Bob Walters flew a fighter jet for 10 years before jumping into the enterprise software business. After stints at the likes of Informix, Red Brick, and Securant, he assumed leadership of Stratum8, a security software startup that managed to secure financing from the likes of New Enterprise Associates and BA Venture Partners in February of this year. In a candid conversation with Sterling-Hoffman's Managing Director Angel Mehta, the former U.S. Marine Corps Officer shares insight on leadership, raising capital, and being a first time CEO in what continues to be a tough market for Silicon Valley startups.
Sterling-Hoffman: Where does the name Stratum8 come from?
Bob Walters: The company was founded in Q1 of 2000 during the days 'when all things were possible.' The founding team was this exceptional group of senior technicians and senior software people; their vision was to change the way the Internet worked and they developed the software foundation for a family of appliances that operated at what they called 'Layer 8.' Let me explain further. The Internet is defined on the OSI as a 7-layer model that starts with the physical layer, the actual wires and then builds up to the application level. This Layer 8, also known as semantic processing, looks at the meaning of application data and code, in much the same way a compiler would. So the original notion of the company was to change the Internet by offering a family of routers, switches, load balancers and security devices that operated at Layer 8. Later, we identified web security as the key market where our team and technology could have the most impact and we now focus solely on that space.
Sterling-Hoffman: What is unique about the technology relative to other security start-ups?
Bob Walters: Roughly 80% of the work that's done in security today is classified as 'Network Security.' Network security deals with the individual packets that run on the Internet, and so today's firewalls and the IDS's are looking mainly at single packets at a time and at IP addresses. These devicess ask questions like: Where is this from? Where is it addressed to? What kind of packet is it? And then making decisions on whether the answer is 'good' or 'bad.' We, at Stratum8, turn individual packets on the Internet into 30 or 40-packet streams to reconstruct the bidirectional conversation between the Web server and browser. We parse that entire stream; we're looking at every byte in the stream just like a compiler would. So it's a very different level of processing. Gartner estimates that 75% of today's web vulnerabilities occur at the application level and firewalls leave the application level wide open.
Sterling-Hoffman: Are there any problems in terms of network security that are unaddressed right now by the offerings that exist? In other words, is there room for another security software vendor?
Bob Walters: Nope - we've got internet security all figured out (laughing)! Of course, there's plenty of them out there. There are two large areas that have not been solved adequately today. The first area is 'web services.' Web services are one of the plays that could be the 'next big wave' of the Internet. This newest version of distributed applications is changing the Internet, and IBM, Microsoft, Sun and other big players are 1,000% behind it. The Microsoft '.net' initiative is part of the web services play and web services security has not been figured out adequately. In fact, Gartner group and others say that security is the Number 1 impediment to the successful implementation of web services. Stratum8 is creating an offering for that space to follow-up on our current offering.
The other big area that is still vulnerable is 'wireless,' especially wireless LANs that are springing up all over the place.
Sterling-Hoffman: Have you found the adoption of wireless LANs has ramped up?
Bob Walters: Big time. Wireless LANs are kind of like Tribbles, for you Star Trek fans. I can set one up in this office in 5 minutes and it's so easy for a rogue computer to come and clone on to that node that it's a very big problem. Again, there are some start-ups that are seeking to address the issue.
Sterling-Hoffman: We know that security is supposed to be a priority for CIO's but are you finding the budgets loosening at all?
Bob Walters: I don't know if the budgets are loosening, it's kind of a paradox. Security definitely is a priority item for CIO's but I would also say that budgets are tight everywhere and security vendors compete for that same budget. So what that translates into for us, is that it's very easy for us to get meetings, do pilots and proof of concepts in companies because security is hot. Regardless, it's still a tough process even for a security company to get the check, to get the customer's order.
Sterling-Hoffman: Talking about getting the check, you closed the last round of financing when?
Bob Walters: February 5th.
Sterling-Hoffman: In an obviously difficult market for financing.
Bob Walters: Right.
Sterling-Hoffman: Tell me about the effort in that regard and how you managed to do it.
Bob Walters: It was one of the bigger efforts that the company or I have ever undertaken. Just as the Fortune 1000 and Internet 100 are interested in security, VC's are interested in security. There wasn't a great deal of difficulty in getting meetings with VC's. Our strategy was to find the best fit between the company and the investor. So we knocked on over 40 doors over a 4-month period. Happily, we had a great outcome. We had multiple investors writing term sheets and did a "Tier 1 round" of $10½ million.
Sterling-Hoffman: So what lessons can you share with other CEO's and entrepreneurs that are trying to raise money?
Bob Walters: First of all, try and pare your business model down to its core elements. I think large capitalization projects and 'we're going to go out and spend a lot of money and take over the world' just doesn't fly anymore. Have a model for reaching profitability that requires the minimum amount of capital that you think you'll need.
The one thing that I would do differently, if I were doing it again, is rather then linearly knocking on 40 doors, I would pick groups of 10 VC's and I would do them in phases. I would go out and have a dialogue. A typical dialogue takes maybe 6 weeks. Have the first couple of meetings and then see what is learned with that 10. I mean, maybe you get funded based on that 10 but if not then re-do your messaging, learn your lessons and then engage with the second group of 10. Do it in phases instead of one large process.
Sterling-Hoffman: Did you find that the venture partners you met with early on were willing to offer detailed feedback as to why they turned you away?
Bob Walters: That's one of the biggest challenges, trying to distill those lessons, because VC's, like most customers, have short-handed messages so entrepreneurs should make a dedicated effort to try and get a deeper more valid debrief from investors. A good way to do that is to talk to the actual venture partner in the group. Instead of getting the top-level feedback from the general partner or managing director that you've been dealing with, take the venture partner out to lunch and ask him or her "What did you really think? How can I improve my presentation? What's the real feel here?"
Sterling-Hoffman: You talked about looking for the best fit between the Portfolio Company and investor. What did you mean?
Bob Walters: Sure. Getting funding is a classic sales process and a lot of entrepreneurs think it's something else. They think it's something more strategic, like 'partnering' or 'bonding.' In truth, after the deal is done, you will be partners with your VC. But until then, you're selling.
The first thing that one has to realize is, 'people buy things from people' so if there's not an affinity between the entrepreneur and the VC, that's a huge signal to go on to the next VC. This brings me to another point. You can't be afraid to go on to the next VC nor can you have your feelings hurt by going to the next VC. For example, if I'm selling my product and customers don't buy it, that's okay, because it's my product and customers don't buy products all the time. However, if I'm selling a piece of my company and by extension, a piece of myself, and the VC doesn't buy it, that's horrible and I feel that I have to somehow remedy that, I have to somehow fix it. The fact of the matter is, just like in a product sales cycle it's quite probable that there is no remediation, there simply wasn't an affinity between the investment objectives of that VC and what you're peddling. Either that or you peddled it poorly. So you have to have this courage and mindset to go 'next' and not let that get you all bent out of shape.
Sterling-Hoffman: Would you rather take money from a Tier 1 venture firm where the partner was less experienced, for example, a junior partner or an associate, or would you rather take money from a Tier 2 venture firm with a much more seasoned partner?
Bob Walters: I think there are a couple of considerations in making that determination. The first consideration is that I personally don't have a huge hang-up about seniority of individual VC's. I rather focus on 'how good do I think that individual venture capitalist is going to be at helping me take my company to the next level. What is their skillset? What is their personal experience base? And often times I'm looking operationally in their past not simply what is their experience-base as a VC; I'm not terrifically biased towards 'got to have John Doerr or this deal doesn't go down' (with all due deference to Mr. Doerr!).
The second thing is I think that there is probably less of a premium that companies get landing a Tier 1 VC as there was in the boom days. I mean, in the boom days the whole objective was to land a Tier 1 VC.
That said, I still do believe that quality VC firms rise to the top and so do their portfolio companies.
Sterling-Hoffman: Is this your first time as a CEO?
Bob Walters: It is.
Sterling-Hoffman: What are the experiences that are different then what you expected in terms of the role?
Bob Walters: I guess the first one is one of the things that people often point to is it's kind of lonely and that the 'buck stops here'.
Second, there are many decisions that have to be made. The sheer velocity of decisions can be overwhelming. At peak (like during a funding road show), I'm literally making a decision every 5 minutes and analysis paralysis just won't work. I think successful CEO's figure that out right away.
The third thing that I think can be a challenge for first-time CEO's like myself, is managing the Board. Executives are usually accustomed to managing one boss. The CEO has many constituencies. Internally, a CEO has his/her executive team and, by extension, the entire employee-base, the shareholders both common and preferred and they have the Board.
Externally, of course, you're right in the middle of customers and partners too. You're often intermediated by a VP but you're right there too, and when things go wrong the customer will not hesitate to call you directly.
So the many 'constituency-thing' and the 'buck stops here' thing are two of the bigger dynamics that take some getting used to.
Sterling-Hoffman: What tips would you have for first-time CEO's, especially entrepreneurs who aren't used to reporting to anyone?
Bob Walters: First of all, you now report to your Board and antagonistic stand-off relationships with the Board seldom work. I would say for start-ups in the 2002 environment, you want to try to cultivate a very collegial, open-exchange type of relationship with your Board Members. The worse thing that any CEO could do is surprise the Board, particularly with bad news. Boards have a great deal of patience for CEO's that surface problems to them, pitch one or more optional solution paths and then execute on those solution paths. This is much better than CEO's that try to hold it all inside and make a big show of things on Board Meeting days.
The Number 2 thing is in today's funding environment your company cannot survive without the support of your Board. You will not get follow-on funding if you have a major rift with your existing investors. The probability goes down to small single-digit percents of getting follow-on funding if your existing investors don't back the gig. I think total candor and early identification of problems are two key things for successful Board relations.
Sterling-Hoffman: To what extent has your military background affected your character and your leadership qualities?
Bob Walters: First of all, just from dealing with fellow executive Boards it's a great topic of conversation. I've done many things in my career with start-ups, Princeton, the Naval Academy, but everybody wants to talk about Fighters. For some executives it's talking about golf, for me, it's talking about Fighters, so it's a great icebreaker with partners, VC's, etc.
There is just no doubt that the discipline and the leadership skills that I learned at Annapolis and then in the Marine Corps apply as an executive or a CEO. That discipline really begins with fundamentals. Annapolis, both on the academic side and the leadership side, did a great job in schooling me insofar as 'integrity is the basis upon which all other leadership is built'. If you don't have integrity many other great things that you might have as a leader such as intelligence and vision will be eroded to the point of making you ineffective. Without integrity nobody can trust you or believe you; you can't build teams to follow you to these great places.
Silicon Valley, especially during the boom lost sight of a lot of leadership fundamentals.
Sterling-Hoffman: For example?
Bob Walters: During the boom, it was so hard to find talent that underperformance was often tolerated, even elevated to higher levels and that's not really fair to the team. I mean, one of the most fundamental things that a CEO or any team leader has is the responsibility for the overall quality of the team. If a leader tolerates improper or substandard performance in a team member, then what do the other team members think? What is their reaction? So what ensues is discord and frustration with a situation like that. It was quite difficult to even compose a team during the Boom times since there was a shortage of skills and we forgot about the basic fundamentals of good leadership. I don't want to make TOO big a point of it but with all the cases of restated revenue and the hype explosion surrounding IPOs and all that jazz, I think we forgot a few integrity things along the way.
Sterling-Hoffman: Is it as much fun being in a start-up post-bubble?
Bob Walters: To be brutally honest, I'd say no. I mean, when we were at LinuxCare for example, we all thought we were going to be multi-millionaires within 60 days and that was quite fun.
On the other hand, there is a ton of satisfaction from building a company the old fashioned way. There is a certain satisfaction from doing more with less capital; you savor every win. Knowing that the increased valuation you get isn't because you know Joe Schmo in some other company or you did some Mickey Mouse partnership with them, but because you delivered value to customers or created a partnership that is a revenue driving win/win for both partners. There is a ton of satisfaction with that, as well.
Plus on the building of the company side, it's never a better time to build a company. Assuming you have the capital to do it with things like hiring and getting office space and all that is terrifically easier and cheaper.
Sterling-Hoffman: What advice would you have for start-ups that are dealing with the issue of having to convince corporate customers they're going to be around in 2 years?
Bob Walters: The first one is the obvious one and that is despite the fact that you're going to get diluted more then any time since 1967 by the capital that you take, go for more then you need. Get at least 2 years of capital when you do your round, particularly if it's a later round like a Series B round as we just did. It's painful on the dilution side but it's almost essential on the operational side and will lend you credibility with your prospective VC's if you recognize this fact and ask for more money.
The second thing, and I hinted about it earlier, make sure you have your burn rate under control. I mean, one can take down $10 or $20 million dollars and if you've got a million dollar a month burn rate…from a million dollar a month burn rate anything is possible including very bad things. What's to keep you from doing $2 million a month? So as a small company just starting out when you're in your early revenue phases try to keep your burn rate as small as possible ideally less then a $½ million a month and take down more capital then you need.
Angel Mehta is Managing Director at Sterling-Hoffman Management Consultants, Sterling-Hoffman Management Consultants is a retained executive search firm focused exclusively on enterprise software companies. Angel can be reached at: angel@sterlinghoffman.com