So you got to let me know
Should I stay or should I go?
—The Clash

To lead you to an overwhelming question….
Oh, do not ask, “What is it?”
Let us go and make our visit.
—T.S. Eliot, The Love Song of J. Alfred Prufrock

Taking the exit

On July 23, 2007, HP announced it was buying Opsware for $1.6 billion in cash. By any measure, it was a very attractive deal for Opsware shareholders. The acquisition price of $14.25 a share represented a 74% premium over the prior six-month average, and a forty-fold return for anyone who had bet on us at our low point in October 2002, when only an intensive investor relations effort had saved us from NASDAQ delisting. Almost five years later, the acquisition multiple of almost 16 times trailing revenue still far exceeds that of any other billion dollar-plus enterprise software acquisition—ever.

The hard work of hundreds of employees contributed to making us the clear high-growth market leader in what was finally an important enterprise software category, but the significant premium we achieved was also the result of a multi-year, strategic business development effort designed to turn a merely good outcome into a truly exceptional one. That business development effort was built around five key principles that you, too, should consider as you build your company:

  1. Always know where the exits are: Take the time to build relationships with potential acquirers. You never know when you may need them.
  2. Step back from the fray occasionally: Review the company’s strategic situation with the board every 12-18 months and evaluate the alternatives with quantitative and qualitative rigor.
  3. In evaluating your alternatives, ask yourself how you would feel if the environment were to change radically: Days before we signed the HP deal, the Dow hit 14,087—its highest level ever. Within months, hedge funds and mortgage companies started imploding and we entered the worst recession since the great depression. Just three months later, a sale at even $8/share would not likely have been achievable.
  4. If you do decide to sell, a meticulously executed competitive process is key to a successful M&A outcome: This SEC proxy statement description of Opsware’s process details discussions with 10 companies, stretching over nine pages. Every one of those contacts was tightly scripted and carefully orchestrated to drive to the ultimate successful outcome.
  5. Creating and managing the acquirer’s psychology is critical: The key is subtly to convince the acquirer that they have no option but to acquire you, but that you have multiple attractive alternatives—and to reinforce that impression in every interaction, no matter how small, until the deal is definitively done.

“Your best exit may be behind you”

As I’ve discussed in previous posts, the best CEOs leverage strategic BD to cover critical flanks not well covered by other functions—helping to navigate crises, driving acquisitions and strategic partnerships, leading international expansion. No great entrepreneur sets out to build a company to be acquired, but as the company grows, it’s important to have options and to understand them well. Perhaps the most important role of a strategic BD exec is proactively to make sure the company always has options and that the CEO and board always know where the exits are. They tell you on an airplane that “your best exit may be behind you”, but that’s not something you ever want to hear in business.

Stepping back from the fray: November 2005

At Opsware, 90% of our board discussions were naturally about the day-by-day work of building a great company: quarterly bookings, wins and losses, product plans and challenges, financials and so on. However, about once a year we would make a point of stepping back from the daily battle for a more strategic review of our situation. As part of this review, we would address more fundamental questions.  For example:

  • How do we feel about our market?
  • How is our competitive position?
  • Who are potential acquirers of the company, and what’s their current state of mind?
  • What are the major opportunities and risks facing us?
  • Bottom line: What’s the likely value of staying the course versus exiting?

Prior to these board discussions, we would make a round of senior visits to HP, BMC, Oracle, EMC and other behemoths to give them an update on the business.  While our ostensible purpose was to explore the potential for a partnership, our real objective was to understand (and pique) their interest in our space and to make sure we’d have an open door if we should ever decide to explore selling.

I’ve linked our board presentation from November 2005 here. As you can see, it’s a pretty thorough analysis. Here’s the executive summary:

In other words, let’s keep marching!

Stepping back from the fray: February 2007

In early 2007, Marc Andreessen, Ben Horowitz and I made another set of visits to the usual suspects in preparation for a new strategic review with the board. We had made major progress since we had seen them last: exceeded $100M in annual revenue, fired up a productive distribution deal with Cisco, added storage automation, expanded internationally. As before, we went through a pretty slide deck that showed a winning company in a strategic category, with a final slide that mused vaguely about partnership. Left hanging in the air at the end of some of the meetings, we could sense the “overwhelming question” in the mind of the big company CEO: “Should we buy these guys before someone else does?” Several of them requested follow-up meetings.

For us, too, the possibility of actually selling the company was of more than theoretical interest this time around. Meeting Wall Street’s expectations was still a challenge every quarter. Our one serious competitor, BladeLogic, was about to go public. Despite five years of strong execution, our own stock price seemed stuck in a narrow band around $8/share due to continued heavy investment in R&D and sales expansion. Strategically, we were now at a critical juncture: Invest even more heavily in new capabilities like monitoring and enhanced support for virtualization—or capitalize on our current position and the strong interest from acquirers. That exit looked pretty tempting.

That said, selling for a typical enterprise M&A premium of 25-30% didn’t feel compelling to us or the board. We hadn’t escaped the jaws of death and worked this hard, for this long, to build a great company, only to sell it for 10 bucks a share. We were resolved: The only way we’d consider selling was for a price much higher than what we felt we could achieve in the standalone case.

Here’s the recommendation from our February 2007 board update:

That led us into a dramatic three-month dance with a series of suitors that would test our negotiating and business skills, as well as our resolve.

Next up: The dance begins

SUNNYVALE, Calif., June 2, 2003
HP and Opsware Inc. Join Forces to Deliver Enhanced Automation for HP’s Utility Data Center

SUNNYVALE, Calif., Feb. 13, 2006
Opsware Announces Worldwide Distribution Agreement with Cisco

These two headlines sound pretty similar—“Small company partners with giant company to reach a bigger market”—but they led to two very different outcomes.  Our 2003 deal with HP didn’t generate a single dollar in revenue, whereas our 2006 agreement with Cisco drove tens of millions of dollars in sales and helped to make Opsware the uncatchable leader in data center software.  Why did one succeed spectacularly while the other never took off?

As a startup with the best product, your challenge is often getting it in front of enough customers and getting them to buy.  In theory, striking a deal to have an HP or an EMC or a Vodafone sell your product to their customers is the way to cover the market and exponentially increase sales velocity.  In practice, however, most “David-Goliath” distribution deals turn out like our 2003 HP deal: great PR, but not much else.  Here’s the way it typically plays out:

  • The deal is announced with great fanfare and high internal and external expectations.
  • Goliath needs product changes, training and lots of help to even attempt to sell your product.
  • Goliath deluges your already overloaded people with feature and support requests.
  • You can’t justify assigning dedicated people to support Goliath because you can’t bank on any new revenue.
  • Goliath sells nothing, or even worse, ends up competing against your sales team for customers you would have won directly at a higher margin.
  • The “partnership” quietly withers away, leaving a damaged relationship with Goliath and a bad taste inside the company.

The temptation for some startups is try to “make it up in volume”—sign as many distribution partners as possible on the basis that none of them is likely to deliver much on their own.  While that degree of over-coverage might feel temporarily reassuring, it only multiplies the challenges exponentially in practice.  The only thing worse than having no partners is trying to manage multiple ineffective partners competing with each other in the market and drowning the company with their demands.

In my experience, one well-constructed, high-impact partnership is better than a hundred run-of-the-mill arrangements.  Distribution partnerships take an enormous effort to make work.  It’s just not realistic to have many of them, which is why picking the right one and constructing it intelligently is fundamental.  At Opsware, we only had one significant distribution relationship over eight years, but it had a massively positive impact on the company.

Time to find a partner

It was early 2005, and things were starting to go pretty well for three-year-old Opsware.  We had just closed our $33 million acquisition of Rendition Networks, giving us a lightweight but powerful network automation software product that we christened Opsware NAS (Network Automation System). NAS would allow us to penetrate and rapidly deliver value to new accounts, then upsell them to our considerably heavier and more expensive Server Automation System.  (Our average NAS deal size was $115k, took a month to sell and a couple of weeks to deploy, whereas SAS deals averaged $765k and could take a year to sell and six to twelve months to deploy.)

It made sense to market and sell NAS as aggressively as possible—but we faced a challenge:  Our direct sales force was small, only covered US and UK, and had few relationships with network buyers.  We needed a big partner with the buyer relationships and global coverage we lacked.

The right partner

The right partner was obvious:  Cisco.  So was the product: NAS.

Thanks to our investment in strategic BD (see Part I and Part II of this series), we’d been calling on Cisco since the founding of Opsware, from the C-suite to mid-level data center managers.  Now we finally had something to talk about.  For all its pre-eminence in router and switch hardware, we knew from customers that Cisco’s management software capability was weak for its own devices and non-existent for, say, Juniper devices in the customer’s network.  We had the market-leading, cross-platform product.  Within days of closing the acquisition, we visited the Cisco SVP responsible for management software and offered him the solution his customers were demanding.

Mission clarity

Before you can construct a high-impact deal, you have to be crystal-clear on what you want to achieve.  We spent a substantial amount of time up front to achieve internal clarity and consensus across the company on what we wanted from a partnership.  These were our main objectives:

  • A real commitment by Cisco to market and sell a lot of NAS product, at an attractive margin to us.
  • Opsware’s right to target every Cisco NAS customer for an Opsware SAS sale.
  • Opsware branding on the Cisco NAS product.
  • Minimal product changes and a single code base.
  • Enough assurance of financial potential to allow us to invest in the support Cisco would need to succeed.

In a seemingly endless series of meetings in Cisco’s blue-gray conference rooms over the spring and summer, we gained a good understanding of Cisco’s main objectives.  They wanted:

  • The ability to sell NAS to any Cisco account, with active support, not competition, from Opsware.
  • Cisco-branded product.
  • Freedom to sell at any price they chose, including throwing in the NAS software free as part of a big equipment sale.
  • “Insurance” against a surprise acquisition of Opsware by a competitor.
  • Access to Opsware NAS source code, and even the ability to make derivative works.   (As you might imagine, this one caused us a lot of heartburn.)

All through the fall and early winter, we shuttled back and forth between Tasman Drive and Opsware’s office on Mathilda Avenue, alternately negotiating a deal structure with the Cisco software team and updating and strategizing with our sales and product organizations to make sure we were staying true to our objectives.  Some issues, like source code, were extremely complex.  Nonetheless, like a figure emerging from the fog, a compelling deal gradually took shape.

On February 13, 2006, a year after closing the Rendition acquisition, we announced a worldwide distribution agreement with Cisco.  Cisco’s enterprise sales force would sell our NAS product, rechristened Cisco Network Compliance Manager, to their worldwide customer base.  Opsware’s sales force would follow their Cisco counterparts, supporting their efforts to sell the network product and in the process building the relationships and laying the groundwork for a subsequent million-dollar-plus server software sale.

Behind the headlines – a deal with teeth

While the press and public endorsement by Cisco were valuable, what made this partnership work unusually well in practice was a smart deal structure designed to achieve both sides’ objectives:

Minimum revenue commitment:  It took us almost nine months, but we persuaded Cisco to make a binding three-year quarterly revenue guarantee that totaled almost as much as we had paid to acquire Rendition.  We helped our Cisco counterparts to understand that this would be a win-win:  Guaranteeing several million dollars a quarter to Opsware would give Cisco huge motivation to drive sales.  In turn, it would give us the assurance we needed to back off our own NAS sales efforts and do everything—including assigning some dedicated sales and product headcount—to make our partner successful.

Substantial revenue share: We secured a revenue share and pricing floors that made a Cisco NAS sale almost as financially attractive to us as if we had sold it directly—because Cisco could actually charge more for the software than we could.

Co-branding:  The product was marketed as Cisco Network Compliance Manager, “built on Opsware automation technology”.

Channel-neutral compensation:  To motivate Opsware’s sales people to support their Cisco sales counterparts instead of competing with them, we compensated them for every Cisco sale in their territory.  While this cost us real money, it made sense because every Cisco sale opened the door for us to sell a much bigger, higher-margin product.

Acquisition insurance:  We committed to give Cisco advance notification of any agreement to sell the company, and the opportunity to enter the bidding if they wanted to.  (Note this is very different from a Right of First Refusal.)

Source code license:  We gave Cisco a three-year license to view our source code and build on it, but came up with an innovative licensing approach that protected us fully and even generated millions in additional revenue.  In any case, we bet they would never actually do anything with the code, and we were right.

Goliath delivers…

Within nine months, Cisco was selling large network software deals into accounts like DHL, Costco, Sprint, USPS and Telstra, and a short time later, they were selling enough to exceed the quarterly minimum revenue guarantee to Opsware.  The Cisco deal would go on to generate over 25% of our bookings.  Cisco’s massive distribution power vaporized our NAS competitors.  Just as important, every NAS sale opened the door for our SAS product in accounts we had never penetrated before, providing a major thrust to our high-margin server business.

Seen in a Cisco corridor

with a little help from his friend.

Of course, there were many challenges along the way.  Cisco people needed lots of training and support to sell the product.  There were occasional conflicts over accounts that had to be arbitrated.  We ran a separate weekly pipeline call with Cisco to track and drive their sales and direct our follow-on server sales calls.  Product change and bug fix requests from Cisco had to be triaged and folded into our roadmap.

However, we were able to handle these demands with equanimity, because we had a couple of dedicated heads in sales and product management to handle them, and a large guaranteed revenue stream that helped the whole company to realize this was a deal worth supporting.

In summary

Like Opsware’s 2003 HP deal, the vast majority of David-Goliath type distribution deals don’t deliver beyond PR[1].

On the other hand, like Opsware’s Cisco deal, the right distribution deal with the right partner can be truly transformative.  In formulating your partner strategy, consider four golden rules:

  1. Quality trumps quantity:  One well-constructed partnership will have far more impact, and be far more supportable, than lots of toothless arrangements.
  2. Mission clarity:  Invest the time up front to get crystal-clear on your objectives and those of your partner.
  3. Demand hard commitments:  Big companies are easily distracted.  Binding commitments focus the mind and create incentive to deliver long after the deal is signed.  (Note this means finding a senior executive sponsor with the authority to commit.)
  4. Make hard commitments in return:  You will need to invest substantially in making your partner successful.  Commitments like sales and product support and channel-neutral compensation are worth making in return for the right commitment from your partner.

Only a few startups invest in the ongoing BD effort to systematically cover the landscape of potential partners and create that game-changing partnership when the opportunity presents itself.  For Opsware, that investment paid off three years after our start as a software company.  Like the Loudcloud-EDS deal and the M&A campaign that followed, the Cisco partnership provides another example of the power of strategic business development. 




[1] Note that our objective (and HP’s) for the HP deal was in fact PR, so it met its objective.  It may well make sense to announce lots of lightweight “partnerships” to demonstrate integration and gain market credibility—just don’t expect them to generate revenue, and make sure the company understands that too.

In part I, I talked about how up-front investment in a high-caliber strategic business development function helped to save Loudcloud when an existential crisis hit in 2002.  But the value of strategic business development didn’t end there.  In fact, it was only beginning.

Opsware V1: Single product, single customer

The EDS transaction closed in mid-August, and we started into the fourth quarter of 2002 in much better shape than we’d entered the first quarter.  That said, we still had plenty of challenges.  We were a single-customer, single-product company.  Moreover, the product—software that automated the administration of servers—was powerful but far from ready for broad commercial adoption.  It had been developed solely for internal use by skilled (and somewhat forgiving) Loudcloud system administrators in a controlled environment.  It was difficult to sell and hard to implement, requiring significant process change on the part of the customer’s IT staff.  It wasn’t easily consumable in small chunks, leading to protracted sales cycles and long implementation periods.

Of course, we had 60 great engineers and plenty of cash, and they lost no time starting the work needed to make the software easier for our small but talented sales team to sell.  While they did that, the BD team led the development of what would become a selective but highly productive M&A strategy to turn Opsware into a broad data center automation platform.

Kicking off the M&A strategy

Working closely with the product and sales teams to understand needs and build consensus, we started identifying and prioritizing categories adjacent to our core server automation category and tracking the key players in each.  Together, we developed a set of criteria for acquisitions, including technical factors such as architectural compatibility and APIs as well as non-technical factors like location, team size, culture and financial profile.  As a general theme, we wanted products that fit with our core proposition of data center automation and were compatible with our server product, but were easier to sell and implement, opening the customer’s door for a subsequent server automation sale.  We briefed the board repeatedly to prepare them for specific acquisition proposals to come.  Thus armed for battle, we set forth.

Going into battle

Any good strategy allows for opportunism and, as it turned out, our first acquisition was highly opportunistic and somewhat unusual.  Tangram was a 20-year-old company, publicly-traded on the OTC “pink sheets” exchange, with a market cap of about $10 million.  Their product was IT asset management software, and while their revenues were growing slowly, their 200 enterprise customers were very satisfied with the product.  We seized the moment and picked up $10 million in annual revenue for stock valued at less than $10 million—a bargain.  The deal brought us a complementary, consumable product, 200 new prospects for server automation software and a low-cost base in Cary, North Carolina, that soon became our “offshore” location for support and sustaining engineering.  In short, a good start to our M&A plans, just four months into our new life as a software company.

Our next acquisition, a year later, was much more strategic.  Our customers were beginning to like our server automation product and wanted to know if we could solve their next pain-point: automating the configuration of network devices such as routers and switches.  We identified the four leading players in network configuration management, visited and screened them all, and ran a competitive process to get them competing to sell to us.  (It’s always better to have them trying to convince you to buy than for you to be trying to convince them to sell.)  We got the one we wanted, Rendition Networks, for a combination of cash and stock valued at around $33 million.  In addition to 30 new enterprise customers and a strong engineering team in Redmond, Washington, we would now have an attractive starter product and a combined server-network automation offering that put us further ahead of our only credible single-product competitor, Bladelogic.  Within a year, Opsware Network Automation was generating over 20% of our bookings.  Even better, the Rendition purchase positioned us for a major OEM deal that would further accelerate Opsware’s breakout lead.  I’ll talk about that in the next post.

With servers, network devices and asset management in the bag, storage was the missing piece of the puzzle.  That proved to be harder—there were few storage automation startups to begin with and none that looked like a great fit.  We ultimately did acquire a small startup named Creekpath Systems in 2006 for $10 million in cash, closing their small Colorado HQ and moving a few team members to Redmond.  Unlike our other acquisitions, storage automation proved just as hard to integrate and commercialize as it was to find an acquisition target, and this was the least successful of our purchases.  Notwithstanding that, we now had a unique full data center automation story: servers, network and storage.

Our fourth and final acquisition was in an emerging category called Runbook Automation.  Having automated individual functions such as server provisioning or router configuration, our customers now wanted to automate entire IT workflows across servers, networking and storage, integrating with other systems such as monitoring or ticketing.  Here there were just two viable targets: RealOps in Herndon, Virginia, and iConclude in Bellevue, Washington.  We knew we wanted iConclude, but again a competitive process of negotiating with both companies helped to drive a speedy transaction at a fair price of $54 million in cash and stock in March 2007.  (iConclude’s founder and CEO, Sunny Gupta, now runs Apptio, an Andreessen Horowitz portfolio company).

Although we only made four acquisitions in five years, spending less than $100 million in cash and stock, the M&A strategy played a vital role in transforming Opsware from a single-product player, solely dependent on one giant customer, to a full-suite data center automation market leader with hundreds of enterprise customers.  The acquisitions positioned the company for a major strategic partnership with a technology giant in 2006 and a billion-and-a-half dollar sale to another a year later.

Who you gonna call?

Just like the Loudcloud sale to EDS, Opsware’s M&A strategy relied on many essential ingredients and actors: an aggressive but disciplined management team, outstanding engineering, marketing, sales, legal and finance functions, an acquisition currency and a supportive board.  Again, however, a small effective business development team was there to leverage these assets and drive the process to achieve results while the rest of the company continued to fire on all cylinders.  While we acquired four companies, we evaluated hundreds and gained massive industry insights in the process.

What’s your M&A strategy?  Who’s driving it?

Next up: Strategic Distribution

This series of posts starts off with a short quiz for the startup CEO:

Q: Who’s responsible for developing your product?
A: That’s easy—Engineering!

Q: Who in your company is responsible for selling your product?
A: That’s easy, too—Sales!

Q: Who in your company has primary responsibility for:

  • Mapping and networking your ecosystem?
  • Building long-term relationships and driving deals with strategic partners?
  • Identifying, evaluating and executing acquisitions?
  • Developing and executing your strategy to go global?
  • Working with you to tackle major strategic opportunities, including existential crises?

A: In many startups, the answer to this one is, “That’s no one’s job yet.”  What’s your answer?

Seizing the transformational opportunity

Given the all-consuming nature of a startup, it’s natural to be focused on your own company first, then on customers and competitors.  What’s often under-appreciated is the importance of expanding that focus to cover the other large and small companies around you.

Over the lifetime of any company, there is a handful of potential deals that could dramatically transform the outcome:

  • It could be a high-impact distribution relationship, like Zynga’s company-making relationship with Facebook.
  • It could be a transformational acquisition, like BEA’s home-run 1998 purchase of Weblogic.
  • It could be a deal that saves you in an existential crisis, like the Loudcloud-EDS deal I’ll describe below.
  • Ultimately, it could be a billion-and-a-half dollar exit, like the Opsware sale to HP that I’ll describe in a later post.

Although every company theoretically has access to transformational opportunities, few actually manage to identify them, let alone seize them.  What distinguishes the winners from everyone else is that they are systematically networked into all of the surrounding companies that matter, so they can identify and seize the transformational opportunity when the time comes.

It’s not Sales

Strategic business development is an investment in systematically mapping and networking your ecosystem to drive transformational opportunities.  Although the CEO will be heavily involved at times, it’s not primarily the CEO’s role.  Nor should strategic BD be confused with Sales.  Although very complementary to Sales, it’s also very different in that it doesn’t follow a quarterly cadence.  It’s focused on a very few high-impact events a year rather than a large volume of quarterly transactions, so it should have separate goals and incentives from those of Sales.  Strategic BD should be low headcount and high impact, led by a senior professional operating at a peer level to Sales, Engineering and other company functions.

Strategic BD in action – Loudcloud/Opsware

At Opsware and its predecessor Loudcloud, strategic business development played a critical role in virtually every phase of the company, generating over $140M in direct revenue and contributing fundamentally to the survival and ultimate success of the company.  In this series, I’ll use four examples from 2002 to 2007 to illustrate the unique high-impact role a small professional business development function can play.  In closing, I’ll talk about the characteristics of the function and selecting a person to lead it.

Example 1: Tackling the existential crisis[1]

It was the spring of 2002, a miserable time to be a startup cloud computing company, or managed service provider as we were known back then.  The Nasdaq had peaked at 5,048 in March 2000, collapsed to 2,200 by the time of Loudcloud’s nail-biting IPO a year later, and slid even further following the 9/11 attacks, floundering around 1,800 by March 2002.  In the year since the IPO, the dotcoms who represented half of our customer base had been dropping like flies as the bust took hold.  Our blue-chip enterprise customers and prospects, although highly satisfied with our service, were becoming increasingly skittish about relying on a small Silicon Valley startup for their mission-critical web operations.  After all, much larger, supposedly safe companies like Worldcom and Exodus were turning out to be highly vulnerable to the downturn.  For Loudcloud, “winning” the technical sale only to have the contract vetoed as too risky by the prospect’s CFO was becoming an ever more frequent occurrence.  With revenues and bookings slowing and ongoing heavy costs for data centers, bandwidth, hardware and staff, we were hemorrhaging cash.  After a year of layoffs and draconian renegotiations of our obligations, things were looking grim, but we kept our heads down and soldiered on.

Then came a killer blow.  Our largest customer, a transatlantic foreign exchange trading venture paying us over $1 million a month, suddenly informed us they were shutting down, blowing a gaping 20+% hole in our 2002 revenue.  Marc, our chairman, and Ben, our CEO, interrupted my St. Patrick’s Day family dinner with an urgent summons to meet at Marc’s house.  We had a crisis on our hands and we were going to go bankrupt within months if we didn’t pull a rabbit out of the hat.

We quickly eliminated all of the obvious options:

  1. Replace the revenue?  Impossible in that economic climate.
  2. Cut costs further to reduce our burn?  We had nothing left to cut.
  3. Raise more money?  The capital markets were slammed shut.
  4. Sell the company?  Maybe we could find an acquirer to cover our liabilities, but we wouldn’t return anything to shareholders—and what a tragic waste of talent, time and money!
  5. Shut down?  Perhaps we’d have no choice in the end, but it would be even worse than #4.

As we discussed the sale option, I brought up the business development conversations we’d been having with a number of major IT outsourcers over the past year.  We knew IBM, EDS, Cable & Wireless/Exodus and others were keen to offer advanced managed services to their customers.  They kept losing deals to Loudcloud’s massively superior offering, which was powered by an advanced software automation platform and a super-talented team.  I had been exploring deals with these companies to resell our service, but several thorny issues made the conversations slow going.  Would we end up competing with each other for the same customers with the same product?  How should their offering be branded?  How could we apportion the service level agreement obligations between us?  Could we find enough margin to go around? And so on…

Perhaps inspired by Jameson and Guinness, we asked ourselves an out-of-the-box question: What if there were a way to sell the company without selling the company?  We knew we’d built something important, and we didn’t want to give up, but it was clear this business model wasn’t sustainable.  And so a germ of a deal crystallized in our minds:  Could we convince one of the big outsourcers to buy the managed services business while we kept the software and restarted as a software company?  It was a crazy idea—the managed services business was our entire revenue stream and customer base and was massively unprofitable; the entire IT industry was in massive retrenchment; our software had never been intended for commercial licensing.  But desperate times call for desperate measures, and so the three of us parted that evening with an agreement to give it a try.

In the days and weeks that followed, we crafted and executed a process designed to rouse three conservative, slow-moving corporate giants to action in time to rescue our heroic but beleaguered enterprise.  In a story to be told at another time, we employed the key ingredients of competition, scarcity and unrealistic deadlines to galvanize senior executives at IBM, EDS and Cable & Wireless to drop what they were doing and engage.

Exactly three months later, on June 17, 2002, we announced a deal for EDS to acquire the Loudcloud business—with 50 customers, 140 employees and 100% of our revenues—for $63.5 million in cash.  In addition, EDS agreed to license our automation software, Opsware, to automate their tens of thousands of servers in hundreds of data centers, for a series of quarterly payments totaling $52 million over three years.  We kept 100 employees, changed our ticker symbol from LDCL to OPSW, and started anew as an enterprise software company with no debt, $65 million in cash, a guaranteed $20 million a year in revenue, and one hugely credible customer.  We had sold the business without selling the business.  Within a year, almost all of Loudcloud’s competitors went bankrupt or sold for a few cents on the dollar.

How did we achieve this improbable outcome?  Certainly, we couldn’t have done it without some exceptional advantages, including:

  • Brilliant and committed founders.
  • An industry-leading product, stellar team, reference-able customers, strong brand.
  • A significant dose of luck, including a visionary EDS executive, Jeff Kelly, who was willing to bet on us.

What enabled us to leverage these advantages to save the company in three months was a decision Marc and Ben had made years earlier: to invest in a strategic business development capability.  By the time we needed to engage IBM, EDS and C&W in an urgent dialogue, the Loudcloud BD team had already been engaged in exploratory discussions with them for over a year.  As a result, we knew the executives to target, what their hot-buttons were, the sales deals they’d lost to Loudcloud and what their competitive position was.  Just as important, they knew Loudcloud because we had educated them and their staffs.  If they hadn’t been primed for the discussion, it could have taken six months just to find the right executive and start the conversation—time we didn’t have.

Getting a deal done in three months required a meticulously crafted and executed process, running 24 hours a day at times and involving a few key Loudcloud managers operating in an absolute cone of silence.  We had to turn zero negotiating leverage and big company inertia into high leverage and real urgency.  Each of us had our role.  Every conversation anyone had with the potential acquirers had to be scripted to send the right messages and add to the picture we were creating.  We needed to keep up the competitive pressure.  We needed to share new developments between us rapidly and strategize the next steps in the process at every turn.  We needed to model potential scenarios, craft proposals and counter-proposals, support clandestine diligence and keep the board updated.  All of this while the company continued to try to win sales, serve demanding customers, meet SLAs and manage increasingly unhappy investors.

The process was driven by the business development function.  While the sales guys stayed focused on selling and the engineers on engineering, the BD guys worked on orchestrating and executing the deal.  Ben, Marc and co-founder/CTO Tim Howes (now co-founder and CTO of RockMelt, an Andreessen Horowitz portfolio company) played absolutely critical roles, which they were able to do effectively because they had people running the process who knew the company intimately and whom they trusted implicitly.

Who you gonna call?

When they started the company in late 1999, Loudcloud’s founders could not have imagined the existential crisis they would face less than three years later.  Their decision to invest up-front in strategic business development enabled them to leverage the firm’s unique assets and execute a company-saving transaction when the crisis hit.

Who will you turn to when you face your existential crisis?

Next up: Strategic M&A

[1] My partner, Opsware co-founder and CEO Ben Horowitz, has eloquently chronicled the Loudcloud story in “The Case for The Fat Startup” – appropriately dated March 17, 2010 (St. Patrick’s Day).

This is the final installment in a five-part series on building a global company from the ground up.

Summing it all up

We’ve covered quite a bit of ground together since I started this series.  Here’s the executive summary:

  1. There are simple steps you should take to lay the groundwork for international expansion from the moment you start your company.
  2. Before you launch internationally, you should have an explicit, well-articulated strategy.
  3. You should assign a qualified executive to develop the international strategy and drive its execution, and involve the rest of the company in the process to gain their emotional commitment.
  4. A headcount plan and budget that cover both the “visible” and “invisible” requirements will set the business up for initial and lasting success.

Some closing thoughts

In closing, a few reminders as well as suggestions that have worked well for me:

  • As the CEO, look for ways to make it clear to the company that going international is a critical priority for you personally.
  • Involvement builds commitment.  Take the time to get buy-in from your managers and their teams, who are probably already overloaded.  Involve them thoroughly in developing the international strategy, and make sure they get the resources required to support it.  Make it their plan, not somebody else’s plan!
  • Assign a small support team to represent the international operations at HQ and to make sure they get their needs met quickly and efficiently.
  • Enlist one respected manager from each company function for a cross-company oversight team, to drive execution and run interference with the relevant departments as issues come up.  The best people for this are usually not the most senior execs, but director-level thought-leaders who have the respect of their organizations.  They will be honored to be chosen.
  • Remember to treat international as a startup:
    • Be realistic in setting schedules and milestones—it will take longer than you think.
    • Be prepared to live with a startup financial profile—likely several years of losses before turning the corner into profitability.
    • Report on the international business separately from the domestic business.  It should be following a similar (or steeper) growth profile, but several years behind.
    • Be ready for exceptions to corporate policies—compensation for top overseas hires will be a prime example!
    • Make sure everyone’s performance objectives and incentives encourage support for a successful global rollout—performance reviews, 360 feedback, compensation for all key functions should include specific criteria.
    • Challenge your management team to ensure company policies and processes aren’t purely US-centric.  A small example:  all-hands meeting times that don’t require overseas employees to dial in at 3am.
    • When you make your first overseas hires, give them a month at HQ before turning them loose in market.  They need time to soak up the culture, value proposition, products and so on, as well as developing personal relationships with key HQ people they’re going to be working with remotely for years.
    • Send out regular updates on international progress—emails, blog posts, all-hands updates.  One company I’m involved with, Shoedazzle, has set up a live webcam feed between their California HQ and their new London office, so the teams can see each other as they go about their day—great idea!
    • Make it fun and celebrate success.  At Silver Spring Networks, we launched our Brazil operation with a big all-employee party at HQ, complete with Brazilian food, music and caipirinhas.  We turned the World Cup into another great opportunity to celebrate our becoming a global company, screening the matches live at lunchtimes.
    • Finally, protect and nurture the international business.  When the domestic business has a revenue shortfall or a product slip, it’ll be tempting to take it out of international.  Don’t—it will send a message to your employees, overseas teams, customers and partners that international is a second-class citizen, and you may never recover.

In conclusion

If you’re really serious about having a big impact and delivering a great return for yourself and your investors, you have to build a global company.  While you may not be ready to cross the border yet, you should be talking and walking the talk as a CEO from the beginning, and building global thinking into the company’s DNA.  As soon as you can afford to, assign a respected manager to lead the development of an explicit international strategy and plan, with participation from all key functions of the company.  Assign the resources to make it successful, and protect it when the domestic business hits a bump in the road.  Remember—your growth in three years should be coming from countries you’re not in today.  Bon voyage!

Comments or questions?

I welcome your comments and questions.  If the comments box is not showing up below, click on the title at the top of the post and it should appear.

This is the second in a series on building a global company from the ground up.

In the first part of this series I discussed the importance of laying the groundwork for a global company up-front.  In this part, I’ll talk about developing an explicit strategy to guide your international expansion.

What’s your international strategy? 

International expansion can happen almost by accident—if you’re a consumer Internet company, you get offered a deal by a big German partner, or if you’re an enterprise software company, your sales guys sign a bluebird deal in Japan to make the quarter—but that rarely turns out well.  The markets you end up in turn out to have limited potential, or the cost to serve them turns out to be a lot greater than you thought.  Customer commitments get missed, or tensions arise between the sales guys who sold the deal and the product people who weren’t involved but now have to deliver it.  All of a sudden, international expansion has a bad name.

It doesn’t have to be like that.  On the contrary, going global can be highly rewarding  for everyone if it’s deliberate and strategic.  Before you make your first move overseas, you should have an explicit, well-communicated, company-wide international strategy that will act as the company’s “True North” as it crosses the border.

Five key questions

Your strategy should address:

  1. What’s our goal?
  2. What countries will we focus on?
  3. With what product(s)?
  4. How will we go to market?
  5. What’s our operating model?

Let’s talk about each in turn:

1.  What’s our goal?  This can be a qualitative statement such as “Be the number 1 player in mobile gaming in the top 5 world markets by 2014”, or a quantitative target such as “Generate 50% of our revenue from outside the US by 2016”—or a combination of both.  It should be big, specific and measurable, because it will set the bar for the rest of the strategy.

2.  What countries?  What countries to focus on, and in what order, is perhaps your most important decision.  Many US companies launch in the UK next, because they speak English and it feels familiar – but is that the next best market for you?  Every new country you enter will require an investment of precious time and money, and will generate a certain return.  In simple terms, you want to prioritize countries offering the most return for the least investment.

That should start with a quantitative, data-driven analysis (aka a spreadsheet!), ranking the world’s countries according to the criteria that define an attractive market for you.

Those should include both Macro criteria related to overall market size—such as Population; GDP per Capita; Internet penetration; Broadband penetration; Smartphone penetration; 3G deployment1—as well as Company-specific criteria.  If you’re an enterprise software company targeting financial services giants, then “Number of banks with over $XB in assets” would be a highly relevant criterion.  For our data center automation company, Opsware, it was Number of servers or Network devices.  Sometimes fairly arcane factors can make one market much more attractive than another:  When I was running @Home International, Availability of two-way cable networks for broadband Internet services made markets like Australia and Netherlands more attractive than much larger countries like Germany.  Competition will almost certainly be a criterion, as will Product fit:  Your product may work with minimal changes in some countries, while requiring months of development work for others. 

This is real work, but it’s a hugely helpful exercise, because it forces everyone involved to think through what makes an attractive market, in terms of both potential and the investment required to realize it.  When you’re done, you should have a ranked top 20 list that will both guide your proactive expansion and give you a fact-based framework to react to opportunities that pop up along the way.

Naturally, analysis doesn’t take the place of judgment—it just supplements it.  You may decide to postpone entry into a market that looks good on the spreadsheet because you believe the company isn’t ready or the risk is too high.  For example, China might look very attractive on the numbers, but concerns about IP protection or ability to enforce contracts might well deter you.

3.  What products?  Obviously, you need product requirements and a product plan for every market you’re going to enter.  Unless you’re lucky enough to have a product like Twitter that works pretty much the same everywhere, that means product management and engineering work, and additional resources to be assigned to getting it done.

4.  How will we go to market in each of the top 3-5 countries?  Another question with major ramifications.  If you’re a mobile app company, maybe a partnership with a mobile operator is the way to go.  If an enterprise company, will you need to hire a direct sales force or can you start with a channel partner?  If you have a freemium model like Box.Net or Splunk, maybe you can seed the top 10 countries by promoting free downloads and then target the most successful ones with direct sales.

If local clones have got there before you (as in Groupon’s case) you have a build/buy decision to make:  Acquiring a local competitor buys you instant market position and a team, but technology that may be hard to integrate and a team you didn’t hire, with values that you may not share.

While every situation is different, and there’s no one right answer, I would generally beware of relying excessively on a partner, and particularly try to avoid joint ventures—more on that another time!

5.  What’s our operating model?  In the rush to launch overseas, this is often the most overlooked question.  The core decision you need to make is which functions you’re going to manage centrally, and which locally.  For example, if a shared global technology platform is a fundamental competitive advantage (as it is for Google, Facebook, Zynga, or Airbnb), then that’s one area where you don’t want to give local autonomy.  In its early years, Yahoo! gave its individual European country teams virtually free rein to develop local versions, leading to a wasteful hodge-podge of inconsistent platforms, petty fiefdoms and internal infighting between European and corporate executives.

Source:  Campaign UK, February 19, 2001

While Google powered ahead with a common technology platform and a clear command structure, Yahoo! Europe never recovered from this failure to pick the right operating model.  Read between the lines of this extract from Carol Bartz’s February 2009 reorg memo:

Regions: There are now two: North America and International. As I’ve said before, international growth is critical for Yahoo!, which has become too reliant on its U.S. business over the years.

The regions deliver Yahoo!’s products, programming and services to consumers, partners and advertisers in local markets. They will partner closely with the newly formed Regional Solutions & Products group in Ari’s organization to help drive a significant shift in how Yahoo! develops products for different geographies. The goal is to have global platforms on which regional product offerings are based.

The North American region—comprised of the U.S. and Canada—is led by Hilary Schneider. The leader of our International region, to be hired soon, will be responsible for a cohesive Yahoo! global strategy and seizing our international growth opportunities. Until we determine who’ll lead the International region, Rose Tsou (Asia), Rich Riley (Europe) and Keith Nilsson (Emerging Markets) will continue to report to me.

Get the sense that an explicit international strategy up-front might have helped?

Operating model decisions drive organization structure decisions:  In most cases, a matrixed structure will ultimately provide the best combination of centralized consistency and efficiency with localized customization and execution:  Local team members reporting dotted-line to a local GM and hard-line to their corporate function (or vice-versa). The org structure will need to change over time as the international business grows in size and complexity.  At the beginning, you should optimize for low overhead and rapid execution, but with enough corporate legal and finance oversight to minimize the risk of bad tax or IP decisions, or worse, fraud or FCPA violations.

Wait—that’s a lot of work!

By now you’re undoubtedly thinking:  I’m already working 16 hours a day, and so is my team—who’s going to do all of this new work?  As the CEO, your role is to sponsor the work and assign someone passionate, credible and independent to lead it.  I’ll talk about that in my next post.

Up next: Assigning ownership and ensuring commitment.

Comments or questions?

I welcome your comments and questions!  If the comments box is not showing up below, click on the title of the post and it should appear.

1 There are lots of good free sources for this data, e.g. CIA World Factbook; ITU; OECD, as well as dedicated sites like Internet World Stats.