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How To Navigate The World of ‘Fat Startups’

Posted on Thursday, Jun 19th 2014

In the Unicorn series, I have so far written about Tableau SoftwareFireEye, and RightNow. Of these, while Tableau and RightNow have followed Lean Startup principles, FireEye is definitely what I call a ‘Fat Startup’ that required a lot of early funding to get to market.

While it is true that these days, we focus a lot more on lean startups than startups that require capital to get going, fat startups still play an important role in developing large-scale success stories with significant defensible competitive advantage. In the FireEye article, we saw how Ashar Aziz has used cross-domain innovation to build a business that has scaled to an over $3 billion market cap.

The bulk of the industry has moved away from the ‘fat startup’ category. Investors expect that you will have your product launched, customer acquisition model fleshed out fully, and a team in place before Series A.

However, infrastructure software, hardware, networking, chips – they need capital. Even in cloud software, to build complex technology like personalization and analytics requires some serious investment.

While in the 1M/1M program, we steer people mostly along lean startup paths, I have pondered and investigated the question: How do people fund ‘fat startups’ these days?

I am seeing a few trends:

One, you need track record to get VCs to write big checks right away, so, often, it is the serial entrepreneurs who get these opportunities.

Two, some VCs incubate such companies with their Entrepreneurs In Residences, who are typically serial entrepreneurs.

Today’s featured company in the Unicorn series is Palo Alto Networks, a leader in cloud security. Founded by serial entrepreneur Nir Zuk, the company managed to pull off a concept financing round of $9.4 million to get itself going.

Prior to Palo Alto Networks, Nir was the CTO at NetScreen Technologies, which was acquired by Juniper Networks in 2004. Prior to NetScreen, Nir was co-founder and CTO at OneSecure. Nir also served as a principal engineer at Check Point Software Technologies, where he was a lead developer of inspection technology.

Juniper acquired Netscreen in February 2004 for $4 billion. Nir had strong feelings about what was happening at Juniper once he got there, and recommended that the company built a new Firewall product.

“Pretty much the entire world was using technology that we invented at Check Point in 1994. It just did not make sense to keep using ten-year-old technology. Hackers did not sleep for ten straight years, although anti-virus vendors did. It got to the point that firewalls were not really doing anything, and everybody knew that firewalls were not doing anything. Despite that, 80% of the network security budget was spent on firewalls and 20% of the budget was spent on anti-virus products that stay behind the firewall.

As an entrepreneur, I recognized that there was an opportunity. I wanted to build something that would cover 100% of the market. I asked Juniper for $10 million and 25 people to build a new firewall based on the Juniper operating system. I did not even hear an answer back, so I left. I raised $9.4 million from Greylock and Sequoia. We hired 20 people, some of whom were people that I wanted to work with on the project at Juniper.”

It was pretty much concept-financing, he says. “I had five PowerPoint slides, and the next day we had a term sheet. Of course I had connections and background, and I was dealing with top-tier VCs.”

Palo Alto Networks started selling the product in August 2007. Bookings shot up to $100 million in 2010. The company spent $49 million to get to cash flow positive, and went public in July 2012 at a valuation of $2.8 billion. Today, its market cap is over $6 billion.

Obviously, the path this company followed to arrive at these impressive numbers was not a lean startup methodology. Nir hired 20 top notch engineers right here in Silicon Valley – a very expensive proposition – to get the company off the ground. With deep domain knowledge, they achieved product-market fit early on, and revenues sky-rocketed.

Nir made those choices because he could. VCs were willing to write a $9.4 million check to bet on his domain knowledge and track record as a serial entrepreneur in that domain. [You can read the full case study here.]

For first time entrepreneurs, the options are more limited.

The most viable option is to bootstrap using services. An earlier elaborates on the subject.

Deep domain knowledge in a certain field may also give you access to capital.

A coherent, high-powered team that is willing to work for equity and build a prototype, along with a clear vision of product, customer need, customer acquisition model may, sometimes, work as well.

A few examples from our series:

Ash Ashutosh is a serial entrepreneur who worked as an EIR at Greylock, a top venture firm, and once he scoped out the market need, Greylock gave him the money to build the product. In effect, Actifio, Ash’s fat startup, was incubated inside Greylock, the venture firm. [Full Interview]

Andres Rodriguez, founder of fast startup Nasuni, has deep domain knowledge in storage and he is a serial entrepreneur with track record. Raising money was based on those two core factors. [Full Interview]

Alon Maor, CEO of fat startup Qwilt, demonstrates an interesting use of bridge financing with Series A (typically, the first institutional round of financing) already negotiated. The product was released 20 months AFTER Series A, which means, the Series A financing happened without much other than a clear vision of what the product was going to be and feedback from customers that they wanted the product.

Alon says, “In our case, since we are approaching the carrier space which is a large software-based capital intensive project, the incubation we did was through 15 worldwide carrier references. We had endorsements from those carriers who said they were behind the idea and recognized our approach as the future of the market.”

Alon did something very nifty. He went to Silicon Valley VCs and sold the concept, got an idea that they would be willing to fund his Series A based on the proven customer interest. He also put together a high-powered team of 10 people with deep technical expertise ready to join upon funding.

Then, and, here the story gets really interesting, he went to a set of angel investors who knew him from prior companies, and raised a seed round as a bridge into the Series A.

Complex? Yes. Smart? Yes. I would say, very smart. [Full Interview]

In this case, funding happened because of a combination of factors: domain knowledge, customer interest, VC interest, and evidence of a strong team ready to come on board post financing.

Austrian entrepreneur Alexander Zache has deep domain knowledge in Art Auctions. He is a first-time Internet entrepreneur from a family steeped in the arts business. He managed to raise series A financing from VCs in Berlin on a slide-deck that explained the core concepts, including a phenomenally lucrative business model: Auctionata takes 20% commission from Buyers and 20% from Sellers, competing head-on with Christie’s and Sotheby’s.

Alex says: “Yes, and we have a very credible strategy for bringing that business online. When I look back at that presentation today, I can see that we have executed exactly what we said we would. We have also hit the revenues exactly as we said we would.” [Full Interview]

Please note, there are certain VCs who are particularly good at these kinds of investments, especially Asheem Chandna and Vinod Khosla come to mind in the IT infrastructure space. Asheem Chandna’s investment in Delphix is a good example of funding a fat startup based on a concept. Delphix was founded in 2008 by entrepreneur Jedidiah Yueh who had earlier founded and sold data de-duplication company Avamar to EMC for $165 million. Vinod Khosla is one of the very few VCs who have not abandoned his interest in Cleantech, a capital-intensive industry where the lean-startup model has limited applicability.

While the industry is obsessed with lean startups these days, I believe there is tremendous value in understanding how to continue to build fat startups as well, alongside the lean ones.


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