funding partners: If you have decided to take outside capital, it is important to find the right funding partner. These days, the options include friends and family funding, organized angel groups and seed capital funds (such as Amplifier Ventures), and venture capital funds. There are advantages and disadvantages to each type of funding partner. Layered upon this are the unique characteristics of the specific funding partner. I will be exploring the stories and lessons from other entrepreneurs in how to choose the right funding path.
  

If you have any additional topics that we should explore or if you have experiences you would like to share I would like to hear from you. I’m looking forward to launching a great conversation with you over the next few months.

In the dance between entrepreneurs and venture investors, the subject of valuation provides more friction and difficulty than any other single factor.  Understanding some of the metrics that venture investors use for valuation, and the unspoken expectations that surround the discussion of valuation, is essential for any successful entrepreneur.  This is a complicated subject, but in hopes of providing at least some guidance for the interested entrepreneur, here are a few thoughts from the trenches.

Let’s start with the basics: valuation of a business for venture financing, while seemingly a complicated process, is actually understandable by taking on board a few rules.  The first one is that there is are “market standards” for venture capital terms and valuations.  Unfortunately, for entrepreneurs this market information largely exists in the experience base of venture investors, and is not really published in any single comprehensive source (compare for example, the closing prices of the NYSE, which are available in various places).  Investors see many deals at a time, and generally discuss potential deals with their colleagues, so a general sense of a company’s market value and the required corporate attributes to be a desirable venture investment is something that they have internalized (or at least think that they have internalized). 

Generally, venture investing is generally made on the basis of future growth and subsequent sale, rather than the cash flows currently generated by the business. Without going too much into the “whys” of this, suffice it to say that venture investing is about financing explosive growth companies, which generally consume more cash than they produce (that’s why they need equity financing).  So, if an investor is looking to value an explosive business, he really has to value an investment opportunity by looking at comparable companies – either on a current basis (what similar companies have been financed recently, and at what valuation metrics) or on an expectation basis (what valuation have similar businesses sold for after 5 years). 

The next thing to acknowledge is that when valuing a current business by looking at potential future exit values, venture investors need to apply some type of growth factor to determine whether a business opportunity is an attractive venture investment. For instance, an opportunity to invest in a company where comparable businesses have been sold five years later for twice as much as the investors put in will likely not be as attractive as one where the investors got ten times their money.  This concept of factoring growth is called the “discount rate” or “internal rate of return”.   The internal rate of return or discount rate applied by an investor will vary, but as a general matter, the riskier the perceived investment the higher the rate used.  In other words, a venture investor is going to expect a pretty large change in valuation of a business from investment to exit.

So we’ve given you a sense of the mechanism of valuation.  But, that’s just the beginning of where it gets tough.  Because the market is “imperfect” (an economic term that in this case means the VCs have a better handle on market prices than the entrepreneur), valuation on any deal is negotiated by the parties on an ad hoc basis.  You don’t go to a stock market to get venture capital you get it by asking an investor for it.  And, this introduces the most complicating factor of all: human behavior. 

Venture valuation is thereby framed with a number of truisms an entrepreneur should be very aware of:

• The entrepreneur is always going to value his business higher than the venture investor.  Why?  Because the venture investor is going to expect that every possible thing that could go wrong with a start up will, and the entrepreneur (even the most realistic) will have a greater sense of his likelihood of success.  In other words, the entrepreneur will always think his business is less risky.  And, since risk perception will affect the discount rate used by the venture investor in valuation a disconnect in agreement on risk will inevitably cause a disagreement on price.
  
• Supply and demand do affect valuation, but expressly trying to create an auction is something that venture investors don’t like.  Because venture investing is predicated on the belief that a constructive venture investor can help to create a successful company, venture investors are constantly looking for entrepreneurs that want to work with them.  In other words, if a venture investor believes that he is fungible with another, he will be concerned that he will not be able to influence the company.  That doesn’t mean that an entrepreneur shouldn’t seek to create demand for his company by talking with multiple investors, but understand that doing it baldly could create a bad dynamic.
  
• Although we will cover this in another entry (or many), venture capital terms (such as liquidation preferences, size of option pool and others) also can affect the true valuation of a deal.  For example, a valuation of $10 million dollars might seem more appealing to an entrepreneur than an $8 million valuation from another investor.  However, if the first deal has a liquidation preference of $6 million for the investors (i.e., the investors money first) and the second deal has a liquidation preference of $2 million, the second deal is actually a better valuation for the entrepreneur.
  
• An entrepreneur should surround himself with experienced help to level the playing field – service providers that do many venture deals, board members that have relevant experience, as two examples.  The point is that market participants that see many transactions can provide the entrepreneur with some sense of the “market” and provide a reasonable counterbalance to the VC’s market sense.
  
• An entrepreneur should have a sense of the valuation of his business before engaging with venture investors.  But, he should not generally make valuation a “drop dead” issue.  Ultimately, the valuation of a business occurs through negotiation and analysis. 
  
• Venture capital is not a zero sum game – the most successful venture investors and the entrepreneurs that work with them do not try to game each other.  That doesn’t mean that parties agree on everything, but they act in good faith towards each other and when negotiating and subsequently working together they seek to find results that allow all parties to benefit.

The most important unwritten rule of all is that venture investors want to work with entrepreneurs that have at least some understanding of the determination of valuation, and the expectations that surround it.  This is because investors want to back winners, and in their world, one of the largest indicators of future success is diligence and care.  Go into a discussion of valuation with an appreciation of what is really going on, and not only will you be more likely to obtain a venture investment, you are also much more likely to have a great relationship with your investor.