With headlines declaring instant riches for 20-something entrepreneurs and the hype machine pumping up mega IPOs, it's easy to forget that the majority of startups fail. Most don't even get funded, never mind getting off the ground and out of the garage.

Prologue
Money makes the world go IPO
No Visa, no cash
Show me the exit
Wrestling with recruitment
No longer fun
Can't get along?
Changing times, new challenges

Prologue

Those that do manage to get funded, build a team and launch a successful product have almost all survived rough patches and lean times, overcoming what sometimes seem insurmountable barriers. The reality behind the easy-riches startup myth is a world fraught with challenges - low salaries, constrained budgets, long hours, technological foul-ups, management mishaps and employee tensions are more often than not part of the ramp-up toward startup stardom.

"At all of our portfolio companies, we always see moments where the line between success and failure is very thin," says Frank Verschoor, a managing general partner at Amsterdam-based VC firm NeSBIC. "When the going gets tough, the real basis for future success is being laid out, but that doesn't mean there aren't some tense moments."

Many entrepreneurs steer their startups through these rocky times with a combination of determination, careful thought and long-range vision. Getting them to talk about the past is another story. If a company fails, the industry vultures set about analyzing what went wrong. If a company succeeds, the world doesn't hear about its near disasters. "You have to do things you have no idea how to do, and sometimes you have to get it wrong to get it right," admits Franck Jeannin, founder and CEO of British startup LinkGuard. Before launching LinkGuard, which provides a technology that fixes broken links on the Web, Jeannin was part of the core team at Business Objects, where he says "we almost ran out of money." Finding cash to start LinkGuard was easier, but has brought another set of challenges for Mr. Jeannin, mostly on the recruitment front.

Business Objects, now a successful public company, is a key example of how financial instability can be the biggest thorn in a high-growth company's side. Without financing, it's impossible to develop. But without a developed business model, it found it hard to get funding. Many other startups have gone through, or are now going through, lean periods of belt tightening, when all available capital is being drilled into development. Forget about salaries, forget about marketing, when the capital is low, most startups sink it into getting the first version of their product or service out the door.

Germain Bourgeois co-founder and CEO of Adesoft, a workflow software company based in Paris, knows all about what it's like to operate on a shoestring. He started the company in 1993 with a fellow student, Olivier Pillon, and couldn't convince any investors to fund the venture. The company - comprised of just Bourgeois and Pillon for the first few years - thought it would be able to get VC funding, but there were few VCs in France at the time, and what few there were "weren't about to invest in a 23 and 24-year old in a garage," Bourgeois said. "The criteria for VCs was a senior management team and a solid company, but we were just two students straight from the laboratory." They turned to banks, but they mostly said no, "because we didn't have any revenues, so we turned to government organizations."

With about 60,000 francs in bank loans to start with, Bourgeois and Pillon went without salaries and worked late into the night developing the software algorithms that became the Adepro workgroup calendaring product down the line. "We worked for the glory," he says, not hiring anyone until 1995. It wasn't until 1998 that the company snagged 2 million francs from a government organization aimed at fostering high-growth companies, but even after that, Adesoft ran on a shoestring. With a recent capital injection from investment house 3i of 1.6 million euros, things should get easier, but Bourgeois admits continual investment in R&D and an expanding staff (now 15 people and expected to double this year) means the company "still has to tighten the belt," paying its directors below market wages in return for stock options.

Thierry Levy, founder and CEO of Quiz Studio, a Silicon Valley-based developer of Java applications for online surveys and quizzes, also spent many moments praying to the cash god. After founding his company in 1993 in France, Levy decided to up stakes for California in 1997, when he realized there was no market for his products in France. This is another barrier many European (especially French) entrepreneurs have had to face, being forced to move their companies to countries with more favorable business and regulatory environments, facing new markets they often know little about. "We went where the market was," he says. "We would not have survived in France."

No Visa, no cash

With $200,000 in seed capital from a small French VC firm and a government grant, the three-person Quiz Studio was able to develop a prototype of its software. After demonstrating the software at the Internet Showcase in San Diego in January 1998, Levy decided "it was time to make a leap of faith," and cancelled his return ticket to France. With no visa, no cash, no place to live and no other team members, Levy set up shop in San Francisco.

"It was way harder than I thought it would be," he says of his early days in the Valley, where he lived on a diet of pasta for many months to save money. Without a credit history, he had trouble securing an office, getting phone lines installed and opening a bank account. Then, without any network to speak of, he couldn't get any VCs to speak to him, let alone potential customers. "I was naïve at the time, I thought because our technology was so good we stood a chance, but we didn't," he says. "In the Valley, 98 percent of companies that get financed are founded by people in the in-crowd, they know people who know people. If you are not in the in-crowd, you're an outsider."

Shunned by Valley VCs, Levy scraped together his last few dollars and booked a plane to France, where he was able to get a further $400,000. With this cash, he moved the other three team members to California and began developing the next version of the product. "It was a very, very difficult situation; we were running out of cash." In January 1999, when Levy says the company "was at the end of its tether," he remembers phoning his original VC to ask for a further $150,000. "Everything hinged on this phone call, if he said no, that would have been the end of it." Fortunately, the VC coughed up the cash and Quiz Studio was able to operate "on a very tight ship" until it signed its first major contract for $600,000 in August. Quiz Studio is now on the lookout for $2 million in funding from French and UK VCs.
 

Show me the exit

Entrepreneurs aren't the only ones who get sweaty when the cash dries up. Investors want to see their money being put to good use, but many startups burn more than they first anticipate, requiring a further capital injection to keep things afloat.

Take for example Versatel, the Dutch telecom provider funded in part by NeSBIC. The telco was almost acquired in 1998, but the deal fell through at the last minute because the acquirer was acquired itself, explains NeSBIC's Verschoor. "At that moment, they were very short of cash," he says. "They had to change direction into a broadband facilities provider - and for that they needed a hell of a lot of a money, not even in the VC ballpark." By securing a high-yield debt offering, the company was able to pull through and go public on NASDAQ last fall. But at one point "NeSBIC almost thought of pulling the plug," Verschoor says. "If they hadn't got money at that moment, Versatel would have been in big trouble."

Sometimes, the only option in a cash-strapped situation is to sell out to a larger player. Claude Amenc, CEO of Nagora, a French Web communications agency, did just that in 1997. One of his earlier companies, IT services firm Ingenia, thrived for the first six years without much funding, turning a profit each year. However, in the seventh year, the company ran into financial difficulties and came up with losses on its balance sheet. "We watched our contracts slow down," says Amenc, who went looking for investors and partners, but instead found a company interested in buying Ingenia. "I had to ask myself, do I continue independently, or lose my independence but ensure a future for my employees and investors?" remembers Amenc. He chose to sell Ingenia in an all-stock transaction, which ended up being highly profitable when the acquiring company doubled its share price in the subsequent months. "We learned how to live through the difficult periods as well as the strong periods, which has given us (the team) strength in our new ventures."
 

Wrestling with recruitment

Obtaining funding is one challenge that is getting easier and easier for European startups. Today, with the European startup market awash in cash from VCs, corporate funds, incubators and angels, companies are choosing the investors that best suit their needs. Once you've got money, you need to start spending it wisely - and a large part of early spending is on salaries. First you have to find employees.
Recruitment in today's skills-strapped job market is the most difficult task, agree many entrepreneurs and investors. "I thought money would be the problem," says LinkGuard's Jeannin, "but the main challenge has been recruitment." Back in the early days of LinkGuard's short history - Jeannin founded the company in March 1999 - Jeannin hit two major snags in the recruitment process. In the summer, the company hired a webmaster to join the then three-person team.
"We thought she was great, and she was, only after a week I caught her forging my signature on a fax to her bank saying she made twice as much as she really did," explains Jeannin. "I had to fire her immediately." Then, LinkGuard signed on a Russian programmer, who had to be let go shortly after he'd started work. "I'm a strong believer in trans-national culture," says Jeannin, a Frenchman living in England. But this time, the employee's approach to work was too at odds with the startup mentality at LinkGuard. The developer had little initiative and "if you didn't tell him what to do in the next five minutes, he was lost," says Jeannin, "so we had to terminate his contract as well."

LinkGuard now has 12 people, but the company is looking to recruit many more developers and managerial staff members by year-end. The company offers bonuses to staff members who can lure new employees, plus uses six or seven different recruitment firms, but Jeannin finds these agencies more or less unhelpful in finding the right people for a startup team.

"We're operating in a very, very strapped recruitment market," agrees Adesoft's Bourgeois. The team is looking for managers, developers, accountants and marketing staff. While many young people are keen to join a startup, managers and senior executives in France aren't yet convinced that making the jump to a startup will pay off in the end, especially with the complications surrounding the granting of stock options in France, he says. Meanwhile, the "market for developers is especially delicate," adding "we've had to go hunting at our neighbors."

Finding the right people is just half the battle; keeping them can be just as precarious. Especially in later-stage startups that have grown beyond the "10 people in a room" stage, employees can begin to feel neglected, overworked and underpaid, says Olivier Maire, manager of Europe, a management consulting firm based in Paris that works with several mid- and later-stage startups. Once the company begins to expand into more regimented departments, people become unclear what their roles should be, says Maire, whose firm recently published a study on the "Nine Top Worries of Entrepreneurs," surveying 40 French startups.

No longer fun

"The question should not be, 'who do I need to recruit?' but 'how do I integrate them?'" Maire says. Many entrepreneurs don't understand why their employees leave, thinking they up stakes simply for higher salaries and more stock options at another firm. But it's not just for money that people leave, it's often because it's no longer fun or interesting to work at the original company, which has grown in all directions without thinking of how to make teams feel a part of the whole, he says.

"The huge problem is not only finding people, but retaining them," agrees Quiz Studio's Levy. Especially in Silicon Valley, if you aren't financed by a big-name VC and can't offer enormous salaries and stock option plans, your employees won't stick around long, he says. "Our development team has been together three years," says Levy, which people find strange in the Valley, but also quite an achievement. By hiring French developers and importing them to the US, Quiz Studio has been able to avoid some turnover issues, but is now up against the difficult task of finding - and keeping - US-trained marketing and sales staff. CAN'T get along?

In fact, a team that doesn't gel can end up being more than a sticky point for some startups. If the team doesn't get along, especially top management, it can sound the death knell for a company's future.

"One company we were in had an initial product launch that went completely wrong," explains NeSBIC's Verschoor. The founders and managers began to butt heads, he explains, and NeSBIC had to do some soul searching as to whether the venture was credible enough to merit further funding. The firm did decide to invest further, but not until the management team was replaced. "It was a real rollercoaster ride," Verschoor says.

For Adesoft, the fact that the two founders were first and foremost friends is key to its survival, says Bourgeois. "When there were tensions and we disagreed, we were able to move past them," he explains. Many startups fail simply because of team friction, he says, but "that was one problem we didn't have, because we can lean on each other." Even though they already spend countless hours during the week together, the two founders sometimes hang out on weekends and spend vacations together.

Changing times, new challenges

Whether it's obtaining a first round of funding, or working through personality conflicts among staff members, startups have always faced obstacles along the road to success. However, with money getting easier to find and recruiting getting all the more strained, today's entrepreneurs are looking at a new set of challenges from their forebears, who almost always had little cash and even less support. Today, the biggest challenge is speed.

"Startups face the same problems as larger companies, only on a much faster timescale," says Europe's Maire. Instead of going through cycles of six or seven years, startups face the gamut of barriers within the first year. Because of this speed pressure, many startups put structures in place randomly, with little anticipation for the future, he says. When startups are in the hyper-growth phase, they don't notice upper-level problems with management and direction, but what they are losing by not acknowledging these issues is productivity.

"When a big company messes something up, it's apparent from the outside," says Maire. "When a startup makes mistakes, it comes out more in performance levels." While a well-oiled startup may be producing at 200 percent, a less focused one will only attain 150 percent, he explains.
"Getting referenceable customers, rolling out technology, assembling a balanced and complete management team and getting a marketing position out there" are the biggest challenges for today's startups, says NeSBIC's Verschoor. "Some people think there is so much money now, it is easy to build a company, but once you get the money there is still the huge race against the clock."

No one ever said creating a startup was an easy job. Getting near the ledge, yet turning things around to avoid defeat, is often part of the process. Regarding those entrepreneurs who seem to coast through funding, recruitment, product launches and onto a stellar IPO; if you dig deep enough, I'm sure you'll find a few months of pasta dinners in their closets.
 

Source: Kristi Essick, Tornado Insider, March 11, 2000