Funding for startups

Bear Market Inspires Hibernation

As the telecom winter wears on, startups are wrestling with a central issue: Should they keeping attacking their market or lay low for a while?

Some startups, prodded by their venture capitalists, are drastically scaling back their activity and in some cases are going into a deep sleep known as "hibernation," in which as little money as possible is spent. Generally, hibernation refers to what happens when a startup significantly cuts its staff and suspends major marketing and sales activities.

Venture capitalists say hibernation is par for the course when the fixed costs of running a company need to be trimmed back.

"If you discover that [a startup] is not going to see revenues for another year, you have to ask whether you really want to spend twelve times the monthly burn rate," says Ravi Chiruvolu, a general partner at Charter Venture Capital. "Hibernation is a risky strategy, and it needs to be thought through carefully."

Each VC, of course, defines hibernation a bit differently. Few actually want to talk about it on the record. But in general, according to several startup and VC sources, a company in hibernation has some of the following characteristics:

  • It has cut its headcount by at least one fourth from its peak employment number -- probably significantly more. This includes companies that have furloughed staff until their market segment recovers. For systems companies, if they've cut back staff to fewer than 80 people, they're probably hibernating, says Doug Green, founder of The Bradam Group, a telecommunications consultancy.

  • It has suspended external marketing activities and reduced the size of its marketing staff by at least half since its peak. In many cases, the role of the VP of marketing is being filled by other executives or the CEO.

  • It spends only on product development and has curtailed all other activities.

  • Though its product is finished or nearly complete, it suspects it won't see any sales for revenue for at least 9 to 12 months.

Systems vendors usually incur the highest upfront costs to get their products to market, and they're the ones most likely to go into hibernation, VCs say. Technology areas prone to dormancy include long-haul DWDM equipment and components, as well as core switching and routing.

But how do you really know when a company is in hibernation? The criteria are subjective. There's no official press release. And, predictably, even companies that appear to be hibernating would rather eat hot gravel than admit that they're dormant.

In fact, Light Reading's search for a company in hibernation was a little bit like an investigation into the X-Files: Everybody would like you to believe you're a nut-case pursuing something that doesn't exist.

"Nobody wants to be identified as a company that's only being sustained for non-commercial reasons," says Marc Cohn, director of product marketing for Alidian Networks Inc.

Alidian, in fact, is one systems company that has had layoffs and now employs fewer than 60 people. A short time ago when it was changing offices, it lost communication with the outside world for several hours, causing some to speculate that it had taken a dirt nap (see Alidian Networks: Lost and Found!).

But is Alidian in hibernation? It doesn't think so.

"From our perspective, we're in better shape than most companies," says Cohn. "We have a maturing product that is in trials with carriers.

"I can't think of any systems company that hasn't cut back on staff," he adds. "It's not like Alidian has been wiped off the face of the earth."

Another company that's gone rather quiet is Tenor Networks Inc. Before May 20, the core MPLS switch maker hadn't put out a press release of any sort since October 15, 2001. The company's last announced funding round was in August 2000.

But is Tenor hibernating? It doesn't think so.

"Hibernation implies inactivity, and Tenor is certainly not inactive," says David Tolwinski, the firm's president and CEO. "Our focus continues to be on the dozen or so largest carriers in North America, and we are marketing directly to them."

Tolwinski adds that Tenor will be one of several vendors participating in a live MPLS demonstration at Supercomm 2002 next week. "If that is the definition of 'hibernation' then so be it. A more accurate metaphor would be sailing a tight ship through a difficult and stormy passage. It's not the time to fly the pretty flags yet."

AcceLight Networks Inc. has a similar story. It has been quiet for months and, though it announced "the world's first photonic service switch" about a year ago, it has not, as of yet, officially launched its product nor has it announced customers. The company also says it won't have a stand at Supercomm, a key place for vendors to be seen.

Is AcceLight hibernating? It doesn't think so.

Instead, it says its marketing department has remained the same size but adds it has been focused on marketing directly to a small base of carriers, rather than the world at large.

"We were never really that noisy to begin with," says Stacey Diffin-Lafleur, a marketing communications specialist for AcceLight. She adds that AcceLight opted not to exhibit at Supercomm so it could launch its product at NFOEC in September.

VCs say hibernating companies aren't calling it quits -- they're intent on surviving until the telecom market recovers. Of course, it doesn't help that both venture funding going into startups and investments going into venture funds are at record low levels (see VC Activity Continues to Crawl).

Most VCs are saying that the cutbacks have helped more than they've hurt. They say companies can still progress on the product development front without huge marketing and sales staffs. "We've seen incredible examples of companies that have substantially cut back but still manage to get a lot done," says Warren Packard, managing director at Draper Fisher Jurvetson.

But if its such a great idea, why wont the VCs talk about them? Even though the VCs claim it's a beneficial technique and that they came up with the idea, most of them won't admit that they have any companies hibernating in their portfolios.

In some cases, it may be the next best thing to shutting a company down. Perhaps the investors devised it as a way of procrastinating. At any rate, many experts think it's simply a bad idea.

"In most cases, going into hibernation is a bad idea and investors would be better off pulling out their money," says Bradam's Green.

"[Hibernation] is a good strategy if you're looking to cut your burn rate," says Kirk Walden, national director of venture capital research for PricewaterhouseCoopers."However, you're not really saving costs -- you're only deferring them."

So how does this mysterious process work? Usually it is driven by the investors or high-level board members who decide it's time to preserve capital.

When weighing whether it should hibernate, a company's board has to make sure it can sustain whatever technology lead it has, sources say. If the technology advantage is slim, the startup must decide either to shut down or to keep attacking its market until it runs completely out of cash. "It can be like running full speed into a brick wall," says Packard.

Once the decision has been made to hibernate, the startup's board must pick just the right time for the company to reemerge. Charter Venture's Chiruvolu says two things to watch are the public markets, which can help gauge the health of potential acquirers, and carrier capital spending.

But the bottom line is that even the hibernating startup will need to be woken up from its slumber -- and that will cost money. By the time the market has revived and it's time to wake the company up, some of the staff may have found other jobs, and the costs of reviving a company, especially a systems vendor, might be too great.

— Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com For more information on Supercomm 2002, please visit: Supercomm Special

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