Wheel of Misfortune

Wheel of Misfortune

Everyone's looking for a chance to strike it rich by jumping to an Internet startup. But knowing which opportunity is the right one is not easy. When faced with such a choice, there are certain questions you should ask about the company and about yourself.

Do You Believe in the Business?

Start with the business plan and study it closely. If the business model is easy to explain and either fits a relatively untapped market or has something unique to offer an established market, potential investors and customers will have no trouble grasping its concept. And if the public understands what a company is offering, they're more likely to use the service, and a company is more likely to succeed.

Robert L. Paquin, COO and CIO at Blue Nile, a Seattle-based online diamond and jewelry retailer, says he was drawn to Blue Nile's business model because of the high margin per item sold and because it negated the need for a large distribution center infrastructure. "I listened for a compelling business model that was sustainable, not just something trendy for an IPO launch," says Paquin, who was the senior vice president of operations and IS at L.L. Bean for six years prior to moving to Blue Nile.

"Diamonds have a strict set of [gem] standards," he adds, "and the business model of targeting men, the predominant online users, also made sense to me." Paquin believed that the Internet was a logical place to sell diamonds. "I remembered what a painful experience it was to go to a jewelry store to learn about buying a diamond," he says. "And I saw the kind of research and guidance that Blue Nile was planning to provide to that target audience. It clicked for me."

Sometimes the attraction to a particular business plan takes on more of a personal sense. "I was drawn to's business model because of my financial background," says Bob Whyte, senior vice president and CTO at, a California-based online bill-paying company. "I knew that other outfits offered online bill payment, but this model could handle all of someone's bills. That was different and compelling," says Whyte, previously a CIO at DirectTV for three years and CIO of Walt Disney's Imagineering division for four years before that.

John Cross says he found AppNet's ideas intriguing because of the company's plan to offer a broad range of integrated Internet services. "By providing a set of services, AppNet can offer clients a faster time to market and stability through the delivery of Internet systems," says the 30-year veteran of BP Amoco, who served 10 of those years as the company's CIO. "It was an astute plan for what businesses needed and what no other single company could offer."

But a good plan by itself isn't good enough. Do the research to discover if other companies have similar plans or are already offering a similar service or product. "First movers will have many advantages-from market brand to investors-that latecomers won't," says Phil Schneidermeyer, leader of the technology officers' practice at Stamford, Conn.-based Korn/Ferry. It's also important to know what stage of development a company is in: embryonic, beta or on the launch pad. Even if a company has a first-mover advantage, it could lose it if it is too slow to get to market because the competition is not going to sit still.

Look for any logical gaps in the plan. Be sure it doesn't take a leap of faith and simply count on something working out. And lastly, if the plan calls for partnerships, research those partners to see whether they have good reputations for delivering what they're supposed to.

Another word of caution: "Some business plans seem to have no intention of profitability," says Whyte. "These plans call for launching the business, going public and getting a lot of money, period. If growing beyond the IPO isn't part of the plan, you might want to think carefully about it and consider what you really want to get from the experience."

Who's Funding This Venture, Anyway?

Once you've determined that a startup's business plan is worth the effort, turn your attention toward funding. "Finding out who the players are will give you some idea about the credibility and substance of the company," says Beverly Lieberman, president of Halbrecht Lieberman Associates, a US executive search company.

Dotcoms will typically disclose where their venture money and financial backing is coming from. A startup with backing from a well-known company with a good track record is the ideal situation. If established VC firms such as Kleiner Perkins, Trinity or Bessemer Venture Partners have invested in the plan, a prospective recruit can take comfort in knowing that the business plan has already passed a rigorous test.

However, if the VCs' names don't ring a bell, it doesn't necessarily suggest that they aren't well-respected or that they don't have a solid track record. Ask the VCs directly what other companies they've invested in. Research other launches they've funded. If they have provided some of the seed money for now-successful companies, it shows that they understand their business and have some insight into whether a company has potential.

Cross suggests talking to some of the venture funders directly, which is exactly what he did before joining AppNet. He went straight to GTCR, the Chicago-based private equity fund that had invested in AppNet. "I wanted to hear from them why they were putting $100 million into this venture and what sold them on the idea," he recalls. By speaking to GTCR, Cross learned that the company makes only a few large investments rather than spreading out smaller amounts among many startups the way other VCs do. The combination of the name and the dollar amount added to Cross's assurance that AppNet had plenty of resources to fulfill its initial expansion and acquisition plans.

Venture capitalists comb through and listen to business presentations every day and are accustomed to discerning the good from the bad. Ask them what stands out about the particular company you're looking into. In your discussions, ask them why they are excited by this offering. By doing so, you may learn that your prospective new company may have relatively few competitors or that it is targeting an untapped market.

Some companies begin life with a head start from an idea incubator such as Idealab. Incubators themselves do their homework and show their belief in the business model by providing basic office infrastructure such as phones, Internet access and a technology starter kit. Pasadena, Calif.-based Idealab backed and Debra Domeyer notes that making the move last fall to CIO of, an online car-buying company in Los Angeles, from the CIO position at Pacific Gas and Electric , was easier to do knowing that Idealab had been an early backer of the company.

Are the Members of the Management Team Credible?

The business acumen of the management team is vital to a startup's success, and the personal chemistry of the team is vital to the company's long-term health. When contemplating a move to a large corporation, you typically might not consider the technical credibility of the CEO or CFO or place too much emphasis on how well you get along with them personally. But this is vital in dotcom land because of how closely you'll be working with the other executives (there's a good chance you won't even have separate offices).

At a startup, the management team will be making significant business decisions that will directly affect the company's future. There are no review boards, no standing around waiting for the OK from someone else. You decide something in the morning and start implementing it in the afternoon. With all this at stake, you'd better make sure you click with the leadership team already in place. "You won't have the luxury of time to gradually work toward a consensus," says Whyte. "You need to be able to get along with [the management team] so that you can set vision plans quickly and then scramble to get things done."

Learn all you can about the management team, the board of directors and the board of advisers. Any previous experience and track record where they've shown leadership and integrity in their earlier ventures will show you what to expect if you join the crew. "Our cofounders have impressive backgrounds in consulting, and our vice president of IT was with [a well-respected online bookseller] in the early days," says Blue Nile's Paquin. "This showed me that the company had a good grasp of what it was doing," he adds.

"If you join a startup with a proven team in the right areas, such as Internet infrastructure services, then you stand a better chance of generating significant equity value for yourself and your company," adds David J. Cowan, a managing partner at Menlo Park, Calif.-based Bessemer Venture Partners. "If you join a rookie team with no backing in a marketspace with questionable value or economics, then you're fighting 50-to-1 odds."

Real-world startup experience from the management team is what you're hoping to find. Barring that, high-level experience with a traditional company will do (after all, that's what your own credentials are). Be wary if no one in charge has run a company before, and be wary if upper management seems to talk only of going public. If the goal of the leaders is to have an IPO and then cash out and leave, you could be left trying to run and fix a mess.

Get a feel for the way the management team operates by asking to sit in on a meeting. "I was given the opportunity to attend a two-day management meeting before I joined," recalls AppNet's Cross. "I watched how they communicated and how they arrived at decisions and what kind of collective vision they had for the company. I was able to observe the group dynamics of how the management functioned as a whole and decide if it was a culture I was going to be comfortable in."

Cross noticed that the managers, many of them young and already millionaires, were energetic and enthusiastic. During the meeting, he watched how each of their individual expertises fit together, and he saw them start to map out strategic plans for the future. The management team's excitement and ideas grew throughout the course of the meeting, having a domino effect of sorts on Cross and his own ideas about where the company was headed.

Does the Company Have Flexible, Scalable Technology in Place?

This may sound like a small point, but it is vital to a company's success. Examine what technology choices have already been made. Specifically you'll want to see that the architecture planners chose tools that are scalable, flexible and capable of handling high-volume transactions.

"Before moving to, I asked tons of questions about the technology plans," says Domeyer. "The more I learned about the business plan, the more I recognized that it depended on a rock-solid technology foundation" because it counted on volumes of Internet traffic and needed to have very reliable privacy and security features, she adds. "Learning about the web-based relationship management and reporting tools and the underlying architecture's combination of Unix, Linux and [Windows] NT made me very comfortable about what we could do in the future."

As a prospective recruit, you should also ask about what technology decisions have already been made, what operating system platforms are in place and what the architectural foundation is. Note if any of the already-purchased pieces have a reputation for scalability troubles. See if the existing technology products come from well-established companies such as Sun Microsystems, Oracle, Informix, Microsoft, IBM and others. "It isn't a good sign if a Web site is based on tools from vendors you've never heard of," says Whyte.

If you see too many inflexible, proprietary technologies in place, be wary because you want the freedom and nimbleness to adapt to quickly changing conditions. If a company is tied too tightly to proprietary technologies, its future choices will be limited and implementation will be slow. Related to that, ask enough questions to gauge whether the company's executives have subtle or not-so-subtle technology biases or favourites. A CEO who consistently encourages you to buy tools only from his or her own favourite vendors will limit your flexibility, which could harm the business in the long run.

Also ask the planners what sites or companies the startup uses as technology models. If, for example, the business plan is for a new kind of online financial services company, it should follow the basic patterns of good financial services sites with extra security and redundancy features. A financial services business plan that overlooks that in favour of the latest load-balancing tools used by online portals has not made thoughtful and solid technology choices.

What Do Stock Options Really Mean?

Finally we get to the good stuff, right? Isn't it really about the almighty stock options? Well, yes and no, and not right away. Yes, you'll get paid, but you'll probably take a pay cut, possibly a big pay cut. You could be working twice the number of hours for as much as 50 per cent less cash compensation.

Cross says he had another offer that was 10 times higher than the salary he was offered at AppNet. "That's the risk you're taking," he says. "You're trading today's income for the chance of tomorrow's wealth."

The common stock and the stock options make up the difference, of course. With that in mind, you need to know what to expect and what to ask for. Whyte says the CIO/CTO-level worker coming into a startup may be offered a 1 per cent to 5 per cent ownership stake. But the closer the outfit gets to launching its service, the smaller that stake may be because a good portion of the initial available stock will have been passed out to early investors and executives. The more rounds of funding a company goes through, the more your shares will be diluted. This doesn't mean the number of shares you get will be cut; it just means that your overall ownership percentage of the company will decrease.

For example, if the company has gone through two rounds and will go through two or three more, your portion will shrink considerably. "If they aren't sure how many financing rounds they'll go through or you're getting very wishy-washy answers to these kinds of questions, it's a definite warning sign," says Whyte.

Taking a look at some hypothetical numbers will show how a stock option package can be attractive. At press time, for example, a 1 per cent stake of the outstanding shares of (an online gardening company) would easily clear $1 million. A similar 1 per cent portion of Internet advertising service Be Free 's outstanding shares would now be worth more than $5 million, and a 0.5 per cent stake in AppNet would now be worth more than $7 million. Although each company has different vesting schedules for stock options, many startups accelerate vesting to reward the founding employees. Some employees can begin to exercise their first set of options (sometimes up to one- quarter of their total shares) to buy company stock a year after they join.

Bigger isn't necessarily better in the world of Internet startup stakes. However, a large offering is a danger sign that a company is too eager to get someone and either is unlikely to have any hope at going public or of even surviving for too long. A combination of too large a stock offer and some uncertainty in your research is reason enough to turn down an offer.

Look into the future value of the company and its stock options by inspecting the periodic valuation reports that the board of directors presents to financial backers. Compare how the value of the company has changed over time and how many shares of stock are outstanding. If the value of the company steadily increases while the number of outstanding shares remains fairly constant, you will be able to plot how the value of those option shares you're offered is likely to increase over time. Look at that valuation growth chart again and see if it calls for a future period of monstrous growth. Startups will certainly grow quickly, but an unusual spike in the forecasted growth should prompt you to ask a few questions. For example, if the company has steadily grown in value by 50 per cent every four months for the past year and a half, a sudden shift to 300 per cent growth is unlikely. If you're counting on a huge leap in company valuation in order for your options to be worth what the other execs are claiming they'll be worth, you need to explore why such unusual growth is forecasted. With a clear picture of how the company is growing, you can plot the kind of value your stock options have and the monetary value of what you're being offered.

This company valuation will also help illustrate when a company is within sight of going public. For example, a company must meet some specific requirements before it can be listed on Nasdaq. One way is that a company must have net tangible assets of at least $6 million and pretax income of $1 million per year, along with a minimum bid price of $5 (to learn more, visit about/FeeStruc.stm).

Jumping to a startup purely for the dollar payoff is a mistake. But jumping for the challenge and the fun will probably bring plenty of rewards. "Even with all of the hours, I'd have to say that I'm surprised at how much fun I'm having," says Domeyer. "There's energy everywhere and the speed of everything is invigorating."

Whyte adds, "Everything is so much quicker that it's scary sometimes. But there's nothing in a Fortune 500 company that compares with the excitement of it all."

It Ain't Easy Being a Startup

Study these issues before accepting a position at a dotcom FACE IT. The odds are stacked against you if you're an Internet startup. Maybe one out of 100 startups go on to become successful companies, says Joanna Strober, a partner at Bessemer Venture Partners, a California-based venture capital firm. As if that wasn't enough, even with good venture capital funding, perhaps 1 in 10 is successful, she adds.

With that in mind, the following is a quick list to run down before saying yes to the all-powerful lure of a dotcom.

Who is backing the company? Venture capital firms? Private funding?

Who is the competition and how well does the company know them?

What round of funding is the company in? How many is it planning to go through?

What kind of technology is already in place at the company?

Know what's coming to you. What will you get and when?

Ask the venture capitalists about their successes. What companies have flopped and why? And what companies succeeded and why?

Do you feel a sense of urgency in the company to get its idea to market?

What were the biggest (or latest) controversies or internal disagreements within the company? How were they handled? (The answer will give you some insight about what will happen when you completely disagree on a strategy or other decision.) Ask about marketing plans for driving traffic to the site. Is the company a little too sure that its good idea will generate traffic all on its own through a "we will build it and they will come" strategy?

-S. Deck

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