For the last decade, I have been convinced that the three most important factors in determining the success of a start-up are (1) team, (2) product or service, and (3) market (timing, size, etc.). Take an A+ entrepreneur, with a great idea for a new product or service, at the right time, and about as fast than you can tweet Susan Boyle you’d have a success brewing.

Recently, I have added one factor to the must-have list: the right start-up culture. In other words, add a dose of bad culture to a team of superstars, a killer product and good market opportunity, the result is almost always death by a thousand backstabs.

What defines a great start-up culture? Justice Stewart’s “I know it when I see it” standard seems particularly apt here, but not actionable. I am hoping to start a dialogue about what a great start-up culture is and what it isn’t from those of you who are actually living it day-to-day. To kick off the debate, below is my best attempt at defining the characteristics of a great start-up culture. I was aiming for a top 10 but ended up with a bakers’ dozen (because in life it’s hard to beat a free bagel). How does your company’s culture stack up?

To read the list click over to Techflash.

In Good to Great, Jim Collins recommends that one of the first steps in building a great company is to get the right people on (and off) the “bus.” Not surprisingly, therefore, selecting the driver of the bus, the CEO, is certainly one of the most important tasks any board of directors undertakes. From the perspective of a venture capitalist working in the world of early stage companies, I have seen the huge, and often immediate difference the right leader can make. Now, I’m not talking about how to find great entrepreneurs who have started a company. While also a difficult process, this series of posts assumes we have already backed a good company, with great technology, but one that is in need of the right business leader.

Selecting the right CEO, however, is difficult, mostly un-scientific and often complicated because of personality and timing issues. Often, in very early stage companies, the “CEO” holds that title simply because he/she founded the company, and not because of any special qualifications or company-building experience. A few founders recognize that they don’t have the requisite skills to drive the bus, but many others figure that if they can drive stick shift in a sedan, how much harder can it be driving the bus? And that might be fine for a short drive at slow speeds, but as the company picks up speed, the probability of a major crash increases. So, many times, the first step in getting the right driver on the bus is convincing the current driver to step away from the wheel. It is often beneficial to have the founder remain involved with their company, just not always as CEO.

Timing is often a further complicating factor. Perhaps the current CEO has left unexpectedly (or been asked to leave immediately) or there is a financing that hinges on the recruitment of a new CEO. The board is under the gun, without the luxury of 6-9 months to do a thorough search for just the right candidate. Having had experience recruiting CEOs and knowing what qualities to look for can help make this challenging process more effective.

Several years ago Madrona surveyed our investment professionals, ranging from analysts just a few years out of college to veteran Fortune 500 CEO’s like Jerry Grinstein, Bill Ruckelshaus and Jack Creighton, who serve as our Strategic Directors.  We wanted to construct a profile to see if there was consensus on the relative importance of various personal attributes, skill sets.

The following graphs reflect the survey results (click on the graphs to see a magnified version).

Over a series of blog posts I will discuss the specifics of some of these attributes, what makes certain qualities more important in a CEO than others, and how, once you have determined what you are looking for, you know you have found it in the candidate. After all, what serious candidate is going to acknowledge that they lack good judgment? In the meantime, join in the dialogue by taking the survey and we will post the results and comments from the community.

Click Here to take survey

On the strategic front, companies should revisit the basic questions they answered when drafting their initial business plans, this time with the words “in this market” at the beginning:

·           In this market, who are our customers?

·           In this market, what is our value proposition?

·           In this market, what is our business model/how do we make money?

·           In this market, who are our competitors?

·           In this market, what is our competitive advantage?

·           In this market, how do we differentiate our product?

·           In this market, what are our core assets?

The answers to all of the above (and many more) questions may have shifted in the last three months. If your customers were small start-ups, you may need to adjust your focus to a customer base that has money to spend.

Are there certain companies that might find your value proposition more compelling because of the downturn? Should you refocus your value proposition and messaging around helping customers cut costs? If your business model was based on certain advertising CPM (cost per thousand impressions) rates, those may no longer apply. Your list of competitors may have shrunk or changed, so rethinking what you need (and don’t need) in your competitive feature set is now relevant. Is the next version of your product really what your existing customers want, or is it what potential customers wanted but no longer can afford to buy? Your existing customer base now may be your core asset, rather than your intellectual property.

To win, your strategy needs to be appropriate for the new market dynamics. Big companies cannot be as nimble as small ones, so smart entrepreneurs should be able to take advantage of thoughtful, but swift, changes in strategy.

Tactics are also critically important, but shouldn’t be confused with strategy. Cutting your burn rate is a tactic in a downturn, but it doesn’t lead to success unless the company also has the right strategy to go along with it. The companies that came roaring out of the last technology downturn not only had exceptional survival skills but, more important, they had a superior product focus and business model.

On the tactical front, the much-circulated VC presentation mentioned earlier pinpointed the major one: cost-cutting. Financing in this market will be much tougher, so increasing your runway is essential for survival. CEOs should scrutinize every expense item and try to renegotiate every contract. That said, cost-cutting is only one of many tactics that companies should consider. Tactical opportunities exist on the upside in this market as well.

·           Hiring. There will never be a better opportunity to upgrade the quality of your team. Start-ups that are well funded and well positioned should have the pick of the litter when it comes to new hires and upgrading talent. Employees may be more flexible on compensation packages than they were several months ago.

·           Marketing. Media always gets cheaper in a downturn, which presents a unique opportunity to acquire customers profitably. If the lifetime value of your customers has remained stable and now you are able to acquire customers for less than their lifetime value (through inexpensive media), you can make a killing in a difficult economy. Classmates.com is a wonderful case study. When the technology bubble burst in 2000, Classmates.com was able to buy Internet display inventory for a fraction of what it had cost earlier. The company knew what a customer was worth (more specifically, what a customer would pay for a subscription) and, therefore, how much it could spend to acquire that customer. The team at Classmates.com was maniacal about tracking conversion rates and focused on buying display media only if it met company goals for conversion. Does your business model enable you to take advantage of less-expensive media? Publishers with undifferentiated inventory should have an especially difficult time selling inventory. Look for screaming deals!

·           Tying Expenses to Performance. In a down market, you may have the opportunity to link your cost structure specifically to performance. Tying employee compensation to performance criteria is the obvious example. On the marketing side, as publishers lose leverage, they, too, are more willing to sign performance-based or CPA (cost per action) deals, instead of CPM deals. No publisher is going to announce it, but companies should be persistent in asking for it.

·           Pricing. Aggressive pricing can be an important weapon against weaker competitors who cannot match your prices or will eat into their cash balances if they do.

·           Mergers and Acquisitions. Even some attractive companies with strong IP or a large customer base will struggle to make it in this environment. Banks are not the only ones who will be looking for good M&A deals. As a buyer, some questions that you might ask include: Would an acquisition be relevant to your new strategic focus, or would it dilute your focus? How long will it take this acquisition to get to positive cash flow? Are you buying people, technology, revenue, or customers? How hard have you scrubbed the projections? How will you finance an acquisition in this market?

No doubt the current market presents added challenges, but it also offers new opportunities for those companies looking to do more than just survive. The companies that refocus their strategies in light of market realities and creatively consider the tactics they employ will be in the best position to win when the economy starts moving again.

Crystal-ball gazing (specially when combined with generalizations) is always a humbling exercise, and I am sure there are many others, but here are six things I think will be different and, for balance, six that I think will be the same:

Differences:

1. Early stage companies have stronger balance sheets and lower burn rates.  In contrast to the Dot Com Boom years leading up to the bust, most early stage companies that have taken venture funding have raised at least 12-18 months of anticipated cash, and haven’t  immediately take on venture debt to bulk up their cash hordes.  Similarly, companies have been more conservative in building headcount and marketing spend that isn’t ROI driven, so their monthly burn is lower.
2. There has been less valuation inflation in the last few years, so down rounds, if they come, will be less draconian.
3. Because there has been less of a sense of urgency in recent years to “get big or go home,” as companies go through the always painful process of reducing expenses, there will be fewer RIF events.  That said, one of the “lessons learned” from the last bust was that it is far better to do one, early, deep RIF, than a series of small ones, always hoping that it will be the last.
4. Venture capitalists are better positioned to fund follow-on rounds.  Venture capitalists have always “reserved” for portfolio company future needs, but during the boom, when companies were being acquired or going public literally within months of a round, and there was always someone else who was panting to lead the next round, venture capitalists significantly underestimated the timing and extent to which their companies would need fresh capital.  Many simply didn’t have any more resources at their disposal.
5. Fewer early stage companies have been funded that don’t have a clear business model.  I say “fewer” because there are still a number who have substituted “unique visitors” as a proxy for revenues. It drives me crazy when I hear a presentation where the CEO says “we haven’t been focusing on revenues to this point, but you can see how powerful this model is,” or words to that effect.  This is just a less virulent strain of the “eyeball-itis” that struck in the laste 90’s.
6. This downturn is likely to be deeper and more prolonged than the last one.  This looks like a Category 5 hurricane bearing down on us (maybe they always look worse when you are in the moment).  We have the lessons learned from the last downturn to help us weather the storm, but it would be best not to underestimate its severity.

Similarities:

1. Companies, large and small, (and, this time, consumers) will dramatically curtail “discretionary” spending, especially with early stage companies.  We went through an era when customer IT budgets plummeted (”we are only going to fund our top three IT initiatives this year, so don’t even talk to us if your product/service isn’t on the list”), and companies didn’t want to buy from early stage companies (”how do we know you guys will be around a year from now?”).  As they cut back, companies will become even more ROI driven (higher hurdle rates, shorter payback time periods).  This is good news for early stage companies that can demonstrate clear ROI advantages.
2. Weaker companies will lose some great talent, and stronger companies will be the beneficiaries.  This will redound to the benefit of the Microsofts and Googles of the world, but early stage companies with  strong balance sheets and solid business models will get more than their fair share.
3. Venture capitalists will tend to husband their resources (both capital and human) to support their existing portfolio companies, and will be reluctant to invest in “someone else’s deal.”  There was a period following the last bust when virtually all follow-on rounds were “inside” rounds (existing investors), because no one wanted to take on someone else’s problems.  That will be true to some extent this time around as well, but there were some notable missed opportunties to become a new investor in a follow on round from that era that will cause venture capitalists (including Madrona) to keep an open mind.
4. Some great companies will be formed during this period.  We certainly saw that in the years following the last bust, and it will be true this time around as well.  In fact, in many ways this is a great time to be starting a company (ok, maybe I should say in “some” ways).  Companies at the very earliest stage almost always have very low burn rates and have not budgeted meaningful revenues in the next 12-24 months, so they 1) aren’t desperately trying to achieve what may now be an unrealistic sales target and 2) it is much easier to control your expenses than your top line. 
5. Venture lenders will move aggressively to protect their collateral.  One of the important (maybe most important) underlying assumptions of banks that lend to early stage companies (ie. those that are not cash flow positive) is that the venture capitalists will continue to fund the companies that have taken down the debt.  When it didn’t happen during the last downturn, venture lenders quickly moved in (or, more accurately, quickly moved out the cash), to protect their interests.  Most, but not all, debt agreements of this type entitle the lender to “sweep” the cash (whether it is in their bank or you have put it in another bank) under certain circumstances (usually fairly vague), and as economic circumstances become more difficult and cash balances (the best form of collateral) decline, expect to hear about some unpleasant suprises.
6. Many companies with weak business models (or weak teams) will go out of business or be sold for peanuts.  That’s no different from any other time, but the pace will  accelerate.