Startup Advice in a Rough Climate

IT venture capitalist shares industry trends and tips

The current downturn in the market, coupled with emerging trends such as cloud computing that may change the face of IT positions, has left many IT pros wondering what opportunities are available. Although times are hard, a rough economy offers a valuable opportunity for startup companies to emerge in a low-competition market where most companies are cutting back. I spoke with Justin Perreault, general partner at Commonwealth Capital Ventures, about some of the trends in IT jobs and IT startup companies, as well as what IT pros can do today to launch the next great startup.

Brian Reinholz: In the original note that Commonwealth Capital Ventures sent to me, you noted that it’ll be difficult for startups to find funding in this climate, but startups that have already secured funding will have a huge competitive advantage. Can you elaborate on this?

Justin Perreault: With the start of the downturn, which was more of a tech center downturn in 2001 and 2002, it became extremely difficult for companies to gain capital from new venture firms. That created a giant squeeze at checkout. Depending on where you were in your growth cycle, a lot of good ideas and good teams ended up not being successful because capital was not available. I think in today’s environment, startups that have strong syndicates or are perhaps beyond the raw startup stage will have a big jump on people coming up behind them. There’s no doubt that, in terms of talent, availability, and quality of people—available in all positions given the amount of downsizing going on—there is a good talent pool to draw on as companies are looking to expand.

Brian Reinholz: There have been a lot of acquisitions recently, with big companies acquiring large amounts of small startups. Will this increase or decrease the opportunities available for startups?

Justin Perreault: That’s a good question, because there are different angles on it. If you contrast the IT industry today with the 90’s, a huge amount of consolidation has already occurred, particularly in the software industry but also in the networking industry. As a result, there are a small number of really gargantuan companies—Microsoft, IBM, Oracle, etc.—that are systematic acquirers, people like Cisco. There are far fewer mid-sized companies which formed a food chain for startups to exit to, so it’s a vastly sparser landscape these days. But I think you’re right, that a lot of the large companies look to acquire small startups for product and technology injections earlier in their life cycles. The implications of that for startups is that that route is still there, oftentimes earlier, which also implies a lower valuation at exit. What that means is that you need to be very capital efficient about building your business, and not burn so much money that the exit value that you can generate doesn’t provide a return for the investors or the entrepreneurs.

Brian Reinholz: Are you seeing an increase in the amount of IT pros looking for startup funding?

Justin Perreault: At this moment, it has fallen off for the end of the year. But the big acquirers have tons of cash, and they’re smart enough and well-managed enough to understand that opportunistically it’s a good time to acquire. It’s important for smaller companies is to be capital efficient so they can sell when they want to, not when they have to.

In the big picture, they’ve been pretty steady at a high rate; actually, we’ve been surprised by how many good ideas are out there. What has happened in the past is that when the economy turns down more gradually, you tend to see a lot of people hunker down beside their big corporations and be a little more risk-averse. But what’s happening this time is that the downturn is so severe and happening so quickly, there are a lot of people that are spinning out of corporations and have a bigger risk appetite because they have less to lose.

I think in general, downturns are good times to start companies, because there is a lot of talent available and fewer startups to compete with, if an entrepreneur has an idea and an inclination to do so.

Brian Reinholz: Are there certain types of startups that are emerging right now?

Justin Perreault: I think the startups you tend to see tend to follow some of the broader themes of the IT industry at large. There are an awful lot of virtualization companies out there; there are certainly a lot of Software as a Service application companies looking to attack various niches or categories of the application space with a SaaS offering. I think enterprise mobility is picking up a lot of steam as well, in part because infrastructures have made it more viable, but also things like the iPhone and Blackberry Storm have captured peoples’ imaginations, and they want to figure out how to use it in the work environment as well.

Brian Reinholz: We’ve seen a lot of new products related to mobility, but also in other sectors such as mobility security, mobility management, etc.

Justin Perreault: Virtualization applied to mobility, too. I think the bigger trend there is that there’s been a mindset shift that a mobile device is as powerful and ubiquitous of a computing platform as a desktop PC or a laptop. IT is starting to think of it as those are networks that need to be managed with the same control and security issues as you would a laptop that is out there wandering around. I think that is driving a lot of the push on that side.

Brian Reinholz: What are the most common profiles of people that launch IT startups?

Justin Perreault: As far as the profile of the teams we back, we tend to place a fair degree of emphasis on having had some meaningful experience, ideally as close to the sector or the space that the idea is going after as possible, at least for those that are enterprise oriented. The reason for that is that as opposed to the university spit out, people with technical experience and business experience in a certain sector are pretty well positioned to spot the next idea or what the customers need next.

Brian Reinholz: We’ve obviously seen some job losses, not as many in IT as a lot of industries, but there have obviously been some. Should we expect to see more job losses in IT in the future?

Justin Perreault: I think we will. I obviously have no crystal ball, but I think because this downturn is being driven by a contraction of credit, from banks right down to the consumer level, that implies a contraction in spending, both at the consumer and business level, which makes for a more protracted downturn rather than a quick bounce back. There is only so much stimulus or pump priming that the government can do. People and institutions are going to be leveraged to a lower level. The spending that was driven by the leverage will fall, and we’ll ration down to a level from where we’ll slowly grow back up. I think how that plays out is that you end up with a tough recession and maybe a slow recovery, which unfortunately is a recipe for a lot of job losses across a lot of industries, including tech and IT.

Brian Reinholz: What IT positions will be the hardest hit? What types of companies will be the hardest hit?

Justin Perreault: I think, at least for the short term, corporations will be more reluctant to build and deploy new applications and new capabilities, unless they are tied to a number one or two priority on the CIO and CEO’s list. I think the mindset for the executives right now is cut costs, save money, not so much develop new strategic capabilities that are a little more speculative. I think that’s why things like virtualization get preserved, but maybe some of the other applications that give you productivity that is tougher to measure will get deferred, because it’ll be hard to justify the immediate payback for the money spent.

Brian Reinholz: What would you recommend for IT pros thinking of creating a start up? Should they hold off and weather the storm, or is there enough funding out there that they can make it if they work at it?

Justin Perreault: I would never discourage anyone from pursuing an entrepreneurial dream and starting a company. As I’ve said, I think some of the best times to start a company are in a downturn. If you can bootstrap it yourself without external financing and make progress, there are fewer firms that are going to be chasing after you, typically in the downturn, plus you can attract higher quality people than you might otherwise if you are competing in a strong economy. But, anyone’s decision to quit their day job and launch a startup has a lot of personal implications as well, so they certainly should be prepared for whatever change in circumstances that comes along with launching a startup.

Brian Reinholz: What do IT pros need to do to be competitive enough to get funding? And assuming that they need a large amount of funding—half a million to three million dollars—what are the best means to secure that funding?

Justin Perreault: I’ll start off by saying that half a million to three million for an early stage funding isn’t an abnormally large amount of funding, so if all the other aspects of the team—quality of market opportunity, quality of idea, quality of people—are strong, those projects have as good of a chance of getting funding now as they did six month ago. I would say and encourage anyone who is seeking venture funding that the more progress they can make to validate the idea—maybe even build a prototype of the product, or get customer feedback and validation—the higher the likelihood that it is getting venture funding. The idea is much further down the road, so there is more evidence that whatever the idea is, it’s more likely that it will gain traction in the marketplace.

Related Reading:
Tracking IT Layoffs and Other More Positive Things You Can Do in a Recession
Recession and Rebirth: Why IT Matters in Tough Times
Microsoft Offers Nearly Free Software and Tools

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