Inside The Microsoft Chairman's Struggling Startup: Is John Thompson Spread Too Thin?

John Thompson

Virtual Instruments, a Silicon Valley-based startup led by Microsoft Chairman John Thompson, faced a serious cash crunch last month after missing its sales targets for the past two quarters. But after a series of meetings with potential investors, and the startup's creditors and board of directors, Thompson thought he and his team had struck a deal that would provide a solution to Virtual Instruments' problems.

CEO Thompson, in an all-hands meeting with Virtual Instruments employees on Oct. 30, didn't specify what kind of deal Virtual Instruments had in place or identify the other party. But three sources with knowledge of the matter told CRN the deal involved selling a majority stake in the San Jose, Calif.-based startup to a firm that specializes in acquiring distressed assets and turning them around.

In the meeting, Thompson told Virtual Instruments employees he was so confident the deal would be finalized that he decided to take a couple days off to indulge in one of his favorite pastimes, duck hunting.

[Related: Virtual Instruments, A Startup Led By Microsoft Chairman John Thompson, Lays Off More Than Half Its Staff]

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"Last Friday [Oct.23] we thought we had a deal, and I felt good enough that I took a trip [to] Manitoba, Canada, to do a little duck hunting, only to realize on Sunday night or early Monday morning that the deal had fallen apart," Thompson told employees in the meeting, an audio recording of which CRN listened to. "So we've literally been scrambling since Monday morning [Oct. 26] to garner the cash infusion needed to keep us moving forward."

A half-dozen current and former Virtual Instruments employees told CRN in recent interviews that they were surprised and dismayed to hear Thompson talking freely about not being present during one of the most crucial periods in the startup's seven-year existence.

"The duck hunting story was unbelievable," said one current Virtual Instruments employee, who didn't want to be named. "[Employees] thought it was in bad taste [for Thompson] to have left the table before the deal was done, and equally bad taste to talk about it openly at the all-hands."

Thompson mentioned hunting once again in a meeting with employees on Nov. 5, in which he was asked to talk about how much time he spends on Microsoft-related matters. He said being chairman of the Microsoft board takes up between 15 percent and 20 percent of his time, or about one day per week, noting that this is in line with the estimate he provided to Virtual Instruments when he joined the Microsoft board in 2012. He became chairman in February 2014.

"The bigger problem for me is, this time of year is hunting [season]. And I spend more time hunting than I do [on] Microsoft stuff, and I guess I'm going to have to cancel that. I have to feed my family, my gosh, I don't get paid here," Thompson told employees in the meeting, an audio recording of CRN also listened to.

Although Thompson said this with tongue in cheek, Virtual Instruments employees aren't in the mood for jokes these days. The once-high-flying startup is facing the fight of its life, and some employees believe Thompson was late to react to the signs of trouble because he was too focused on outside endeavors.

In two waves of job cuts in the past month, Virtual Instruments has laid off or furloughed nearly two-thirds of its staff of around 300 employees. And Thompson, in the same meeting where he talked about the arrival of hunting season, did not rule out the possibility of additional furloughs in responding to employees' questions on the matter.

Sources told CRN that a significant number of Virtual Instruments employees who were laid off and furloughed had been hired in the past six months, including some who'd only been at the company for a few weeks before they were let go.

As a result of the cash flow problems, Virtual Instruments halted payments of sales commissions and employee expense reimbursements in September, around the same time that it halted payments to its hardware suppliers, sources familiar with the situation told CRN recently. All of these payments have recently resumed, said the sources.

Most alarmingly, seven out of the eight members of Virtual Instruments' board of directors resigned en masse late last month, including representatives from its four major investors. This leaves Thompson as the lone remaining board member.

"The naive part for me -- and I take full responsibility for this -- was [that] I did not realize or assume that we did not have the full support of the board," Thompson told employees on Nov. 5.

The events of the past six weeks raise numerous questions, not least of which is: Why did Virtual Instruments continue to hire after the sales slowdown became apparent? Sources close to the company told CRN they believe the problems could have been mitigated by a more conservative approach to running the company.

Employees who spoke with CRN believe the problems stem in part from the fact that Virtual Instruments only targets the Fibre Channel storage market, and has been slow to expand its focus to network-attached storage and IP storage.

Virtual Instruments did manage to secure $10 million in incremental cash on Oct. 29 to keep the company afloat, in the form of additional debt funded jointly by the TriplePoint Capital Group, Menlo Park, Calif., and existing investors, Thompson said at the Nov. 5 employee meeting.

Now, Virtual Instruments is in a race against time. Thompson told employees the startup's current cost structure is between $8 million and $9 million per quarter. Sources close to the company told CRN that sales for the current quarter look healthy due to the closing of a number of large deals. But given the recent turbulence, they said it's unclear if customers will continue buying from Virtual Instruments at previous levels.

Thompson initially agreed to a phone interview with CRN but then canceled. A Virtual Instruments spokeswoman subsequently said he would not be addressing CRN's questions about the startup's struggles.

Thompson did provide the following statement through the Virtual Instruments spokeswoman:

"Like many tech startups, Virtual Instruments has been investing to drive long-term growth. However, like many venture-backed companies, the plans we envisioned didn’t materialize. We’re pleased with both the products and the customer base we’ve developed over our eight-year history.

"I’ve dedicated more than 80 percent of my working time over the past five-plus years to support the Virtual Instruments team, our investors and customers. And, my commitment to the company has not waned even during some of our most challenging times," Thompson said in the statement.

Promising Beginnings

Virtual Instruments' current struggles are surprising because it was, not very long ago, one of the hottest startups in Silicon Valley.

The company's flagship product, VirtualWisdom, is an integrated software/hardware appliance that uses analytics to give organizations real-time visibility into the operations and performance of mission-critical apps running in physical, virtual and cloud environments.

VirtualWisdom, by optimizing storage performance, can enable organizations to save money by purchasing less storage. That's important because many organizations tend to overprovision storage as a safeguard against performance problems, an approach that tends to be expensive and ineffective.

As a pioneer in the infrastructure performance management space -- which Thompson has previously described as a $9 billion market opportunity -- Virtual Instruments quickly gained a reputation for solving tough technical challenges in complex IT environments for some of the world's largest companies.

Hewlett-Packard and EMC are among the many large enterprises that use VirtualWisdom in their environments, sources close to the company told CRN. Virtual Instruments customers include "50 or 60" Fortune 500 firms, including banks, insurance companies, hospitals and telecom carriers, Thompson told Business Insider in February.

Virtual Instruments grew like gangbusters in its early years, and until about 2013, was considered a strong candidate for an IPO. One former employee told CRN the startup saw an average annual compound growth rate of more than 60 percent in its first three years.

"That kind of growth rate is something very few companies in Silicon Valley can claim," said the former employee, who didn't want to be named. A Virtual Instruments spokeswoman said the privately held company doesn't comment on its financial results.

Thompson also told Business Insider in February that 2015 "should be a big year for us" and that Virtual Instruments was on track to hit $100 million in revenue. After the June and September quarterly misses, however, that target no longer seems realistic.

Thompson told employees in the Oct. 30 meeting that Virtual Instruments sales have actually been trending down since last year. "We had quite a strong year in 2013, our growth slowed in 2014, and quite frankly, has become negative performance in 2015," he said in the meeting.

Thompson said Virtual Instruments has had "huge problems" in the marketplace with VirtualWisdom version 4, and that customers running version 3 of the product have not been upgrading at the rate he and his management team anticipated. Virtual Instruments will address this by improving the functionality and scalability of VirtualWisdom, he told employees.

"One of the underlying expectations for the team was that VirtualWisdom 4 would drive incremental performance in the marketplace, and it has not," Thompson said in the meeting. "So we've got some work to do to fix that problem so we can move on from here."

Thompson told employees that Virtual Instruments' second- and third-quarter sales hit the wall at the same time it was trying to accelerate its business by moving to what's known as a concurrent development model, where multiple teams work in parallel on projects.

The switch to concurrent development caused Virtual Instruments' burn rate to soar to $6 million a quarter, or nearly double its previous rate, according to Thompson. "That's a very costly model and, quite frankly, it burned a lot of cash," he told employees.

While some employees believe Virtual Instruments has been slow to extend his focus beyond Fibre Channel storage, Thompson said in the meeting that he thinks there is still plenty of opportunity in this space. The main problem is that Fibre Channel deals take some time to close, he said.

"The gestation cycle on those deals is just very, very long," Thompson told employees. "That's been one of our go-to-market challenges from the very beginning. I don't think that's going to change."

Why Did The Board Quit?

Virtual Instruments actually shopped itself to prospective buyers earlier this year, before it missed its June and September quarterly sales targets, Thompson revealed in the Nov. 5 employee meeting.

In the "the March-April time frame," Thompson hired San Francisco-based investment bank Evercore to lead the campaign to find a buyer. Thompson told employees the goal was to see how much Virtual Instruments could fetch in what he described as a "frothy" acquisition market.

But after six months of searching, Virtual Instruments received just one offer, and that "was somewhere around $100 million to $110 million," Thompson told employees. He said the offer was rejected because it was for less than half of Virtual Instruments' $207.5 million post-money valuation after its last round of funding, a $27.5 Series D round in September 2012.

Virtual Instruments has received just over $76 million in funding in six rounds since its founding in June 2008, according to Crunchbase.

The weak offer, combined with Virtual Instruments' misses in the June and September quarters, convinced the startup's seven board members that it was time to resign, Thompson told employees.

Included in the resignations were representatives from Virtual Instruments' major investors: Hemant Taneja of General Catalyst Partners, Christopher Schaepe of Lightspeed Venture Partners, Jeff Parks of Riverwood Capital, and Craig Hanson of Next World Capital. None of the four responded to a request for comment.

Thompson told employees that another reason the board members quit was to reduce their fiduciary liability risk, and because they'd decided beforehand that they'd either be "all-in or all-out." He said he's in the process of building a new board of directors, but that this one will be strictly advisory in nature and its members won't have the same liability risk.

Steve Mankoff, general partner at San Francisco-based venture capital firm TDF Ventures, and one of the board members who just resigned, has agreed to rejoin the advisory board, Thompson told employees. Mankoff didn't respond to a request for comment.

"While we may not have a 'board', we will have an advisory board, and from my point of view there's very little difference," Thompson said in the meeting. "I just want the insights that those guys bring to the table."

Has Microsoft Been A Distraction?

Thompson, 66, led the software giant's search for a new CEO after Steve Ballmer in August 2013 disclosed plans to retire, which culminated in the hiring of 22-year Microsoft veteran Satya Nadella in February 2014.

The five-month Microsoft CEO search took much longer than most industry watchers expected. According to The Wall Street Journal, the search involved the vetting of more than 100 candidates.

Some Virtual Instruments employees told CRN they believe it's no coincidence that Virtual Instruments' growth began to slow during the same year that Thompson was named chairman of the Microsoft board.

Yet Thompson has said he sees no conflict between his roles as Virtual Instruments CEO and chairman of Microsoft's board. "The CEO runs the company day to day. The chairman’s job is to manage the relationship between the board and the management team, the board and some of our investors," he told Business Insider in February.

According to Microsoft's 2015 Proxy Statement, Thompson's board chairman position includes serving "as an advisor to Mr. Nadella on strategic aspects of the CEO role with regular consultations on major developments and decisions likely to interest the Board."

In Microsoft's fiscal 2015, Thompson's compensation as board chairman totaled $675,000 -- $100,000 in cash and $575,000 in stock awards. Microsoft's board held a total of 24 meetings during its fiscal 2015 year, which ended June 30, according to the Microsoft Proxy Statement.

In the Nov. 5 meeting with Virtual Instruments employees, Thompson said his role as Microsoft chairman is focused on shareholder issues and governance-related matters as opposed to operational issues.

Yet some Virtual Instruments employees feel Thompson should be spending more than 80 percent of his time on the startup. This sentiment is readily apparent in comments on company reviews web site, where Thompson's approval rating has nosedived in the past two months and now stands at 43 percent.

"Look, we deserve all of the bashing that we got on Glassdoor. We made some mistakes, and I'm the first to admit my share of those," Thompson told employees on Nov. 5.

Thompson is also a board member at two Silicon Valley startups: Illumio, which focuses on cloud security, and Liquid Robotics, an ocean data services vendor best known for making Wave Glider, an autonomous robot that's used to collect data for defense, oil and gas exploration, and environmental assessment projects.

It's not clear how much of Thompson's time these board roles consume, as he declined to answer CRN's questions on the subject.

While Thompson has big-time brand name recognition in the IT industry, some of his current and former Virtual Instruments employees believe his board roles have distracted from his oversight of Virtual Instruments.

"It's great having a rock star CEO because it opens lots of doors. But John's got a lot of hobbies, and it can be difficult at times to get his attention and his time because he's involved in so many different projects," said one current Virtual Instruments employee.

Virtual Instruments' Path Forward

Thompson has built a sterling reputation over a career spanning more than four decades. He spent 28 years at IBM, rising to general manager of its Americas business, and then spent 10 years as CEO of Symantec.

A savvy sales veteran, Thompson is now focusing his pitch on convincing the remaining Virtual Instruments staff that the startup does indeed have a future.

But employees told CRN it's tough to square Thompson's optimistic view of the future with his acknowledgement that he and his management team were looking to sell the startup just a few weeks ago.

Thompson told employees that after he returned from the duck hunting trip on Oct. 26 to find that the deal he'd struck had fallen apart, he learned that Brocade was interested, so he asked his bankers to call them.

Employees see this as an interesting twist because Brocade and Virtual Instruments have had a rocky relationship in the past. Thompson had a public falling out with Brocade CEO Mike Klayko in 2011 after Brocade -- a once-close Virtual Instruments partner -- launched a similar infrastructure performance management product and started going after its customers.

Thompson didn't explain to employees what happened in the recent Brocade talks, but he said Virtual Instruments is no longer actively looking to be acquired. "If Brocade wants to call, I'm happy to take the call, but it's not the same fire sale price this week that it was last week," he told employees. A Brocade spokeswoman declined comment.

Thompson also said he has stopped "proactively marketing" Virtual Instruments and will instead be "proactively working to stabilize the company and get us on the right footing."

Virtual Instruments is working to restructure its equity so that "remaining employees get to participate in the upside" once the company gets back on track, Thompson told employees. He said TriplePoint Capital is supportive of his plan to also give employees a cash incentive "that creates both reward and retention for all of you who have chosen to stay."

Yet during the meeting, when an employee noted that Virtual Instruments has experienced a precipitous decline and asked why people should remain at the company, Thompson didn't sugarcoat his response.

"You have to decide that for yourself. I can't tell you why to stay. You either want to be here, or you don't. And if you don't want to be here, leave soon. Let me be clear: Leave soon, because we don't need a festering sore -- we just don't," Thompson said.

"I'm here because I believe in the company. I have not taken a dime out of this company other than to cover some modest expenses along the way. And I could have invested money in a lot of other companies, but I chose to invest here. And so, if you don't want to be here, let the door hit you where the good lord split you. But if you want to be here, don't bring that up again," Thompson told the employee, whose identity couldn't be determined.

Employees told CRN that while they understand the gist of Thompson's comments, they felt his tone and choice of words came off as arrogant -- especially in light of the recent turmoil at Virtual Instruments.

Thompson also told employees that he decided not to invest more of his own money in Virtual Instruments. "It was real simple for me: I've put $6 million in so far, I've worked for nothing for six years, and I've flown my plane around the country supporting the field teams. I think I've made a big enough investment," he said.

Thompson did say he'd be willing to kick in $1 million to $2 million more into Virtual Instruments if circumstances warrant an additional cash infusion.

Thompson, returning to salesman mode, told employees that he plans to manage Virtual Instruments in a "very thoughtful, cash flow positive manner going forward."

Virtual Instruments' new structure is aimed at making it a "cash flow break-even company," Thompson told employees. "There are many, many companies in the tech space that run on a model of 10, 15, 20 percent growth. That's what we're going to build."

To get there, Virtual Instruments is moving from its existing services-led model to one focused on billings, because, as he told employees, "billings are what generates cash flow." In the services-based model, the startup wouldn't get paid until the service was delivered, but that's no longer a viable approach, he said.

"The focus has got to be on billings and how much we get to bill every quarter," Thompson told employees.

Virtual Instruments will need to have between $8 million and $9 million in billings every quarter to break even, and Thompson told employees he doesn't anticipate that being a problem. In the "recent history" of the company, Virtual Instruments' worst quarters have seen billings of around $6.5 million, while the best quarters have seen billings in the $23 million range, he said.

Thompson said Virtual Instruments is also shifting from a quota coverage sales model to one focused on productivity, noting that historically, one-third of the startup's sales team has generated 80 percent to 85 percent of its quarterly sales.

Those salespeople were retained, and Thompson told employees he expects them to continue producing "the vast majority" of the startup's business.

It remains to be seen whether Virtual Instruments employees buy into Thompson's vision to turning the startup around, but any further attrition "would be devastating," one employee told CRN.

With the recent $10 million in funding, Virtual Instruments has apparently bought itself enough time to attempt a turnaround. But given its cost structure, its margin for error would appear to be razor-thin, employees told CRN.

Thompson told employees in the meeting that Virtual Instruments won't have to start paying back the $27 million it owes TriplePoint Capital until the first quarter of 2017.

"We got a reprieve, if you will, as we went through the restructuring process with them," Thompson told employees. "My belief is that we will have this company fully stabilized, and quite frankly on a different track, by the first quarter of 2016 -- 2017 for sure."

However, when an employee asked Thompson how long the recent $10 million cash infusion will last, he didn't mince words.

"It's as much a function of how well did we do this quarter. If we do the minimum, we're in great shape. If we do below the minimum, we're screwed," Thompson responded.