Forty-seven billion dollars. Such was the valuation of WeWork just months ago. “How do you change the world?” founder and CEO Adam Neumann asked at the time. “Bring people together. Where is the easiest big place to bring people together? In the work environment.” And with such big dreams, he steered the company towards a public offering.
As we know, the valuation has now plunged by over 80%, and the company is on the brink of bankruptcy. It’s scrambling for cash in an effort to stay alive and continue to serve its customers.
The world of venture capital-funded startups is full of romantic tales of glory and riches. But much less publicized are the stories of failure.
Most startups fail before they get to critical mass. But while WeWork’s flameout is on an extraordinary scale, the failure of startups that have come to serve significant numbers customers is quite common. (If you’re curious, here’s a list of 179 such collapses.) And while investors bemoan any business startup failure, the greatest damage done is to customers left abandoned as a result.
Customers entrust mission-critical processes with startups, often without fully realizing the risks they are taking when they give their business to financially unstable firms. When such startups suddenly collapse, not only are customers’ businesses badly damaged, so too are the careers of the employees responsible for the vendor relationships in the first place.
Examples of such disasters abound; here’s the reaction of a CIO who found that his CRM platform provider had gone bankrupt:
“Then the day arrived. I got a phone call telling me that the provider had gone under…We were put on notice that in 24 to 48 hours that all of this was being turned off.”
This risk to businesses, as well as to people’s careers, is an inherent product of our venture capital-funded startup ecosystem. When vendors are funded by speculative investment rather than their own economic success, they can appear robust when, in reality, they’re startlingly fragile.
This phenomenon is on full display in the marketing technology ecosystem.
How do vendors get in such perilous situations? And why marketing technology is currently in such a dangerous period? Most importantly, how can you mitigate these risks and ensure your mission-critical technology doesn’t disappear overnight?
The Perils of Hype
Startups are exciting. And they should be. They have ushered in some of the most dramatic transformations to how we all live and work. Google, Apple, Salesforce, and Adobe are all examples of businesses that started in garages, received VC funding, and went on to change the world.
Venture capital funding is an integral part of the formula for these game-changing startups. Here’s how it works, from the startup perspective:
- Build product
- Make money
The opposite sequence is not feasible. VC dollars enable startups to lose money early while they build their product with the goal of eventually making money and earning high returns for their VC investors.
This process is so routine that there is an identified recurring process, called the hype cycle.
A new technology or business model emerges, called a technology trigger. For example, there’s the new notion of the “shared economy,” and entrepreneurs all rush to build “the Uber of X.” VC money flows in to invest in these startups. Customers rush to try out the new technology.
But then the hype becomes excessive. Customer excitement starts to wane. Business becomes much more challenging. And these new categories slouch toward the trough of disillusionment. And here in the trough of disillusionment, companies either die off or transform.
Transforming companies focus on the needs of their customers. Often they focus on a particular segment of their customers (e.g., just small-scale financial advisors or just suburban teens) to really nail the needs of a certain group. The ability to satisfy customer needs in a profitable way is the essence of any business, and focusing enough to do so pulls these businesses out of the trough and into enduring success.
This transformation takes both time and a reckoning with the financial reality that a business must eventually graduate out of VC dollars and into the kind of sustainable profitability that comes from serving customer needs. Thus in a seeming paradox, it is often the startups that raise relatively less VC capital that succeed in the transformation of the trough, since they cannot use VC dollars to ignore financial reality and, having raised less money, they have lower growth expectations from their investors and can thus place more focus on transformation.
Startup death can take many forms. But for startups that make it up and over the hype peak, the death that is most dangerous to customers is that of a startup that should have died long ago but remains alive artificially due to life support in the form of VC dollars.
These startups ride up the hype wave and bring in large quantities of VC funding, allowing them to avoid contending with financial reality and instead throwing their efforts behind revenue growth rather than on making customers happy.
In a perpetual rush to make the next sale, these startups often have low customer retention and thus need to spend heavily in sales and marketing to sustain revenue growth.
These startups continue to lose significant money—often multiple millions of dollars—year after year. They continue because their investors are loathe to acknowledge that their startup has failed, and continue to pump money in to keep it afloat.
Here’s the scary part: From the customer perspective, the startup appears robust: It spends millions annually to build its technology and market its offering, which to most people seems like signs of health. But once the VCs stop writing new checks, the lights will be shut off quickly and customers left in the lurch.
Hype and MarTech
I know this story well from my experience as the co-founder and CEO of a marketing technology startup, Kapost, which provides B2B content marketing software to the world’s leading marketing organizations.
In the early 2010s, when Kapost was a fledgling company, there was a huge surge in VC funding in marketing technology, sparked by the realization that CMOs were on track to spend more on technology than CIOs. The hype spiked in Kapost’s sector, content marketing, around the same time, when it became the must-have strategy and technology.
But as always, that hype didn’t last forever, and the shine soon began to fade from content marketing.
In this period, many of our competitors continued to raise and spend large quantities of money (our two major category competitors raised $80M and $100M, respectively). They had huge valuations and were forced to pursue as much revenue as possible from as large of a market as possible.
At Kapost, we took a different path. As we saw the dip into the trough of disillusionment, we pulled back on spending. More importantly, we had the support of our board to take a step back and consider our business and chose never to raise more capital (our total was just under $20M). Instead, we spent time listening to our customers and recalibrating our strategy.
First, we realized that we needed to focus on a smaller market segment so we could really nail their needs. B2B marketing organizations were the subset of customers of ours that were having the greatest success, so we focused there.
Second, we reflected on what we were actually hearing from our customers. While most people in the industry were talking about “content marketing” and “brand journalism” at the top of the funnel, our customers told us a different story. They told us about their struggle to manage all content across the entire journey: Yes, top of the funnel assets, but also less sexy assets like emails, sales presentations, and quick start guides.
So instead of “content marketing,” we shifted our focus on a competency that SiriusDecisions and we were pioneering: content operations. We developed KPIs to measure the success of our customers’ content operations. And we made the achievement of those KPIs the major focus of our entire team: not just customer success, but services, engineering, and even sales, who had to qualify and educate prospects around those KPIs properly in order for the entire process to work.
With this transformation, our customers received more value from us, our retention rates improved, and we became profitable.
So when Upland Software started looking for the right content software vendor to buy, they quickly saw Kapost’s industry-leading retention rates and profitable business model as the obvious choice. And while we at Kapost had a profitable business and did not need to sell, we saw Upland’s vision for an industry-leading suite of marketing and sales enablement products as the best path to continue our vision of serving marketing organizations.
But from what I’ve seen, this approach of focusing on a smaller market, slowing spending, and achieving profitability is the exception, not the norm, in the marketing technology sector. And we’ll soon see where this leaves those that took a different path. Overall the hype for marketing tech has subsided, and VC investment in the sector is in sharp decline: Forrester predicts that investment in marketing and ad tech will drop by 75% in 2019 from $7.2 billion to $1.8 billion. Furthermore, Scott Brinker, aka Chief Martech, the guru of marketing technology declared in September of 2019 that marketing technology is in the trough of disillusionment of the hype cycle.
What many of our peers are left in is a dangerous position: When the hype dies off, VC firms stop writing checks, and for many marketing software vendors whose expenses dramatically exceed revenues that can mean a sudden end to their business.
The result? Marketing software buyers and managers may soon be left with an abandoned system if they’re not careful.
Imagine having a content marketing system implemented with hundreds of users and thousands of content assets. This content is the lifeblood of both the marketing organization and the revenue machine of your business. And if your vendor, kept solvent through VC checks, suddenly flew off a fiscal cliff and shut off your systems, the effects on your business would be disastrous.
How to Stay Safe
But fear not: There are steps you can take to avoid the calamity of your vendor having a financial catastrophe. As a software customer, you have the right to request the financial records of your vendor. As the CEO of a software vendor, I can tell you we do this all the time. We see this particularly around RFPs, but often customers simply ask for a check-up. I’ve always been surprised that every customer did not partake in such regular checks.
As part of this check, the vendor will likely request that you sign a non-disclosure agreement (NDA). The NDA simply states that you will not publicly disclose any of the financial information you receive from the vendor. As long as you have no intention of publishing the vendor’s financials, executing an NDA provides no risk to you. In fact, I recommend that you delete the vendor’s financials after you check them so that your risk is fully eliminated.
If you are willing to sign an NDA and the vendor is not willing to share their financial information with you, mark my words: That vendor has something to hide.
It is also important to insist that the financials you review are audited financials prepared by an independent third party. Many software vendors play games with their numbers, especially in the subscription world of software-as-a-service (SaaS). Only with audited, third-party financials can you be sure that you are looking at GAAP (Generally Accepted Accounting Principles)-compliant numbers. Again, this is standard, and we at Kapost do it all the time. If a vendor is unwilling to provide this, you should be concerned.
What you should be looking for is the track record of financial stability and self-sufficiency.
If a company is less than four years old or shows hyper-growth—i.e., a revenue growth rate greater than 75% per year—losses are expected (though this is a risky stage).
However, consider it a red flag when you see losses from a vendor that is…
- more than four years old
- not in hyper-growth
- losing a material amount of money (more than $2 million per year)
These vendors are very risky—the change in the whims of a VC could mean a sudden collapse.
The risky state of content MarTech poses great risk to marketing software customers. But you can mitigate the risk by reviewing the financial information that you are entitled to seeing.
Don’t end up on the wrong side of the next WeWork!