August 10, 2004
Strategy, success, and survival: Software business insights from industry legend David Hanna
by Bruce Hadley, SoftwareCEO

If there's someone who's more qualified for the role of software business mentor than David Hanna, we've not met them.

Hanna is truly a legend in the biz, partly because he's unique in that he's managed small companies as well as large, across a range of software markets, yet has managed to maintain a perfect batting average in terms of success—big-time success.

When Hanna joined State of the Art Software as CEO in 1985, the company had revenues under $1 million, even though it had been in business for four years. Hanna transformed the company over the span of 13 years and wound up selling it to Sage Software in March 1998; at that time, it had a market value of $263 million.

For the next year, Hanna stayed on as CEO of the U.S. subsidiary of Sage, Plc, a public company based in the United Kingdom, then became an entrepreneur again. "It was always planned that I would leave," he says. "My intention was always to transition to a new management team."

While some CEOs would look at the handoff year as an opportunity to kick back, Hanna, with the power of Sage behind him, kicked it into high gear: "I stayed for a year, and we did two more acquisitions: Peachtree and Best Software."

Today, thanks in no small part to Hanna's groundwork, the U.S. division of Sage is a half-a-billion dollar company, and is the U.S. leader in accounting software and support for small and medium-sized businesses. Hanna continues to play an active role at Sage as a non-executive director, senior advisor, and consultant.

He's also the chairman of four companies—Tropos Networks, Blue Coat Systems, Mitem Corp., and Hanna Capital Management—and is on the board of two others: Handmark and Infogain.

In his spare time—insert large grin here—Hanna serves on the boards of the Alzheimer's Foundation, the Graduate School of Management at the University of California , Irvine, and Empower America, a not-for-profit organization that promotes free enterprise solutions to societal problems.

OK, so it's hardly surprising that the Software Council of Southern California recently gave David Hanna its Lifetime Achievement Award to acknowledge his contributions to the growth and success of the region's software industry.

What is surprising is that Hanna is still willing to make time to mentor other software executives and entrepreneurs. We caught up with him last week for an informal and informed conversation about what it takes to succeed in the software business today.

Listen up, boys and girls: If there was ever a guy who deserved a "Been There, Done That" T-shirt, it's David Hanna.

What does it cost to break into this business?
Because Hanna is now in the business of funding other software businesses—Hanna Capital has $100 million under management and is moving out of public markets to concentrate more time on venture investing, through Hanna Ventures—we thought that would be a good place to start:

Just how much money does it take to start a software company nowadays?

"I think we're getting back to basics and fundamentals," Hanna says. "We went thru a period of time, from about 1997 through 2001, where too much money flowed into software and other investments.

"So, I guess the answer is, much less than people were accustomed to. The company I just finished running, Tropos, got to first customer ship with a little over $4 million in cash—and that included the development of a hardware platform."

Hanna Ventures looks for early stage investments, Hanna says: "Seed and A-round, mostly, with a focus on wireless software, like smart phone software and Web-based applications or security. We may do some investments in hardware on the wireless side as well."

Hanna's firm will typically kick in between $500,000 and $2.5 million in venture capital, preferably in partnership with one or two other VC firms.

"In the early rounds we tend to not put in as much, and I tend to go with much less money than your average entrepreneur may think about," Hanna says.

"I want to invest in people who use their credit card—they've got a lot of skin in the game. It speaks to the character and temperament and how they're going to run the company as it scales and grows."

Can a software entrepreneur do it with less? We used to say that it takes $1 million to pull success out of the bag; is that still realistic?

"To get to the point of an IPO or some meaningful point, it will take more than that," Hanna says. "But if it's a niche company, you need less. It doesn't take more to start with—but it may take more to get where you want to go."

Where are the software market opportunities?
Or, from a more pessimistic point of reference, are certain software markets closed up to new players?

"I think so," says Hanna. "Starting a database software company now, for example, or starting a company where there's huge entrenched competition would be a mistake. No matter how much money you put into it—I don't care how much money you have—it's next to impossible to do.

"There is still great opportunity, but there is less than there was 10 or 15 years ago, because the whole market is mature now. Is there room for innovation? Of course—but you need to be much more discerning in terms of the pain or the problem you're trying to solve.

"I tell entrepreneurs who come to me, you need a pain killer, not a vitamin. There are too many vitamin business plans around—they make you feel better, yet they don't solve a real problem. You have to solve a genuine, real, industry problem.

"You have to start with a very, very good idea; it has to be a problem, and it has to be a big problem that the market has. Without that, it just doesn't make sense."

Is there a particular Hanna favorite? "I think Wi-Fi and industry standard radio—namely, 802.11b and 802.11g—are going to be as important trend as any of the big waves I've seen in the last 20 years.

"It has a lot of the character that we saw with the PC in the '70s, and that Cisco had with the router in the '80s, and the Internet after that. The big market growth is not in PCs anymore; wireless is a huge, big trend."

Whatever market you target, beware of the ongoing trend toward consolidation, Hanna says. "Consolidation will continue to be a factor; you need to keep that in mind. If you're in security apps, for example, be ready for it.

"The big companies—for example, Symantec, Network Associates, Checkpoint—some are starting to see their growth rates slow, and I think you're going to see some major consolidation there.

"If you're an existing player, you may want to consolidate now, and if you're not a player, it might not be the best time to try to get in to that market."

Who should be the first players on your team?
If you were starting another software company today, we asked Hanna, who are the first people you'd bring in? Where would you recruit first?

"In my case, the first would be the right technical people to build a product," Hanna says. "I consider myself to be the strategist and marketing and sales guy; I'm not a development guy.

"I'd bring in the person who could develop the product and develop the team. And, industry knowledge is important—I'd be looking for someone who had credibility in the industry.

"For example, the person we brought in to run Mitem is a doctor, a Stanford and Johns Hopkins MD who has great industry knowledge. He knows the doctor, he's technically strong, and he understands the industry at large."

In the early stages of any software company, it's a mistake to start setting up separate corporate silos, Hanna says. "The CEO has to stay very involved in all of it, and passionate about it.

"The CEO has to be the chief evangelist and PR guy wrapped up in one. He has to be all of these things to hire the right people, to close the right customers, and to raise money.

"Andy Rachleff—he's a partner at Benchmark Capital—once said that passion is more important than anything else. I don't go quite that far, but it is essential in those early stages.

When is it time for the CEO to bring in sales help?
It's a given—or at least it should be—that every company's first salesperson is the CEO. But what about later? As the company grows, how do you know when it's time to bring in dedicated sales reps?

"There's really no defined event," Hanna says. "My functional background is sales and marketing, so I tend to stay in that role longer, and never really leave—which means I can wait longer than some.

"If the CEO does not have that background, then once he sets the right direction, and has the money, it's time to bring the sales guys in.

"But, keep in mind, very few sales guys can determine the strategy. You've got to determine what runway you're going to land on before you bring in the sales guy; they are there for execution. You need to determine the market you're going to go after, then you start building your execution team.

"One of the big mistakes young companies make is they bring in the wrong people; they build a team too quickly, before they have a solid strategic direction for the company."

OK, that sounds sensible enough, but how does a young company know that it has a solid strategic direction? Aren't many entrepreneurs prone to an abundance of wishful—and sometimes sloppy—thinking?

"Somebody in the company has to have enough vision to get you pointed in the right direction," Hanna says. "In some cases, it can be the venture capitalist who has the vision and recruits the team.

"Take your idea to a VC; find a VC who likes to work with early stage companies. I've gone in several times, at the request of Benchmark, and I've performed that role.

"When I went into Tropos, they had four engineers and one young MBA guy. They had a vision of where they thought it should go, but they didn't have any experience in the functional roles of the company.

"My role was four-fold: Build the team, determine which runway, launch the first release, and raise the first venture round." Which he did: $500,000 from Hanna Ventures plus $2.5 million from Benchmark. Plus, he guided Tropos to a second round of capital, $4 million, at the end of 2002, after he'd been there one year.

But without solid, functional, operational milestones, the second round of investors never would have bit. "They came in because they saw the product—it was released in September 2002—and they saw the market we were going after. Several months later, we raised nearly another $5 million."

You say you hate VCs? We say grow up
Much of Hanna's advice relies on the notion of using the venture capital community for guidance, advice, and leadership. But some of you are skeptical, we suspect, since Hanna's now a VC himself.

What if you don't want to deal with VCs? What if you subscribe to that "vulture" slur? What if you don't want to give up control of your company?

"I understand that feeling," Hanna says, "and if you can do it without the venture capital guys, do it. Venture capital is just one route to go.

"If you don't want to go that route, and you need capital, there are angel investments groups around; these guys are usually ex-CEOs who have made enough money, and if you pick the right ones, they will help you run the company.

"The smart entrepreneur will take the company as far as he can himself, then bring in the right investment team to take it to the next level.

"If you're Bill Gates and can take it to the next level and the next level and the next level, more power to you. But most people are not in that position—and I think the days of doing what Gates did are gone."

Which sales models have the biggest risks and rewards?
Hanna sees a big change in software sales models over the past few years—both in the way you sell software and the way you manage the process.

"There are enough changes in the industry's sales models that you must rethink everything," he says. "Here's a real life example: Tropos. We're selling into two markets: it's $3,000 for a single node, and a typical transaction is $25,000 to $2 million, either through direct or channel sales.

"The difference today, with the advent of the Web, is that we're using salesforce.com; everything we do is on salesforce.com. That's a very powerful Web-based tool that changes the way you deal with your sales team."

No, Hanna doesn't work for salesforce.com, and this isn't a commercial nor is it a simple celebration of a nifty tool. His point, rather, is that the combination of the tool and the Internet have radically altered sales and business processes at Tropos—and could for you, too.

"We now do our board meetings on salesforce.com and WebEx," he says. "We literally cycle through the salesforce.com data to look at individual accounts, and look at the last two or three sales calls. The sales VP who used to use PowerPoint to do his presentation now does it all on salesforce.com.

"As recently as a year ago, we used contact managers, but this is revolutionary. It's a tired old word, but it really is a kind of real-time manger. You can stay on top of the sales process, which gives you a time-to-market advantage.

"Siebel is a good tool, too, but it is being used more for customer support and customer tracking; in fact, I'm kind of surprised they haven't acquired salesforce.com."

Because he's such a strong believer in new tools like salesforce.com, Hanna lists that as a new—and mandatory—skill set for any software sales rep you hire.

"You want to hire sales executives who are current with this technology, and current with the new marketing techniques that are being deployed," he says. "It's probably the smartest thing you can do."

What about channels versus direct sales; any preferences there? "We sell direct, and we sell through channels," Hanna says. "It's fairly easy to avoid conflict today.

"We compensate the sales force whenever they bring the channel into an opportunity. They get a number—a quota—and they can't achieve that number without bringing the channel into the process.

"In the very large deals—for example, when you're bidding on job to set up New York City —the answer really is that the implementation is just too significant for a little company to do without channel help."

Software as a service, and how it ties to outsourcing
What about the much ballyhooed move to software as a service? Is software really dead, as salesforce.com CEO Mark Benioff is fond of saying?

"I don't think software is dead; I think you're going to find more salesforce.coms springing up because it makes sense," Hanna says. "With the trend toward outsourcing as one of the powerful trends, I don't think it's black and white anymore.

"You remember when ASPs were the big hot thing? Well, it just didn't happen, and of lot of venture money went chasing after that.

You're going to see more salesforce.coms—sales and HR applications, especially—and I think it's an important trend, but I don't think it's going to take over the industry. When Benioff said software is dead, that was simply a great sales pitch for him."

In addition to the Internet, the second big trend Hanna identifies as key to the future of the software industry is outsourcing. That's not a particularly new thread, but it's interesting how Hanna ties it back to the Web.

"Outsourcing is a very important trend," he says. "The mindset in corporate America is that companies are much more willing to give up control because of this outsourcing trend. Instead of running the SFA in-house on Siebel, we've essentially outsourced it to salesforce.com."

In other words, as outsourcing becomes more and more mainstream—despite the fact that it's a political football in an election year—that mainstream mindset creates new opportunities for software companies to develop and deliver.

"If I were starting out today, I think that's where the opportunity is," Hanna says. "I like an outsource model, because it allows you to pick the brightest and the best and not incur a lot of expense."

OK, we said, but salesforce.com owes at least part of its success to the fact that it burned through nearly $60 million in venture capital before attaining profitability. That didn't dissuade Hanna; he brought up a couple of examples of his own: "I know for a fact that Microsoft and Oracle didn't raise a lot of money.

"Sure, if you use salesforce.com as model, the average guy is not going to be able to raise that kind of money. And it's also true that many of the traditional markets are mature; they're saturated, and they just don't offer the same opportunity that they used to. And, competition hasn't changed; there's still lots of it.

"But, there are important new trends, such as Web-based apps and outsourcing, that are going to have a tremendous impact on the industry. And despite all the barriers, when all is said and done, it's still easier to get into software than most other businesses."