Smith's next move was to put together his story and try to round up the kind of first-round financing he'd need to make Clarity fly. Since he'd never written a business plan, he engaged the help of Thomas Bredt, general partner at Menlo Ventures, who'd been a friend for 20 years, dating back to the time both worked at Hewlett-Packard Co.
Bredt supplied an outline for a plan and a referral to an experienced lawyer, and Smith hunkered down to put his scenario on paper. At night his wife proofread the plan and typed it. Then Smith headed out into the field for the unpleasant task of negotiating for financing. Venture capitalists took notice. Rapport, it seemed, had just the right appeal. "We like products that are easy to understand," says Joe Rizzi, a partner at Matrix Partners, in Menlo Park, Calif., who is also a Clarity director. "And I think Rapport is it."
Another thing VCs like is equity -- as much as they can get. In exchange for a little less than half of his nascent company, Smith gathered $3 million from three funds, including Bredt's, in just 60 days. Smith figured he'd still have room to raise additional cash at a later date, with a smaller portion of the remaining shares -- which, with any luck, would have increased considerably in value. In three years, after a string of profitable quarters, says Bredt, Clarity would be taken public, and it would reap large rewards for the investors.
Now it was just a matter of turning all that planning into a real product. Smith's next move was to persuade SGI to lend his start-up some workstations and provide the references needed to secure a cheap office directly across from Route 101, the main artery that runs through Silicon Valley. Clarity's offices fit the image of the typical high-tech high flier. The surroundings are surprisingly spare -- except for the borrowed $10,000 workstations at most carrels -- and they could benefit from nicer lighting or even the odd plant or two.
But Smith knew that if his start-up was to succeed, decor wasn't where he needed to spend money. In the software business, your biggest capital investment is in building your team. By December 1989 Smith had compiled a short list of executives he might recruit for the company. He recalled that some of the most creative engineers he had worked with in his 25-year career had been Hewlett-Packard cohorts. He began to try to entice them to spend the next several months of their lives writing software codes. Smith's offer was two-pronged: after convincing a prospective executive of the strength of his idea, he promised to match his or her current salary; then he added a small slice of equity to sweeten the deal.
By March 1990 Smith had hired his first employee, a Hewlett-Packard engineer. Then he hired the first of what would grow to a six-person management team. Within six months, Smith says, he had broken the first rule of finance. "I had made the same mistake everyone makes. The $3 million was to take us through to product launch and marketing. It wasn't enough."
Nearly three-quarters of the initial money went to top-tier salaries and equipment, plus royalty payments for software that was used in the development process. The balance was divided between early marketing research, sales plans, and administration fees, including an outside bookkeeper. "This is very typical," observes Menlo's Bredt. "It takes $1 million to $3 million to get the product done and another $3 million to get the marketing done."
Indeed, a series of problems hounded Clarity. For one, Rapport's function is based on pieces of software called converters. They are programs that permit Microsoft's Word, for example, to be translated from its IBM PC version into one that appears in Unix, with the same formatting, spaces, and typefaces. That way users can keep their favorite software and not have to reformat a document every time it runs on a different operating system. All those operations are transparent to the user, but they must work flawlessly, and that means finding the best converters on the market. Though Clarity, unlike some manufacturers, doesn't rely on a broad array of vendors to make its product, it still contends with the issue of quality. Now Smith suddenly had to deal with being a small, unknown start-up with little clout when it came to asking his suppliers to solve a problem.
"We can turn a problem inside the company around in a week," Smith grouses. "But external problems can take months. You quickly find out that you're number 15 to be called back. It took 25% longer to get a product out."
Because of the delays, Smith and his chief technical officer, John Busch, didn't have a working version of Rapport ready until June 1991. At that point, funds in Clarity's coffers were running perilously low. Luckily, what Clarity had developed proved practically eye-popping to the venture community. Rapport incorporated all the functions Smith had wanted behind a series of pull-down menus, and it painted stunning presentation graphics in 128 colors.
The original backers signed on for a second round but wanted to spread the risk, and suggested finding a fourth fund to share in another $3.5-million investment. When word got out, more than 20 companies asked for a demonstration and a copy of the business plan. Again Smith had to chip off some of the company's equity, but a much smaller fraction than before, since Clarity's value had jumped based on the prototype.
Besides a dazzling software display, the potential second-round investors saw a revised -- and much more modest -- business plan. The first copies of Rapport were shipped in July but got off to a slow start, in part owing to the lingering recession. Smith realized his early sales weren't going to come near his original projections. At the start he and Gwen Peterson, vice-president of marketing and a crack researcher formerly with Dataquest, had estimated that first-year sales would be $10 million. But the economy wouldn't cooperate. Not only were budgets being cut; there was no guarantee that the decision maker to whom you were selling today wouldn't be on the unemployment line tomorrow, and the sales pitch would have to begin all over again. Now Smith soberly projects sales for the fiscal year ending June 30 to be $3 million.
