Cutting costs for long haul

Start-up marketing anti-spam software finds vastly different financing world.

Pavni Diwanji made a small fortune starting and selling a tech company for $120 million during the boom years. Then she had a child.

By Matt Marshall
Mercury News

Now she’s going back to work — to start a new company. But this time, she’s doing it at one of the most depressing times in Silicon Valley technology start-up history.

Over the past 3 1/2 months, Diwanji, 34, has learned what it takes to put together and manage a company during the downturn. She has learned to plan for the long haul in a way she never had to before. And she has learned to cut costs and save money relentlessly to get there.

Diwanji and co-founder Brian Wilson named their Palo Alto company MailFrontier. Its Matador software uses several techniques to combat spam. It allows one employee to hit a junk button on Microsoft Outlook’s toolbar to get rid of spam in the in-boxes of a whole group of people. Another feature guards the in-box by demanding verification from senders it doesn’t yet recognize.

She fell upon the idea six months ago: Spam, she said, had become a daily pain, and she feared its potential effect on her child. So she and a small group of co-workers started with her own money until she could get some venture capital.

Problem was, the start-up world had changed. She found investors skeptical of funding an anti-spam company when a slew of others had already been funded. Venture capitalists demanded the right to meddle more and negotiate harsh terms. Even if she did get money, it wouldn’t be very much.

When Diwanji launched her previous start-up, Kendara, in 1999, it took only four weeks to raise money. She visited VCs with a PowerPoint presentation and only a prototype of her product. She contacted five VCs and got five offers. Within a year, she had sold the company to At Home.

This time, it took 2 1/2 months to raise money — and that’s quick by today’s standards. She talked with 12 VCs — four expressed interest and two invested.

The lack of capital has shaped her business plan: She is giving away the software free to consumers to run on their PCs, hoping to spur a “viral marketing” campaign — where word spreads from user to user, without any marketing expenses. In October, she will launch a souped-up version, along with a server, to corporate customers — this time for sale.

Good cop, bad cop

The money drought has also forced her to scrape for the lowest rates on everything, from rent, to salaries, to lawyers. The pain, say her venture backers, is good for her. “We’ve structured the company so that there’s a real sweat equity. . . they have to starve a bit,” said Stewart Alsop, a partner at New Enterprise Associates, who has installed MailFrontier’s software on his own computer.

But Alsop is the “good cop,” according to executives and venture capitalists familiar with the deal. The “bad cop” is Tim Draper, a partner at Draper Fisher Jurvetson. Together, Alsop and Draper injected $5 million into the company in July.

Draper, a VC veteran, says he is being tough because the technology industry veered into excess during the boom years. Frugal companies last longer and win bigger, he says, pointing to Cisco and Hewlett-Packard. “They became huge, successful companies because they watched money carefully,” he said.

Hotmail backer

For Draper, the viral marketing strategy comes with a touch of irony. It was Draper who first backed Sunnyvale’s Hotmail in 1995, which helped spark the e-mail revolution by giving away Web-based accounts for free and then was sold to Microsoft. Hotmail’s reported 150 million users make it the most ubiquitous service in the world. As such, its users are the source of much of cyberspace’s spam.

Alsop took Diwanji through a rigorous process. He had three meetings with her and the company. He sat in on two calls with potential corporate customers and sent a letter to six chief investment officers — the people who make tech purchasing decisions for big companies — asking if they cared.

Draper went even further; he combed through an estimated 40 companies that were already trying to combat spam, making sure there was room for another.

Times have changed

Meanwhile, Diwanji spent about 40 percent of her time doing market research, talking with chief information officers and others — asking them what their problems were. The CIO of General Electric’s medical division in Europe said the company was facing a “staggering” onslaught of spam. She drew up a report of these talks and made it available to VCs.

Three years ago, such due diligence wouldn’t have been necessary, even if she had had the time. Then, she spent much of her time hunting employees, spending hours with them, massaging their egos, increasing their perks, pleading with them to take a job.

When Diwanji announced the launch of Matador last week, the phone rang off the hook with people looking for work. The office manager shut the phone down, directing incoming calls to voicemail. MailFrontier is getting 150 e-mailed resumes a day, Diwanji said.

The pressure by VCs has helped in some ways. Draper negotiated a low cap — reportedly around $15,000 — for the amount lawyers received for their role in deal. That’s about half of what some big New York law firms demand for their services.

In return, the Silicon Valley-based lawyers got a stake in the start-up. SparkPR, the company’s PR firm, also has reduced its rates in return for equity.

Forced to `scrounge’

Board meetings have changed. During the boom years, they used to be about strategy, says Diwanji. Now, the board meddles in day-to-day operations — especially when it concerns money.

One surprise came when she proposed salaries for a list of employees she wanted to hire. She thought she already had market rates, but the board, led by DFJ’s Draper, pushed her to go lower.

“It forces me to scrounge,” she said.

She has been cutting costs on rent, too. At Kendara, which was located just down the road from MailFrontier, she spent $3.20 a square foot. Kendara was the eighth company to make the offer and got the property because one of her VC investors played in the same band as the landlord.

Now, she says, real estate in the same area costs $1.50 a square foot, without connections. Better yet, landlords are throwing in furniture, cubicles, janitorial services, high-speed Internet network connection. She’s about to close on a lease.

“This is a good time to raise money,” she says. “You have to jump through more hoops when you go out to the market. But it makes you stronger.”
Contact Matt Marshall at [email protected] or (415)477-2518

http://www.siliconvalley.com/mld/siliconvalley/3996802.htm