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Making decisions

by • November 17, 2011 • Best of, Funding & investmentComments (2)118

Making decisions

You have a profitable bootstrapped business with good, linear growth. You’re on track to take over your niche and should be able to hold it, but it’s hard to imagine how you’ll make the leap into the mainstream on your current trajectory.

On a bit of a whim, you talked to a major bank and they want to license a white-labelled copy of your whole system. The deal they’re talking about signing will add 50% to your yearly revenue just on its own, but all of that revenue (and more) will be eaten by additional support costs you don’t currently have.

They’re also demanding exclusivity for a year.

Big decision, right?[1]

3 choices

Licensing to just one bank is a loss in terms of profits, so you could walk away from the deal to remain small and profitable.

You could either take or reject the licensing deal (based on your feelings about the exclusivity clause), and then plan to bootstrap the transition from a consumer-marketing model into an enterprise-sales one. It’s possible, but means you are beholden to a few large clients for the coming years and simply aren’t going to be able to turn down their requests.

Finally, you could use the discovery of this mainstream market to raise a round and begin scaling a sales, support & infrastructure team.

What do you do?

In the meantime, you’re pulling your hair out and product development has ground to a halt. You’re not sure what to tell to anyone you talk to. A week ago you had a profitable business — now you’re not sure where you stand.

The worst decision possible

The worst possible decision is this:

You sign the deal, hire enough support staff to keep everything running, begin talking to investors, and plan to ramp up for sales-mode in 9 months when the exclusivity is beginning to expire.

Doesn’t seem so bad, but bear with me.

This plan embodies everything that is wrong with bubble-era startups. It’s got three leap-of-faith situations in it:

  • That the current deal is not a freak outlier
  • That you will close a funding round
  • That other corporations will still want to buy from you in a year

Why am I raining on your parade?

After all, exciting stuff is afoot!

Timing is the real issue

My bullet list of complaints is hard to take seriously because they are framed as grumpy opinions:

But you might not close that round!

It’s the sort of perspective founders [rightfully] learn to ignore, from yet-another-naysayer (YANS!).

But beyond the grump, there’s a real problem: one of timing, options, and information.

The plan outlined above means you’re committing to support costs before discovering how keen investors are, and you’re trying to raise money before knowing how deep this opportunity goes.

Signing the client deal right now is only useful if you want to bootstrap into an enterprise model (i.e. you are categorically opposed to raising investment), and even then I would still want evidence [for myself] that there’s going to be a large customer base waiting in a year’s time.

If you were to stay small-and-profitable, then the deal is worthless because it increases revenue but reduces profits.

And finally, if you have your heart set on funding, what sort of investor is going to pitch in with an enterprise sales company which can’t even begin selling for another 9 months?

Closing a funding round typically takes 3 months, and at that point, the investor may as well wait for another 6 to see what your pipeline looks like. After all, you haven’t increased revenue since they started talking to you…

The “right” decision

With the caveat that real situations are a lot more ambiguous than the one outlined here, here’s how I would approach it:

Tell the customers you’ll get back to them asap and start reaching out to investors right now. Like immediately, using whichever internet-enabled gadget is most readily available.

Ideally you’ll have met them previously at an event or during a failed pitch, and they’ll have politely declined while saying something like

Great talking to you. Stay in touch and let me know if I can ever help out.

Now is the time to call in that favour. Even on cold emails, you will have an easier time than most because you tick all the boxes:

  • Launched and profitable means good team & customer understanding
  • Big client deal on the table means you can go a lot bigger than you are
  • Strategic inflection point means investors can sink their teeth into a serious problem and prove their worth

It feels a bit like the rocketship is about to take off, and you’re giving them a chance to take a look around the cockpit, point you a little bit more in the right direction, and decide whether or not to stick around for ride.

Either on your own or through the investor conversations, you need to get in touch with more potential clients. You’re looking for evidence of market pull to help close your round, and also leverage to push back on the exclusivity term in the original proposed contract.

If you can’t get other clients excited, then there’s no funding and no scalable future business. You can make your decision about the original deal as if it’s a one-off. That’s a much easier decision, because it’s just a question of comparing the costs to the number at the bottom of the paper.

If other clients are excited, you’ll have a much easier time getting rid of the onerous exclusivity clause. With two exclusive deals on the table, you can tell one of them that it’s a deal-breaker term, and if they walk away, you sign the other and have lost nothing.

The good, the bad, and the bootstrapped

The red herring in this situation is that you need to make a strategic decision. You do not. It’s about re-arranging your activities to put learning before commitment.

The “bad” approach was ordered: commitment & costs, funding attempt, market discovery.

The “good” approach is ordered: market discovery, funding attempt, commitment & costs.

And of course, the third option is to turn down the deal and keep on keeping on with your profitable little business.

The extra bonus of the “good” order is that if either market discovery or funding fail, you can fall back on your current bootstrapping model. The “bad” approach offers no such luxury, and you’re stuck supporting an unprofitable client for the coming year.

You don’t want that. Small teams weren’t built for 24/7 phone support.

The best option here costs nothing, significantly reduces risk, and allows you to make a major strategic decision about the future of your company with more information.

[1] This situation is based off a conversation I recently had with someone, but I’ve tweaked the particulars in a way which obscures the real deal and leads to a different conclusion.

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2 Responses to Making decisions

  1. kelley boyd says:

    Great post Rob.

    I agree that your “conclusion” for the way to approach is solid – however, there is something I don’t agree with – and that is “being able to turn down their requests”. I commented a few weeks ago on another post and my comments here reinforce the thinking. That is to build an enterprise sales model you must get deep engagement and “partnership” from early customers. DON’T agree to support a white label solution with the same structure as a branded solution – require the customer deliver first line support. Have them underwrite the development of the training for support – they likely have a training department, and staff – use them.

    If an innovator/early adopter is enamored enough to be your first customer in a segment but not enamored enough to invest in making sure the solution works the way they need it to (and is supportable) – I don’t think it was sold right.

    • robfitz says:

      Good points! Thanks :).

      I will say, though, that a founder switching from marketing-based B2C to enterprise sales is likely to make a few “not sold right” deals before they figure out exactly what’s going on. Ideally it wouldn’t happen at all, but as a newbie, it’s easy to trap yourself into a bad 12 month gig.

      Any advice for first-timers?

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