Evaluating Tech Startups: The Risks And Rewards

Evaluating Tech Startups: The Risks And Rewards

Unwilling to take a chance on an emerging technology vendor? Your company could miss out on the next big breakthrough.


Nov. 10, 2007

Tech startups are enthusiastic about the prospect of selling to
businesses, and rightly so. Opsware, VMware, Salesforce.com–they’re
just a few recent examples of startups that hit it huge, whether
through buyout, IPO, or organic growth. Venture capital firms are
pouring money into promising early-stage tech companies–$1.1 billion
went toward 187 software deals in the third quarter, according to
PricewaterhouseCoopers and the National Venture Capital
Association–and Web 2.0 has everyone thinking again about all the
business possibilities on the Internet. The pieces are in place.

Except for one. IT organizations, the ones with the purse strings,
treat startup vendors like they’re radioactive. Blame it on tight IT
budgets, a preference for doing business with fewer vendors, and a
once-burned, forever-cautious attitude after Web 1.0. The tech
industry’s innovation engine is revving, but CIOs have a foot on the

"After a while, you don’t take risks anymore," the CIO of a Fortune
500 manufacturing company said in a meeting of peers a few months ago.
"Your world is so complicated, you can’t take those risks." InformationWeek
Research bears out that thinking. In our survey of 150 senior business
technology executives earlier this year, 74% described their companies’
IT cultures as being moderate or conservative; only 26% called
themselves aggressive.

Entrepreneur Marc Andreessen says the number of business technology
early adopters has "dropped dramatically" over the past few years.
Andreessen characterizes most IT departments as being "stuck in the
mud" and laments they "actively look for excuses not to act."

That’s a harsh assessment from someone who has struck pay dirt with two
tech startups: Opsware, which Hewlett-Packard is in the process of
acquiring for $1.6 billion, and Netscape, whose 1995 IPO was one of the
biggest in corporate history and which sold to AOL for $4.2 billion in
1999. Andreessen is now on his third startup, social networking site
Ning.com. So does Andreessen see IT organizations warming to startups?
Hardly. Entrepreneurs who go knocking at the data center, he says, are
met with "deadbolts, chains, shackles, boiling oil, pits full of
sharpened steel spikes, iron maidens."

Ning offers service options for businesses, but Andreessen isn’t going
after the IT crowd this time around. "If businesses want to use it,
that’s great," he says. "If not, there are 1.3-plus billion consumers
on the Internet who will."

IT personnel, of course, have good reason to exercise caution. Startups
sometimes get acquired or fail; patent disputes can drag them down; and
data centers are no place for unproven products. The CIO of a
multibillion-dollar company says too many things can go wrong with
startups–software bugs, an inability to scale, lack of resources–and
she doesn’t want to be left picking up the pieces.

In the face of such concerns, many startups are pushing ahead with new
software, services, and appliances to businesses. IT pros may be fewer
in number than the billion-plus Web users, but they make up for that in
buying power. The average IT budget for an InformationWeek subscriber is $48.7 million.


Zenoss' CEO Karpovich is taking on BMC, CA, HP, and IBM in systems monitoring -- Photo by David Deal

Zenoss’ CEO Karpovich is taking on BMC, CA, HP, and IBM in systems monitoring

Photo by David Deal

And, some of that money does in fact go to startups. Opsware managed to
exceed a $100 million annual revenue run rate selling to customers such
as EDS, General Electric, and JPMorgan. Aveksa, a startup specializing
in data access governance software, recently landed health insurer
Cigna. PeopleSoft founder Dave Duffield’s new HR-as-a-service company,
Workday, has signed 26,000-employee Chiquita Brands. "They’re the ‘try
it out’ kind of guys," says Duffield. (As these examples show, a
startup’s lineage counts. Aveksa, Opsware, and Workday were all founded
by well-connected software industry veterans.)

Just last month, 2-year-old Zenoss revealed that IPTV and wireless
equipment provider UTStarcom has begun using its open source IT
management software, which competes with established products from BMC,
CA, Hewlett-Packard, and IBM. With annual revenue of $2.7 billion,
UTStarcom is the kind of blue chip account that tends to reassure other
potential customers. Thousands of companies use a free version of
Zenoss’ software, but only 50 or so have signed to use its enterprise
version, which lists at $50,000 for 500 managed nodes.

Zenoss gives its software away in hopes of hooking paying customers
later with more features, support, and indemnity from any legal claims.
That’s one way startups get around bureaucratic roadblocks in the IT
department–find a few early adopters among IT staff who champion their
cause. "No CIO ever chose Linux in the early days. It just showed up,"
says Zenoss founder and CEO Bill Karpovich.

IT managers tend to use startups to fill gaps in their infrastructures
or to make processes faster, better, or cheaper. Craig Shumard, chief
information security officer with Cigna, uses startups to tighten
security when he can’t find what he needs from established vendors.
"They’re more nimble," Shumard says.

Cigna’s need to manage data access more methodically caused it to take
a look at new software from Aveksa for establishing user access
privileges. Last year, when Aveksa first approached Cigna, the startup
was only 2 years old, with few customers and not much of a track
record. But Aveksa’s executives were experts in identity
management–CEO Deepak Taneja is the former CTO of Netegrity–and the
company’s software sounded like just what Shumard needed to put the
finishing touches on a role-based access control system in development
at Cigna since 2002.

The task was daunting–Cigna has 26,500 employees, 22,000 PCs, 9,000
laptops, thousands of applications, and 140 Tbytes of data. "I’ve got a
lot of pressure on me from our business people looking to enable our
business securely," Shumard says.

Aveksa’s software promised to do something Cigna couldn’t find
elsewhere–let business managers collaborate with compliance personnel
and security pros in defining roles that determine entitlements, or
employees’ data access rights. Promised
because Aveksa’s suite didn’t fully support that capability at the time
the company started talking about it. Aveksa’s full-blown workflow app,
Aveksa Role Manager, will become commercially available in December.

Cigna’s experience underscores two advantages of working with startups:
Early adopters can influence the tech road map, and they can steal a
march on their competitors by getting functionality not generally

Vince Delperdang took the path less traveled two years ago when he
chose Pillar Data Systems–at the time a relative newcomer to the data
storage market–over EMC and HP. Delperdang, IT manager with
O’Donnell/Atkins, a real estate and land development company in Irvine,
Calif., used to stop by EMC’s nearby office for lunch. But Pillar
offered more storage for the price and better support with no services
requirement–and won the business.

Businesses are more likely to gamble on tech startups in certain areas.
Security is one of them, because it’s still the Wild West. Security
technology and approaches are in rapid flux as businesses scramble to
prevent data breaches, block increasingly sophisticated malware, and
comply with regulations that mandate better policy enforcement. Other
tech startup areas that face relatively low barriers to business entry
include Web operations, wireless, and open source.

The Washington Post‘s Web site became an early user of Aggregate
Knowledge’s Web site recommendation software after WashingtonPost.com
executive editor Jim Brady heard about Aggregate Knowledge last year
when talking to a venture capitalist. Founded in 2005 and backed by $25
million in funding, Aggregate Knowledge’s algorithms analyze what
people do on a Web site, then make product and content recommendations
based on what like-minded visitors have done.

Brady was impressed enough with the hosted service to ask the
publisher’s technical and financial teams to check it out. Such due
diligence must be standard practice when working with startups for the
first time. In addition to stress-testing the new technology, IT
departments must know something about the company principals, check
customer references, and even make an on-site visit to the vendor’s
offices (see story, "9 Questions To Ask A Tech Startup").
At Cigna, financial experts go over the startup’s revenue, costs,
debts, and assets, and they may get on the phone with the company’s CFO
or CEO for more information.

Even with those steps, however, there’s an element of risk in turning
over some aspect of your IT operation to an early-stage company. "On
the Web, you try things knowing they may not work," Brady says. "If
you’re not failing a couple of times a year, you’re not trying hard

So far, so good with Aggregate Knowledge. The discovery engine makes
content recommendations to WashingtonPost.com visitors, resulting in a
stickier Web site. That’s key to enterprise acceptance–a startup’s
ability to demonstrate that its technology delivers an advantage that
can be measured in dollars, customer loyalty, or speed to market.

And if that technology can be implemented with minimal fuss, it stands
a much better chance. The popularity of Salesforce and other on-demand
software has as much to do with ease of implementation–no software to
install, no servers to manage, no massive upgrades to deploy–as it
does with ease of access for users. Software as a service can spur IT
departments into action in response to user interest–or take the IT
department out of the equation entirely.

To encourage startups to write software for its expanding ecosystem,
Salesforce in April opened a Silicon Valley incubator where
entrepreneurs can get office space and business support. In the first
seven months of the program, 34 startups have signed up, including
Right90, a developer of sales forecasting software for manufacturing.
Right90 had only three customers in its first two years of business.
Since offering its software on Salesforce’s AppExchange online
marketplace, Right90 now has 17 customers.

The appeal to startups is obvious: They get to host their apps in
Salesforce’s data center and have access to its growing customer base.
What’s in it for IT departments? For one thing, they can spend less
time vetting the scalability and security of the startup’s on-demand
facilities because Salesforce, having spent $100 million on redundant
data centers over the past three years, already has passed muster.
"You’re piggybacking on all the work that we’ve done," says Ariel
Kelman, Salesforce’s senior director of platform product marketing.

The result is that big businesses are more likely to give the
incubator’s startups a chance. Right90 signed electronics company Sharp
as a result of its relationship with Salesforce. Now Right90 has an
influential reference account when it approaches other potential
customers. "It’s huge for us," says Paul Connolly, Right90’s VP of
business development. "You really need an enterprise-scale early

That’s especially true for startups trying to sell big-ticket items.
The average selling price for Aveksa’s enterprise access software is
$300,000, with a sales cycle of six to nine months. "This is a
strategic sell to a head of security," says CEO Taneja.

Saeed Amidi, president of PlugandPlayTechCenter .com, a Silicon Valley
tech incubator, estimates it can cost an enterprise software startup
from $50,000 to $100,000 in sales and marketing costs for each new
account it signs. The rule of thumb, he says, is that such companies
need $20 million in venture funding to sign up enough customers to
sustain themselves.

That’s too steep an admission fee for many entrepreneurs, who are
tossing the old sales model. Spiceworks, for example, is having success
distributing ad-supported help desk software–no licensing fees
involved–while Web 2.0 startups such as Ning are trying to appeal to a
mass audience. Andreessen’s advice to entrepreneurs: "You’re much
better off starting a company aimed at a market that wants to adopt new
technology, such as consumers, or a self-service model for workgroups
or small businesses."

Startups like 1-year-old Techrigy in Rochester, N.Y., start with a few
tire kickers, then build from there. In October, Techrigy released its
first product, software that monitors what employees and outsiders are
saying about your company online. It has its foot in the door of two
companies–a consulting firm in the United States and a
telecommunications company in Italy–but both installations are modest
in size. "The first customer is always the hardest," says Techrigy
founder Aaron Newman.

IT departments need to pay attention to the fresh ideas coming from
companies such as Aveksa, Right90, Techrigy, and Zenoss. "If CIOs don’t
take a chance on new technologies, they run the risk of missing out on
the breakthroughs that can help propel their business," warns Credit
Suisse software analyst Jason Maynard.

Worse, if too many IT departments slam the door on startups, it becomes
a self-fulfilling prophesy where innovation dries up for everyone. So
do your homework, then give a startup a chance.


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