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Before investing in a CRM application (and consequently in its maker), how can you pick a vendor that will be around in the future? The process is far from an exact science, but you can improve your odds by following the example of those who invest in CRM companies for a living: venture capitalists. Before providing financial backing to start-up companies, these investors thoroughly research and analyze them to determine if factors essential to success are in place.

Though this process may be much more extensive than you can undertake, asking the basic questions venture capitalists ask about a vendor's management, the market, customers and competitive advantage can enhance and secure your investment in CRM technology.

"Apply the same standards to the problem that the venture capitalists do," advises Steve Waters, vice president of marketing for FirePond, a CRM solutions vendor that has successfully completed several rounds of venture capital funding since 1997. "Look at the company's vision, its ability to execute its business plan and the strength of its management team," he advises. "Don't be seduced by hype; focus on fundamentals."

Spare A Dime?
Those fundamentals guided an enormous amount of VC investment last year. According to VentureOne, a San Francisco-based firm that tracks venture capital, total VC investment in the United states reached $12.5 billion in 1998, a 12.5 percent increase over the prior year's total of $11.2 billion. Information technology accounted for over 60 percent of that amount, with roughly $143 million going to sales/field force automation companies.

These figures represent the culmination of a financial courting ritual in which entrepreneurs try to convince venture capitalists to give them money in return for what is usually a minority stake in the company (see "Ain't Too Proud To Beg," this article). For their part, venture capitalists want a very high rate of return-typically, says one investor, "from 50 to 100 times my original investment."

"One vendor described the due diligence process by simply saying, "The horror, the horror."

The ritual that brings VCs and would-be software barons together goes something like this: Through networking, advertising or other channels, entrepreneurs connect with venture capitalists, to whom they give a proposal and a business plan. VCs then study the plan, which more times than not ends up in the garbage. "We fund about 20 to 30 companies a year, but we get 2,000 to 3,000 proposals a year," says Brad Jones, general partner of Brentwood Venture Capital, which recently invested in field force automation vendor FieldCentrix.

Those few companies that make the cut are then subjected to a grueling due diligence process during which VCs try to find out everything there is to know about a company, its management and the market. (One vendor described the due diligence process by simply saying, "The horror, the horror.") The venture capitalists use their findings and their own expertise to determine if this company will succeed or fail. "It is not unlike the process of going public," says Waters. "It is a deep assessment of your ability to do business and your ability to get to market."

It is from this "deep assessment" that the fundamental VC criteria for business success emerge. Though they vary from firm to firm, as a rule venture capitalists focus on the following areas when considering making an investment: (1) management; (2) market; (3) customers; and (4) competitive advantage. Can this management team lead the company to success? How does this company fit into the market, and what is my potential return? What do the company's customers think about its product? And finally, what, if anything, gives this company an edge over its competition? A closer look at how venture capitalists answer these questions offers sound advice for investors in the CRM market and for customers like you.

When evaluating potential investments, perhaps nothing is more important to venture capitalists than the quality of the company's management team. These are the people who will guide the company to success and craft its viability, and they must show exceptional promise. While this may sound like a no-brainer-good people are important to any endeavor-venture capitalists view it as absolutely essential. To them, a successful manager has a mix of experience, moxie, brains and vision. "If we are focused on the CEO, for instance, generally this person has run another business of some size," says Jones. "We tend not to invest in people who are just smart and energetic. We get a lot of people coming to us who are smart and high energy and they think that is enough. It is not. You need experience."

Jonathan Flint is a founder and general partner of Polaris Venture Partners, a VC firm that recently invested in Incentive Systems, a vendor whose software manages sales incentive plans. Flint says that even solid experience is not enough. "We are looking for people who are extraordinary entrepreneurs. Brains are cheap. We want people who are not just smart, but creative. These people are visionaries, with high integrity and a history of accomplishment."

VCs interview management team members extensively, just as an employer might interview a prospective hire, because in a way, that is what's happening. VCs and management work closely together as the company grows, a situation that requires both professional and personal compatibility. David Lane is a general partner in Alpine Technology Ventures, which recently invested in On The Go Software, a maker of expense management applications. Lane likens the working relationship between entrepreneurs and investors to a marriage. "When you invest in a company, you are marrying that company until you are able to achieve liquidity or the company is sold," he says. "You have to understand them from a personality standpoint; there has to be a chemistry mix. This is someone you want to spend the next five years with."

More than ever, a vendor's long-term viability depends on its understanding of the market in which it operates and where that market is going. It also requires that a vendor's product clearly satisfy a need. According to Lane, the front-office automation market offers a unique set of circumstances that vendors must understand if they are to succeed. "With ERP and other types of deployments, you had low-wage, back-office labor that was forced to accept the solution being offered. As we move into the front office, this is not going to be the case. Here, you will find that the most highly valued employees-the ones who touch customers-will be able to push back on IT and force them to provide a solution that meets their needs."

The future of the CRM and other software also promises an almost complete reliance upon the Internet. "I think that any CRM application that doesn't have the Internet as the core implementation of its strategy will not get funding, will not be accepted by corporations and will not be successful," says Lane. "The Internet will revolutionize all business structures much more so than PCs."

Lane also cites application outsourcing, or "Web hosting," as a new trend that will transform the entire software market and the companies that compete in it (see "Host With The Most?" in The Edge, this issue). "In the future, companies with 15 to 20 employees, as well as Fortune 500 companies, will no longer run in-house applications. The Internet creates very inexpensive computing solutions that can get applications up very quickly inside of corporations at a minimal cost." Lane believes that only those who fully understand Web hosting and adapt their products to it will succeed in the market of the future. "This is on the very leading edge," he says. "Unfortunately, some entrepreneurs just don't understand it."

To fully understand the market, one must first understand the customer. Who is going to be using this product and does the vendor understand their needs? According to Flint, talking directly to customers is an invaluable way to gauge a company's potential worth in the market. "We look for a big problem that people want to get solved immediately," he says. "With Incentive, we made many, many calls to companies that had large sales forces. All of these companies had six to 10 very frustrated CPAs figuring out sales incentive compensation on Excel spreadsheets. After talking to them, we knew there was a need for this product."

Venture capitalists also expect entrepreneurs to have close contact and open communication with companies that might buy their products. "If an entrepreneur is smart," says Lane, "day one they are talking to potential customers. If they haven't, this is not a good sign."

Customer contact also provides entrepreneurs and venture capitalists with a better understanding of the competition. "We talk to prospective customers and find out how they like the features of the product and how they compare it to other products in the market," says Jones. "I would advise potential CRM software customers to do the same."

Competitive Advantage
By taking a "know thine enemy" approach to CRM software market analysis, venture capitalists try to determine if a potential investment offers a product with a sustainable competitive advantage over the competition. "We look for products which are deep, complicated, technology-rich products," says Flint. "We want products where you can come out with version one that begins to solve people's problems, then continue to add functionality to make the product even better. With each release you look for putting more distance between you and the competition. That's what makes a competitive advantage sustainable."

VCs also draw upon their own experiences and knowledge of the market to determine if a company has what it takes to get ahead and stay ahead. "The most interesting thing about my job is meeting with very bright, successful entrepreneurs every day," says Lane. "We have a lot of individuals coming in to present their plans. We meet with friends and associates and try to understand different viewpoints. We do significant networking to try to explore new and innovative ideas."

Likewise, Flint says that expertise in a given market requires an ongoing learning process. "We have been doing this for 15 years and we are aware of the markets and companies we think are interesting. We keep current on the latest technologies and we make a lot of calls to customers, CIOs, CFOs and others."

Follow The Leader
Venture capitalists, like all businesspeople, win some and lose some. No amount of due diligence can guarantee the success or failure of CRM software vendors in today's volatile market. But the fundamental criteria these investors use for picking winning companies are based on sound business principles, principles you can apply when shopping for a CRM solution. "Customers should spend time with the vendor's management and get a good feel for their strengths and their vision. They should also talk to some reference accounts," says Flint. "Bottom line, they should look at the things we look at." In the tumultuous quick-kill software market, today's uber vendor may be tomorrow's Chapter 11, leaving customers without support, upgrades or any competitive advantage. Too many well-intentioned companies are left stranded along an information highway littered with the wreckage of software vendors whose products worked more effectively than their business plans.

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