These days whenever I run into colleagues, friends or new acquaintances, the first question I’m typically asked is “What do you think of this economy?” Rather than lamenting the drumbeat of negative economic news splashed across the headlines, my response has become consistently the same: “Well, it’s tough out there, but companies that have the right value proposition are still managing to sell and hit or exceed their numbers.” Some might just chalk this up to classic, VC Pollyanna-ism, but it’s becoming clear as we move towards the end of the first quarter of 2009, that it is indeed true in the world of commercial software.

So what value proposition is resonating with business customers? Not surprisingly, it’s two things: cost cutting and compliance. IT departments will spend money on a product/service if it takes cost out. A payback period that meets the historical internal hurdle rate is not sufficient – the product/service needs to take cost out immediately. Or, in the case of a compliance driven sale, the company is required to make the purchase because of regulation such as PCI. Goldman Sachs released their most recent IT Spending Survey this week and one of their top level themes reinforced our observation: “Top priorities for spending include “cost reduction” and other strong ROI or compliance related spends.” We at Madrona heard this articulated clearly going back to last fall at a roundtable discussion of nine Seattle-area CIOs we hosted and, if anything, it has become more starkly true in Q1.

This brings me to the second question I have been consistently hearing after the one about the economy – “Are you still making investments and, if so, what spaces are you excited about?” The answer to the first part is “yes,” we are absolutely still actively investing, making 4 new investments in the last 6 months. As for the latter, one area of great interest to Madrona (and many VCs) is cloud computing. Although arguably the largest trend sweeping IT, the term “cloud computing” has undeniably become overused and overhyped. Many companies have tried to hitch their train to the wave of hype without having real products and real customers to back up the marketing buzz. The reality, however, is that cloud computing is catching on with small companies and enterprises alike in a very real way. Not surprisingly because, in the near term, cloud services can deliver the cost savings value proposition that is critical to selling in this economy. From a VC perspective, the cloud is appealing because of its long term potential for disrupting the way software is delivered to and within businesses (it has already done so for consumers). The trick for an investor like Madrona is to find companies that have the team, the technology and the product that are actually delivering on this, rather than just attaching themselves to the hype.

Clearly large players like Amazon, Google and Microsoft are making bets on cloud computing. But what are some tangible examples of emerging companies that are excelling by leveraging the cloud, differentiating themselves from the big players, and selling primarily around the theme of cost savings? One Madrona investment that clearly exemplifies this trend is Apptio, whose Saas IT cost optimization solutions provide the added visibility into costs, utilization, and operations of IT services that CIOs need to readily identify cost saving opportunities. Another great example is Skytap, who delivers 100% self-service provisioning of complex IT environments – you can think of it as a virtual data center in the cloud – for dynamic IT labs.

Skytap enables companies to take advantage of utility-based “pay only for what you use” pricing to test their applications in the cloud, demo their software to prospective customers, and/or provide remote training. This means that companies can use opex for what has traditionally required capex for on-premise infrastructure. They are differentiated not only with their platform, which enables existing applications to run unchanged on industry-standard platforms, but also by their SaaS virtual lab management solution which enables IT control of costs while allowing self-service access to virtual environments by end users. With this value proposition and a robust product born from technology spun out of the University of Washington, Skytap has managed to cut through the hype and get significant traction with paying customers from large enterprises to start-ups even in this challenging market climate.

Given all this, it’s not surprising that Madrona and Skytap’s other major investors, Ignition Partners and WRF, closed a new $7 million Series B investment in the company last week. Skytap is selling successfully in this down economy with a strong cost-savings value proposition. They are a leading player in a large, high potential space, have a compelling and differentiated product, and a great team that is executing on their vision. It’s this type of company that will thrive in this down market and precisely the type of company in which Madrona will continue to invest.

Getting the Right Driver on the Bus

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