Things are moving pretty fast at Splunk and I wanted to comment on the exciting news we announced last week.

In 2004, myself, Erik Swan and Rob Das started Splunk with a vision to battle IT complexity by embracing it. We were thinking of things a bit differently. A different way to address the management of IT by applying search to millions of data center artifacts. Traditionally these artifacts were summarized, filtered and reduced and then forgotten - leaving us humans in a pickle when we needed to figure out what’s really going on. For us Splunk was also about a different way to interact with the market taking an approach of utter transparency. Our public product road maps, freely downloadable software and straightforward marketing had even our early stage venture capital investors thinking we were crazy.

By start-up standards, we seem to have succeeded. Splunk now has more than 250,000 user downloads, more than 750 enterprises, service providers and government agencies worldwide as paying customers and a growing list of partners who embed Splunk into their software, hardware and managed services including companies like Cisco and British Telecom. According to my venture capital friends, very few start-ups make it to where we are today. But, fueled by a love for innovation and so many passionate users we’ve challenged ourselves to see beyond achieving success as a start-up. We believe Splunk can be a company that gets the IT industry thinking differently.

Creating change isn’t easy and we’ll need all the help we can get. Fortunately, we’ve been blessed with an ability to attract top talent at all levels. But our most recent success tops them all. Godfrey Sullivan has joined us as our new President and CEO. When you meet him you’ll realize the incredible passion he has for building great companies. Most recently he was President and CEO of Hyperion Solutions. He took Hyperion over a period of six years to $1B in revenues. Hyperion was acquired by Oracle in 2007 for $3.3B. Godfrey also serves on the board of directors of Citrix Systems, Inc., and Informatica Corporation. Just as important as his business and leadership abilities, Godfrey has the cultural DNA that fits right in at Splunk.

Here’s the yin and yang that is Godfrey. He owns one of only 4,038 1994-1997 Ford GTs. Now this thing is fast, really fast. 0–60 mph (0–96 km/h): 3.3 seconds 0–100 mph (0–160 km/h): 7.3 seconds Standing 1/4 mile: 11.2 seconds @ 134.2 mph Top speed: 212 [11] And his other car is a Toyota Prius. Enough said. Godfrey couldn’t join us at a better time. We’re scaling all aspects of the business and need the leadership of someone who’s been through this type of explosive growth before. For me personally, it’s pretty cool to work beside someone of his experience, talent and steady as she goes outlook on life. And I get to continue to do what I do - build things. I’m now leading the team building our partner ecosystem working with Developers, MSPs, Resellers, Technology Partners and System Integrators around the world.

Of course this hyper growth wouldn’t be possible without your passion and support. Thank you all for that.

Happy Splunking!

The US economy is heading into a recession and technology spending is in for a steep decline in 2008. So every major prognosticator and news outlet from the Wall Street Journal to the Financial Times would have us believe.

Are these people watching the same movie I am? There are two problems I have with this economic hyperbole. Yes that’s what it is. I guess it sells newspapers and gets people to watch things like CNBC. But boy is it misleading.

First of all, in macroeconomics, a recession is a decline in any country’s gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. Yet nobody that I’ve read is forecasting negative growth. They’re forecasting a potential slow down in growth from the current 3.5% per quarter to 1.5 to 2.5% per quarter. But the news outlets feel compelled to use the “R” word just to get attention. Totally irresponsible.

On to my second gripe. With regards to technology and IT spending, I believe, based on what I see, we are in beginning of a long-term gradual increase in IT spending within large enterprises that started eighteen to twenty four months ago.

Sure the current credit crisis may have a short-term impact on budgets within Financial Services companies, but I don’t see any slow down yet. The major consumer, commercial and investment banks we work with have so many critical, revenue generating IT projects in backlog I fail to see how spending is going to slow at all. The telecommunication sector is finally back on the mend after the post early 2000’s bubble and hangover.

Social media, online shopping and the always on dimension of the Internet have online services and large Internet sites like MySpace and Amazon accelerating software, hardware and services spending just to keep up. And security, privacy and compliance initiatives and mandates have companies, service providers and government agencies increasing spending on these items by some 20% or more in 2008 to try and limit their exposure and risk.

Just a month ago the Financial Times had a great piece entitled “What’s on CIO wishlists?” Here’s a quick summary.

1. Business alignment and strategy
2. Hiring and retaining the best staff
3. IT innovation/new methodologies
4. Security
5. Collaboration technologies
6. Controlling costs
7. Compliance and regulation
8. Virtualisation
9. Customer service
10. Mobility (Green issues came 11th)

Doesn’t look like a slow down to me.

I’ve written previously about our experience this year raising a $25M Series C round of venture financing. Venture Diaries: Part One discusses why you want to think before you act and investigate who to target as potential investor partners. Venture Diaries: Part Two looks at how to perform your investigation. In this third part, I look at how to handle the horse race that inevitably develops once you get a few term sheets.

For me it all started when the first term sheet came in. Funny how some VCs still use fax machines. I had to go figure out where ours was. In the current seller’s environment (yes that’s what you are, a seller of equity in your company) one thing to keep in mind is your first term sheet will just be a starting point. Expect that it will probably be lower (perhaps significantly lower) than where you want to end up. Also expect once the first term sheet comes in things will really start to heat up. Nobody wants to miss out on a good investment and VCs are just egotistical enough to really help your cause. However, you should realize each VC has their own style. Some will try to move first in hopes of stealing the deal from others. Others will try to wait till the end and trump any offer — figuring the last hand in has the best chance.

This is where the entrepreneur’s job gets difficult. You want to put everyone on notice that you have a term sheet. This way things really get moving and you can quickly figure out who is really interested and who is just playing along. But what process should you use? How do you maintain your integrity when everyone is asking you for information.

The analogy of selling a home comes to mind. Some sellers will run a sealed bid process. “All offers are due on Tuesday by 5pm and the top offer wins.” This tends to work better in real estate because you already have an asking price. Buyers know what minimum price you expect. In addition, most markets have an established bid/ask ratio where homes get sold (unless your in a rapidly declining or accelerating market which isn’t often the case).

When you’re selling equity in your company to venture capitalists the number one rule is don’t, under and circumstances signal an asking price.

You will get hammered by investors wanting to know what your expectation is for your company’s valuation. There is one and only one correct way to answer this question every time. “We believe we’ve made significant progress since the last round, but the market will price the deal.” This way you signal you’re expecting a nice increase over the last round price but you don’t set a ceiling on this round’s price. Trust me they will all ask you over and over and over again, but don’t give in!

Back to process. Sealed bidding doesn’t work. So what does? I call it the Road Runner strategy. Remember how the Road Runner used to always chase Wile E. Coyote to the edge of the cliff and then watch him fall off?

This is what you need to do with each of your potential investors. To maximize your terms and perhaps most importantly figure out what it will be like to work with each of the potential VCs you have to push them to the edge of their comfort zone. While sometimes uncomfortable the process will show you what your potential new board member and investor is really like. Chances are the way they handle a competitive negotiation is the same way they’ll handle themselves in difficult board meetings.

Start out by telegraphing the fact that you have a term sheet to the other investors looking at your company. Be careful not to disclose any of the terms, but tell them it is a competitive offer. If the terms are clean, telegraph that as well. In my case I found it helpful at this point to set a deadline a week or two out whereby everyone must wrap up their due diligence and get you a term sheet. It’s actually a good idea to have a soft deadline communicated in your first meeting with each investor. This way nobody is surprised when you reinforce the deadline. You’re deadline will be soft, but make it seem firm without being pushy.

This is the point where you need to be in constant communication with each interested investor. Return phone calls and emails within an hour. Make sure everyone knows you are available to get them any information they need.

Chances are the VCs will really start selling you at this point. Remember all those tricks Wile E. Coyote had? Most of them some type of Rube Goldberg device manufactured by Acme Corporation. Like the Coyote’s tricks, most of the VC’s points about why they’re the best are somewhat fictitious and sometimes totally outlandish. But none the less they’ll try. You’ll hear all sorts of stories about why you should take a lower offer and how each investor needs to own a certain portion of your company in order to dedicate the time to sitting on your board. Listen attentively, thank them all and then remind them of the deadline and ask them to make their best offer.

According the National Venture Capital Association (NVCA), there are 798 venture capital firms managing more than $235B in the United States. These are long-term, professional investors who specialize in funding and building new, innovative companies.

So how do you figure out who to approach for funding? This is the area where I find entrepreneurs make the biggest mistakes. Most of us approach investors we know. Perhaps you have a friend who knows a VC or you have a friend who is a VC. How do you know if your friend or the person you get introduced to is the right investor for you? Most likely they’re not. Not all VCs are alike. Some are geared for early stage and some are not. Some are suited for late stage investments while others just say they are.

You can’t always trust what an investor says their appetite is either. I’ve pitched to investors who say, “yeah we do Series A” only to be barraged by questions like, “how many paying customers do you have that we can talk to.” On the other hand, I’ve presented to wanna be later stage investors that were only prepared to pay an early stage price.

You need to do your own research. Venture capitalists are for the most part, creatures of habit. They don’t change investment philosophies much. Often within a firm it will take a generation before new blood arrives and can affect major change. In addition to the succession challenges, VCs are bound by the structure and economics of their business. Venture funds are seven to ten year financial vehicles. VCs raise the money for their funds based on an investment strategy which takes several years to play out.

I suggest doing your own primary research. Identify eight to ten prospects with a track record of backing entrepreneurs like you. Look for a history of focusing on your market and the stage your company is at and the type of involvement you want. Suspend your judgment during the your data gathering. Just get the data and avoid acting surprised or judgmental. Get specific data on the number of projects and stages of investment each firm has completed recently.

When we raised a Series C round earlier this year, I identified eight firms to approach based on their past investment history. Specifically, I was looking for firms and partners that had done a majority of their investments in late stage, infrastructure software companies over the past eighteen months. I wanted to focus on VCs who demonstrated a track record of paying a fair price to invest in revenue generating companies that need capital to accelerate growth. I gathered data on how many investments each VC made, how many of the investments were later stage and how many later stage investments they actually led versus just participated in. My goal was to focus on investors with the highest percentage of later stage deals led as a function of total investments made.

Of the VCs I researched the percentage of Series C or later deals led ranged from 15% to 95% of the total deals invested in during the prior 18 month period. Surprisingly the firm with the 15% invested in far more deals and far more later stage deals than anyone else. But the participation in later stage deals was mostly follow on investments in their existing portfolio. This was not the type of later stage investor I was looking for to lead our financing.

There were two VCs that approached us and pitched themselves as later stage investors. But the data just didn’t support their claims. The one had a 19% rating and the other a 17% rating. Despite showing great interest both of these investors dropped out of the financing process when we had several term sheets and commented, “the price is too high for us, we can’t dedicate our time to the project unless we can own more of the company.” At which point the leopard really showed his stripes.

The core set of later stage VCs I focused on had ratings ranging from 50% to 95% indicating they had led a significant number of later stage investments in the past 18 months. Every one of these investors delivered us a term sheet at a competitive price.

How do you find this information? The brute force way is to visit a number of firm’s websites and go through their portfolios. This takes a while but can yield the information you’re looking for if you put in the time. It is certainly a lot less time consuming (and less humiliating) than pitching investors that will never invest in your profile situation. There are a variety of venture capital databases that can make your research much faster and easier. If you have a friend that’s a VC they likely have access to one or more of these sources. If the answers about a particular firm are vague drill down and get the real story. If you can’t figure it out, move on. You’ve got 798 firms to choose from.

A few months ago I started working on a next round of funding for our company, Splunk. As an exercise I decided to keep notes on the progress of the fund raising in hopes of looking back and perhaps sharing a thing or two with other entrepreneurs. I’ve raised a lot of venture money (this is my sixth venture backed start-up) and learned to avoid many of the traps most first time entrepreneurs fall into. This time around I had a chance to apply several best practices I’ve seen over the years and invent a few new tricks that really helped things go smoothly. We closed a later stage round of financing on outstanding terms in just sixty days from first conversation to money in the bank.

Whether you’re raising a Series A round or a mezzanine round, you can sail through the process if you are prepared and you avoid the common pitfalls. My hope is to find enough time to tell the story of how we pulled this off and offer tips and insights along the way. Feel free to add your comments or contact me directly with your feedback and questions. I’ll try to post a bit every few days as time permits.

No doubt the current market for funding is a sellers market. The supply of capital for early and late stage companies is abundant. However, most entrepreneurs and management teams forget this simple fact. When you raise money you are selling equity in your company. You are inviting investors in to purchase part of what you have built and what you’ll continue building long after they invest. Why is this important? Its an important distinction. Compare selling equity in your company to selling a home. When you’re selling a house you feel very invested in the decision of who you sell to and what price and terms you get when you sell. You remember all those weekends you spent remodeling the kitchen or painting the master bedroom. And when you open your house up for potential buyers to tour, you’re letting them into the most private parts of your life.

Tip #1: When you raise money you are selling equity in your company. Its a privilege not a right for investors to take a look and consider partnering up with you.

Selling equity in your company is no different. You’re inviting potential investors in to learn all the ins and outs of your strategy, execution and plans. But remember, you’re inviting them. Its a privilege not a right for investors to take a look and consider partnering up with you. I make this point first because most entrepreneurs and management teams forget this very fact. Drive this point home with your team and everyone will feel much more invested in the fund raising process. You’ll all be much more discerning about who you invite to your open house and how you conduct the conversations.

Who am I to second guess it. Virtualization is hot. In the past week VMWare went public closing at the end of the first day with a $20B market cap and Citrix agreed to buy XenSource for $500M.

WOW! This kind of activity make the bubble days pale in comparison.

I mean okay VMWare, hot company, fast top line revenue growth but also accelerating expenses. In 2006 the company reported revenues of $704M and net income of $87M or 12% of revenue. In 2005 VMWare reported $387M in revenues and net income of $67M or 17%. So revenue was up 82% but net income is declining on higher spending all around. If the company continues to grow revenues again this year at 82% the current $20B market cap means a 28x trailing twelve months revenue and a 15x current run rate revenues.

Compare VMWare to the Bladelogic IPO or the Opsware acquisition by HP and it looks pricey by comparison. But, given the market is so starved for growth stories it kinda makes sense.

But, XenSource is another story. The company just started shipping product in January of this year and according to Business Week’s Aaron Pressman and 451’s Rachel Chalmers, XenSource had less than $1M in revenue over the past year. That means Citrix paid 500x trailing 12 month revenues. WOW! Okay yeah Citrix needs a new game, they’ve been looking for their 2.0 story forever. But I mean anyone could pick up Xen and integrate it. It’s open source for crying out loud! Is there really $500M worth of value in the XenSource management tool for the Xen Hypervisor? Citrix seems to think so.

I think this points more to the continuing trend of acquiring hot technologists not so much technologies. Despite what Matt Assay writes Tim O’Reilly may just be right on with his assessment of Open Source companies eventually being bought by proprietary companies. These acquirers are not buying the software or the licensing model, but the people. The licensing model doesn’t matter. Customers pay for innovative ideas that solve problems easier, cheaper and faster and they’ll buy it in almost any form if it works better than what they’ve got.

Sure Cirtrix paid a whole lot. But they might be right about owning the brightest minds in virtualization software. If virtualization is the future and they captivate the biggest thinkings perhaps 500x is not too much?

Last week two significant developments took place in the world of datacenter technologies. At first these two events may seem unrelated but a closer look makes for an interesting debate about how we’ll be managing our IT environments and who will be providing the solutions.

First Marc Andreesen posted on his blog, “HP bought my company for $1.6B.” He thanked everyone that had ever worked at Loudcloud and then Opsware as it is now known. Marc also pointed out anyone who had ever bought his company’s stock made some money. That’s cool.

The $14.25 a share HP paid was a 39% premium, but I was actually surprised by the acquisition. I expected Opsware to go much further on their own.

After eight years Opsware is still losing money, $10M in the last quarter on $28M in sales. I remember running into Marc in Palo Alto a few years ago and he said if a customer wasn’t willing to spend at least a million dollars it didn’t really make sense for Opsware to engage. IMHO much of this originates from the fact that the original Opsware product and technology does something very ambitious making it harder for potential buyers to try it out. This requires a significant effort by Opsware to support those customers who decide to take the plunge.

On the flip side BladeLogic floated their initial public offering last week. Although a much smaller and newer player than Opsware, Blade Logic closed after one day of trading with a $655M market capitalization. Comparing the two Opsware reported more than $100M in trailing 12 month revenues and BladeLogic reported $36M. HP bought Opsware for 15x trailing revenues and Bladelogic is trading at 18x trailing revenues. But, prior to the HP acquisition Opsware was trading at just 9x trailing revenues or half the relative valuation of Bladelogic.

So what do the Blade Logic share holders know that Opsware’s didn’t? Perhaps after eight years and different business models Opsware’s supporters just got tired. Maybe the frothiness of the public market for tech companies is back and shining on BladeLogic?

Certainly it seems BladeLogic has an easier to adopt solution given the fast ramp in customers and revenue they’ve experienced. Yet it is unclear looking at the numbers as to whether Bladelogic has a higher growth and/or more leveraged operating model than Opsware.

But in their most recent quarter Bladelogic did report $12.5M in revenues on an operating loss of just $185k and it does seem Wall Street likes the new darling better.

So will you be buying a do it all automation solution from HP or an easier to deploy bite size product from BladeLogic to handle your routine datacenter tasks?

I’m Michael Baum. Welcome to my blog.

I hope to find time to write about some of my favorite topics including:

• Splunk and IT Search.
• Technology gadgets and software — the stuff we all like to use.
• Datacenter applications, servers, networks and security — the stuff we all have to keep running.
• Business, entrepreneurship and venture capital.
• Wall street and investing.

Comments are always welcome and you can also reach me via email at thebaum (at) splunk (dot) com.