Reflections on the early days at Zendesk (part 2)

This is part two of my post about the early days at Zendesk. The first part is here.

Small, fragmented and no potential for differentiation

As mentioned in the first part of this post, the seed round was only $500,000 and it was clear that we’d need much more money soon. That’s why Mikkel and I started to work on a pitch deck and a financial plan almost immediately after the closing of the seed round and started to pitch to VCs shortly thereafter.
In my personal experience as a founder, raising money has never been easy, and so I didn’t expect that it would be easy. I was quite optimistic though, since I thought we had a pretty good pitch: a well-rounded team of three complementary and experienced founders, a beautiful product, a proven business model, paying customers and nice (yet early) traction.

So why did all European VCs pass? I’m getting asked this question a lot and I don’t have a perfect answer, but here are a few important factors:

• There just weren’t (and still aren’t) that many VCs in Europe who can write a Series A check. If a couple of them pass for whatever reason, you’ve quickly exhausted your available options.
• Our timing was horrible – it was almost at the height of the global financial crisis which had started in 2007. While we were trying to raise the Series A, Lehman Brothers imploded and a collapse of the entire global financial markets seemed possible.
• We had failed to convince investors that we were going after a large market and that we could build a defensible position. One feedback that we got was that the market for help desk software is “small and fragmented” and that there are concerns about the “potential for differentiation” and several other VCs were concerned about the size of the opportunity and our ability to differentiate, too.

You’ll notice that I haven’t mentioned the “European VCs are risk-averse/dumb/whatever” theme to explain why we haven’t been able to raise money in Europe. While I do think that there are differences between how VCs work in Europe vs. the US, I think it wouldn’t be fair to blame European investors for missing Zendesk: With hindsight Zendesk looks like a clear winner, but back in 2008 it wasn’t that clear. It was still very early.

At a critical juncture

A few months later, after having talked to a number of US investors and and after an almost-deal with a West Coast VC which was pulled back at the last minute, we eventually got an offer from CRV in Boston. We were relieved, but the valuation was much lower than what we had hoped for.

Because of the dilution which the investment round would mean and because the whole fundraising process has been so hard, Morten and Alexander got more and more doubts if going the VC route was the right thing to do at all. They were wondering if we couldn’t go the 37signals way instead – stay a smaller team, grow organically and maybe raise money at a later point in time when we’d be in a stronger position and when the market conditions would be more favorable. That was definitely a viable alternative and worth considering, but Mikkel and I strongly believed that we had to raise money and that we shouldn’t wait. This led to a lot of long emails and Skype discussions between the four of us. It also led to some very heated discussions between Mikkel, Morten and Alexander, which is no surprise, given how much was at stake. We were at a critical juncture.

One relic from those days is this email snippet (Alex in red, me in green):

I still need to buy Alex a T-Shirt with “I’m not confident that Zendesk can grow into a $100 million company” on it.

In the end we decided to take the investment from CRV, but we took a smaller amount than what Devdutt had offered us to reduce the dilution. It was still a significant hit in terms of dilution, but given how many doors the CRV investment has opened for us and how much Devdutt has done for the company it proved to be the right decision.

The rest is history – get Mikkel’s book to read about it!

Reflections on the early days at Zendesk (part 1)

Yesterday I posted a brief review of Mikkel’s excellent book “Startupland”. For me, the book is also a good opportunity for some reflections and to share some thoughts in relation to Zendesk’s journey.

The first date

When I stumbled on Zendesk in 2008 I knew absolutely nothing about enterprise software, B2B or SaaS. I had always been a consumer Internet guy, having founded comparison shopping engine DealPilot.com back in 1997 and personalized homepage Pageflakes in 2005. If Zendesk’s website hadn’t been so beautiful and if the product hadn’t been so easy to try and use, Zendesk would never have caught my attention (and I wouldn’t be writing this post now). The nice little buddha, the logo/brand and the tone of voice of the site also helped, massively.

Interestingly, if I had been an enterprise software investor, Zendesk probably wouldn’t have caught my attention either, since the website didn’t look like a typical enterprise software website at all. Today the “consumerization of the enterprise” has become mainstream, but in 2008 it wasn’t. Apparently you had to be a consumer Internet entrepreneur looking for the next big thing on the Web in order to stumble on and be attracted by Zendesk. This characteristic – not being a consumer Internet startup but not being a classical enterprise software company either – has probably contributed to our difficulty raising a Series A later on, but more on that later.

So when Mikkel and I met for the first time, I knew nothing about SaaS and probably asked a lot of dumb questions. At that I also knew nothing about inbound marketing and customer success – topics which are now near and dear to my heart for some years – and I was somewhat puzzled when Mikkel explained to me how they’ve been getting customers. I was worried that the inbound marketing plus customer success (at that time, called “customer advocacy”) approach wouldn’t scale and thought that they’d have to do outbound sales soon to keep growing. That turned out to be epically wrong: Zendesk grew to 10,000 paying customers before starting to build a real sales team, and up until this day, the vast majority of customers come from organic sources.

Having been an entrepreneur since the age of 17 I did know a few things about starting and building companies though, and since both DealPilot.com and Pageflakes were VC-funded I also had some experience with venture capital. So Mikkel and I were very complementary, or, as Mikkel puts it in the book:

There was a good vibe between us, even though we were extremely different. […] Ultimately, I think we recognized that we were a good balance for one another.

I remember that a couple of years later, at the first PNC SaaS Founder Meetup in San Francisco in 2012, Mikkel ended his speech saying something along the lines of: “Kudos to Christoph for investing in us back in 2008 – I would never have invested in these three guys”, referring to his co-founders Morten, Alexander and himself. My response was: “Kudos to you for taking money from me – I never would have taken money from me”. I think there’s no better way to sum it up. :-)

After the financing is before the financing

Following our first meeting, we very quickly concluded that it would make sense to work together, agreed on the terms, and voilà, a six-figure dollar amount changed hands. I was excited, but it was also a little bit scary because it was my first angel investment (aside from a few small investments that I had made many years earlier). I didn’t have a diversified portfolio, and I didn’t know if I’d ever have one because I had no idea when I’d make my second investment. I didn’t have deal-flow, and I’m not even sure if I knew the term deal-flow.

I didn’t worry too much about it though, and the mood was good. Quoting Mikkel from the book:

We now had a new direction. The investment from this seed round inspired a new mindset and created a big change in pace. Christoph helped us with a business plan and helped us build out what would be the first attempt at describing the financial model of our business. [...] He helped us think about scale—and about the possibilities.

The seed round, including the friends & family investments and my own investment, was only $500,000 though. It was enough for the founders to take a modest paycheck and to hire a few people, but it was clear that we’d need a much larger round soon. That’s when things started to become worrisome for me, since it quickly became clear that raising a Series A round would be very difficult.

This was the first part. Part two coming soon.
[Update: Here is part two.]