Peter Lilley and Doug Stuart MAICD are keen to bust two myths. First, the tech startup scene isn’t just a young person’s game. Secondly, the Silicon Valley model is not what it’s all about. “We’re not all twenty-somethings,” says Stuart. “It’s not all about unicorns and disruptors.”
“A startup doesn’t have to be a unicorn to be successful or interesting to investors,” adds Lilley. “The hypercharged valuations of Silicon Valley are not normal. There are still good investors out there, including in the US, who really value experience.”
Stuart and Lilley were in their early thirties when they bootstrapped their first startup in 2003 — the ethical hacking firm Stratsec.
Kool-Aid acid test
Lilley stops short of admitting they set out to “disrupt” the cybersecurity industry with Stratsec, but with a decade of experience managing large IT projects for the likes of the Department of Defence, they wanted to loosen the grip of big technology vendors. “The motivations of a big commercialisation vendor are to get you dependent on their products and proprietary features,” explains Lilley. “Once you’re at the mercy of technology lock-in, they come at you with aggressive pricing at renewal time. You’ve made the investment, so there’s a lot of inertia to change.”
Stuart reckons inertia was the main reason it took Stratsec a few years to gain momentum, because corporations in Australia were “drinking the Kool-Aid” of the big technology vendors in North America. “The big banks kept on buying safe until one of them had an issue their vendors couldn’t fix,” he recalls. “They came to us saying, ‘It isn’t working, we have to do something different,’ and once we got our foot in the door at one bank, we started to grow. Within 18 months, we were providing services for all the banks.”
Stratsec’s growth was fairly organic, according to Lilley, because most of its business was won through laborious tender processes and referrals from regular customers. He sometimes wonders if they should have taken funding to grow more aggressively. Could they have opened in the US? Still, in 2010, the firm’s steady expansion across Australia and into Malaysia saw it win the Telstra Australian Business of the Year Award and attracted a $24m buyout by BAE Systems (with an agreement the pair would stay on a few years). “We probably could have run even harder,” he says, “But then we’d probably still be doing it today. Now we have a venture-backed business with Instaclustr. It’s heavily growth-driven, and we run very hard.”
Don’t call it a pivot
In 2013, when Lilley and Stuart’s exit term from Stratsec was complete, they could easily have settled into a comfortable midlife investing in other people’s startups. That was almost the plan. “We were honestly just going to be hands-off investors when we met a couple of clever young lads [Ben Bromhead and Adam Zegelin],” recalls Stuart. “They had this idea for a data marketplace,” adds Lilley. “We thought if we gave them money, something good would happen.”
What happened wasn’t good, at first. They couldn’t find any customers for the data marketplace. But the work they’d begun on the back end to make big data easier to access and manage was worth something.
Instaclustr got its name from the act of spinning up data clusters almost instantly for cloud-based solutions that need enormous scale. Plenty of organisations would like that ability, but don’t have the tools, knowledge or budgets.
“The guys were looking for a storage solution when they came across the open-source database, Apache Cassandra,” says Stuart.
“They said, ‘We’ve done some tooling around this database and there seems to be real demand for it,’ so they put a credit card payment on the front and we had customers before we knew it.”
Coping with rapid growth
Instaclustr’s first five customers were worth US$5000 in monthly revenue which, as Lilley points out, isn’t bad for a fresh startup. “Tech startups should pop the minimum viable product out there and see if you get traction. Off the back of that, we attracted AdStage in the US, our first big customer and a heavy user of Cassandra.
We learned a lot about operating at scale as AdStage grew — and having an anchor tenant on our platform was a key to our successful growth.”
The two bootstrap investors realised more funding was needed to help the business handle rapid growth, so they showed the AdStage case study to venture capitalists and in September 2014, brought in seed funding of more than $2m. “When we were doing the deal, Peter and I said, ‘We’ll get this sorted then go off into the sunset,’” recalls Stuart. “I’ll never forget Nick [McNaughton, CEO of ANU Connect Ventures, which led the round] telling us, ‘No, you guys have to be involved if you want this funding. You’ve got the experience from building Stratsec and you’re needed here.’”
Second time is a charm
After a “little bit of resistance”, the second-time startup founders accepted. Both now recommend that every startup seeks experienced entrepreneurs to complement a first-time founder’s passion — and establishes a board of experienced advisers early to get the strategy and governance right.
Peter Nichol was hired as CEO in 2015, bringing extensive experience growing technology businesses in the US, including Platform Computing, bought by IBM in 2012. “We needed that US presence to start to own some senior relationships, because that’s where 95 per cent of our customer base was,” says Lilley. “He’s the secret to our success,” adds Stuart. “We gained proper process around sales and our growth trajectory ramped up. And each time we’ve added new investors, we’ve also gained new board members who help build our strong financial resilience.”
Instaclustr’s board now includes McNaugton, Jerry Stesel, founder of Our Innovation Fund, and Benjamin Levin, founder of Level Equity, as chair.
“When you run a business, you can feel like your challenges are unique,” says Lilley. “Having access to investors and their portfolio companies means there’s usually someone to advise you who’s faced the same thing. We’ve gained effective strategies for dealing with complex compliance issues such as labour rules, and sales and use taxes, across 52 different jurisdictions, because we could lean on our board’s network.”
In the early days of Instaclustr, the Australian government’s export market development program and R&D tax incentives were useful, says Lilley. That government support meant he and Stuart could continue to invest in improving Instaclustr’s managed technology platform and export market opportunities to grow the business. However, a big challenge when growing a technology business is attracting and keeping tech talent, which can quickly take the company over the state payroll tax threshold.
“State payroll tax can be anti-growth,” he explains. “Apart from the admin burden and accountants’ fees, when you’re investing everything into growth and not generating profits in favour of future returns, state payroll taxes can claim several engineering positions you could have hired earlier, and which would have delivered growth earlier. Something such as payroll tax offsets for early stage growth companies would be an interesting idea.”
Having championed open-source solutions at Stratsec, Lilley and Stuart are baffled that many technology leaders in large Australian organisations still prefer US proprietary software. “It dumbfounds me we still have people in charge of choosing technology in Australia who are so enamoured by US vendors,” says Stuart. “Yet we’re displacing those same vendors on their home soil throughout North America because our customers there understand open-source and cloud-native businesses like ours better.”
Advice for tech startup boards
Funding takes time
“The funding process can be difficult and distracting, and always takes longer than you think,” says Stuart. “Plan fundraising as much as you would plan and review budgets and operations. Build a list of opportunities and run investors like a sales pipeline,” adds Lilley.
Culture needs constant care
“Remember cultural fit when hiring as it helps build a positive work environment,” says Stuart. “Outliers are useful when you’re looking for innovation, but everyone has to be on the same team. That’s hard when the team grows quickly. Hire HR people early to help recruit the right people and manage team dynamics.”
Govern for performance
“Governance is wanted by most entrepreneurs,” notes Stuart. “It brings stability to a hyperpaced environment. The board needs to be supportive and assertive. It’s a fine balance of encouraging innovation, delivering on vision and building a strong company that meets its KPIs.”
Encourage sustainable growth
“Founders need to be reminded it’s not about the exit payout,” notes Stuart. “Boards can remind them to focus on their customers and people, not the final prize. A strong sustainable business with strong fundamentals and metrics will be worth more.”
Watch the cash
“There is likely to be significant investment in developing the technology,” says Lilley. “Too many tech startups burn cash without considering liabilities building in the business, then try to raise new capital too late.”
Ensure sales and tax compliance
“Boards need to help entrepreneurs deal with the changing tax environments across countries and states,” says Lilley. “Changes to sales and use taxes on services sold by remote sellers into economies are often driven by the behaviour of large multinationals. The compliance burden for tech companies can be enormous and result in penalties or reduced returns at exit time.”