A few years back, several close friends of mine worked for a remarkable startup. Their trajectory was incredible, growing from $0-$75+ million dollars in their first 4 years and becoming a recognized brand name in the process. At its height, the company employed more than 130 people and their products reached customers in dozens of countries. After being featured in hundreds of publications, online and off, they were both national media darlings and the envy of the local community.
But, tragically, 3 years after their apex, this firm sold for less than their annual revenue, laid off nearly the entire staff, and left common stock shareholders, my friends included, with nothing.
What happened? How? Why? And, most importantly, can we learn from the pain and heartache this company went through in its final few years?
I’m intentionally anonymizing the identity of this company and my friends who worked there, so there’s no big reveal at the end. Unfortunately, I can’t write about the company transparently, because I’d be sharing stories and details that aren’t mine to share (and I haven’t asked everyone for permission). To make things easier in the post, though, I’ll refer to the startup as “Anonyware” from here on out.
In the early days, Anonyware’s founders had a great idea and amazing execution. They created a product customers loved, found unique and scalable ways to market and distribute their creation and focused intensely on two things: product quality and company culture.
Culture, in particular, was central to the Anonyware’s success and to the dedication of the employees. Many of my friends took salary cuts and invested thousands of hours of overtime to work there. The company focused on the importance of loyalty, investment in people, empathy and family. The theme of Anonyware as a family was, perhaps, the strongest of their cultural tenets.
Several years into the business, things were going amazingly well. Anonyware had close to $100 million in revenue with their core products. They employed dozens of people and their distribution and sales were on track to grow dramatically over the next few years. The founders, however, had a disagreement.
The CEO wanted to take things “to the next level” – seek another round of venture investment (though they’d recently become independently profitable) and use the money to expand into new fields and dominate not just their industry, but the entire sector. An analogy might be a company like the Netflix of 6-7 years ago moving into movie production, television programming and hardware manufacturing.
Anonyware’s co-founder disagreed and wanted to continue focusing on their core products and put the profits back into growing out new projects one-by-one. The co-founder reasoned that costs were high, and they were in a business based on big hits, so the expansion into many new niches could be a massive risk.
I don’t know the reason, but soon after these discussions, the co-founder left the company and the CEO raised a large venture round (we’ll say $50 million for purposes of this story). The money was used to add another 60 people to the team, contract the development of the new products, find distribution channels and expand marketing and advertising.
Simultaneously, the CEO was gaining prominence in the entrepreneurial community and the media. Articles in the press lauded his accomplishments and charisma – and he was charismatic. One friend told me “I would have followed him off a cliff. He made me believe in Anonyware – and in myself.”
This prominence appeared (to my friends) to have a peculiar, adverse effect.
Curiously, the CEO hired an exceptionally attractive young woman to be his executive assistant, despite questionable qualifications (no familiarity with MS Office, no history in the field). He bought a new, luxury sportscar that, according to another friend, “didn’t fit with the image I had of him.”
The CEO also began micro-managing more than he had historically. Tiny decisions like colors and layout design had to get his approval. Even though there were more projects and more work than ever before, it was harder than ever to get things done. Employees told me they perceived that the CEO injected his opinions in every part of every development in the company.
Anonyware’s success in its original product line continued – growth in the US slowed as they reached some market saturation, but overseas sales were terrific. Unfortunately, the new products had massive development costs and even though a few were relative hits in new niches, they couldn’t offset the costs. In the final year before the sale, Anonyware’s losses were close to $100 million.
That last year featured more tragedy than just the losses. Three rounds of layoffs left the remaining employees’ morale in the gutter. I remember meeting some friends at a bar after one of these layoffs, and it was heartbreaking. The laid-off employees were worried about how they’d support their families and pay their rent, and they worried that the stock and options they held would be worthless.
The CEO, meanwhile, separated from his wife, and began a personal relationship with his former assistant, who now held a management role at the company (I don’t know the order of events, but as you might imagine, many of the employees felt these actions did not embody the spirit of the company’s core values).
With Anonyware’s losses building, a fire sale was imminent. There were only a few potential acquirers, and only one was serious. Without multiple bidders or an alternative (outside funding or cutting costs to stay profitable and make up debts), the final price was considerably lower than the previous year’s revenue. Assuming we use my previous funding number of $50 million, the company sold for ~$110million total (on revenues of $150 million). The second-round VCs, though, had a 2X liquidation preference, meaning that the first $100 million went to the venture investors, while the remaining $10 million went to founders and some of the first-round investors.
The employees, even those who had purchased extra stock during their tenure, were left with nothing. The acquiring firm laid off the remaining employees with the exception of a small transitional team.
The CEO made a few million dollars (the exact split wasn’t disclosed, but some senior management filled me in on the liquidation preference and the funding quantity). He was lauded in the press for having a big, “successful” exit (the rough price of the transaction was leaked, though the company’s revenues stayed private). He is still active in the startup community. Many people still speak reverentially of him.
The Lessons I Took Away
It’s hard to know how perfect my information about this situation is (another reason I’ve anonymized the names and kept details out of the story), but I trust the sources and the ratio of revenues, losses, final price and outcome are, to my knowledge, accurate.
Over my career at SEOmoz, there’s rarely been a time I don’t think about the story arc of Anonyware. My perception has been that after the product-market fit is reached in a startup, and revenue/profitability are achieved or in sight, the primary risks faced are perfectly reflected in Anonyware’s story. Since I’ve only had one startup experience personally (I’ve been at the company that became SEOmoz since 2001), I try to internalize and learn from the mistakes of others. Anonyware is a big part of that.
The following are the lessons that have stayed with me from this experience:
1) The minute you start believing that you’re something special – that you’re the smartest, most talented guy in every room – is the minute things start to fall apart. Although I surely fail sometimes, I try to stay humble and never let a little progress or a big success make me believe I’m smarter or better than the people I’ve hired and trust to do the job right.
2) A CEO, more so than any other employee, needs to live the company’s culture. Core values are set at the top, and they flow from the top. When the CEO doesn’t live up to the expectations created for the rest of the company, everyone’s in trouble.
3) Those values you set for the company must be reflected not only in your professional life, but in your personal life, too. Don’t create a scenario where your employees can’t respect you because of poor personal choices.
4) Expanding quickly into new sectors can be a good move, but growing too fast without the security of capital and profit from other parts of the business is a dangerous game, especially when you’re growing off the back of invested or loaned capital.
5) If your stock or option-holding employees don’t come out positively in an exit, that exit IS NOT a success. If I left SEOmoz with a multi-million dollar exit, a positive press profile, but little or nothing for the employees who’ve dedicated years of their lives to the endeavor, I’d consider it a failure.
6) Micro-managing is dangerous, particularly when you hire talented senior management. Those managers can’t do a great job with a CEO second-guessing their every move and, perhaps worse, great managers won’t tolerate micromanagement – they’ll move to greener pastures leaving the company with second-tier talent.
7) If you take venture capital, watch out for the terms. In this case, liquidation preferences killed the returns for employees. Had Anonyware stayed on their previous, profitable track, they wouldn’t have been desperate and wouldn’t have taken a lowball price. (more about liquidation preferences in this post from Fred Wilson)
These aren’t the takeaways everyone would have, but they’ve stayed with me these past few years as my own company has grown. And when I see my former Anonyware friends, I still viscerally feel the impact its collapse had on them.
p.s. Comments guessing at the identity of the company won’t be published. My intent is not to tarnish anyone’s reputation or name, but to share my takeaways from the experiences of others.