Startup City: Startup Fundamentals

In case you haven't noticed, startups are back. And not just the Web 2.0 kind that appeal to hyperconnected youth. Today, new companies aiming to solve complex enterprise problems are sprouting up as if the dot-com bust never happened, which increases the likelihood CIOs will engage with them. While buying product from a startup requires many of the same risk/reward calculations as buying from established vendors, the immaturity of a new company changes the equation in fundamental ways.

First is financial stability. There's no question Microsoft and Oracle will be around next quarter. But, by definition, startups have yet to build a sustainable revenue stream, which means customers are essentially placing bets on the company's future existence.

To ensure that you aren't making a sucker bet, look closely at the funding structure. Who has invested in the company, and what's the exit strategy? Do the investors have a record of long-term growth, or are they looking for a quick return via acquisition? If it's the latter, investors may push the startup to change its strategy or business model midstream to capitalize on "hot" trends.

A startup's pedigree also should be considered when assessing risks. How experienced are the founder and the executive team? What are their past accomplishments? Who's on the board? Experienced founders bring not just knowledge but contacts. They can recruit capable talent and tap a Rolodex of investors and potential customers, which can mean the difference between a successful launch and a flame-out.

Jon Lowell, CIO of the Leukemia & Lymphoma Society, says pedigree strongly influenced his decision to engage with Workday, a startup that provides human resources management applications via the Web. Workday was started by Dave Duffield, the founder of PeopleSoft. "Duffield has a great track record and has built a great team," says Lowell.

A startup's immaturity will be reflected in the quality and capabilities of its product. As you would when considering an established vendor, a CIO must conduct technical due diligence. Just because a product has launched doesn't mean it's ready for a production environment. And be prepared for bumps in implementation and support: A new company is still training its employees on the product at the same time it's installing and supporting it in your organization.

You can minimize these risks in several ways. First, do extensive pilot testing, and start with a small deployment. Second, build flexibility into your deployment schedule, and have backup plans ready if the startup fails to meet critical target dates. "We've got an aggressive implementation plan," says Lowell, "but there's no cliff we fall off if we don't get it converted by date X."

Finally, build contractual safeguards into the business relationship with the startup. For instance, Lowell says that if Workday happens to go south, his organization has guarantees it will be able to extract its data.

Companies look to startups because they promise to solve problems faster, better, or cheaper (sometimes all three!). But there are other benefits. Beta partners and early customers have considerable influence on development; they can use that leverage to get their needs met and help direct the evolution of the product. First-comers may also get preferential treatment, which can take the form of favorable pricing, extended support, and direct access to executives.

Startups play an important role in driving technological innovation. With a careful assessment, CIOs can make sure startups work for them.