When A Startup Worth Hundreds Of Millions Goes Dark: Klout's Quiet Year Of Growth And Struggle

Instagram/KloutKlout employees beneath a sign in their California headquarters.

"What do you want to be when you grow up?"

It's a question all startups have to answer between giant fundraises and figuring out business models.

Some growing companies, like Twitter and Facebook, handle adolescence well. For others it's awkward and takes serious soul searching to find a place in the business world.

Klout is one of those companies.

In early 2012, the social-importance ranking engine was on fire. Kleiner Perkins, Microsoft, and other big-name backers pumped $30 million into Joe Fernandez's company at a valuation worth hundreds of millions of dollars.

Then Klout vanished from headlines. Last week it reappeared. The news wasn't good.

Klout's COO, Emil Michael, resigned. He left for Uber, the latest red-hot startup worth billions of dollars, to be its SVP of Business. Michael remains on Klout's Board of Directors.

Losing Michael as COO was one of a few snags the company has faced since its 2012 fundraise. The rumor mill has started to churn.

Why did Michael leave?

Is the company burning too much money?

Does it have a real business or revenue?

Are investors fed up?

Is Klout failing?

And so on.

We spoke candidly with Klout's CEO Joe Fernandez and others who are close to the company.

Klout isn't dead. It is soul searching.

How jaw surgery and 4 months in Singapore spawned a 9-figure startup

Joe Fernandez KloutJoe Fernandez, CEO of Klout

Klout is a 5-year-old company that was devised while its founder, Joe Fernandez, lay in a hospital bed. His mouth was wired shut following jaw surgery, so he used sites like Twitter and Facebook to communicate. It was then that he realized the power of social media platforms, and how much information people were providing about themselves.

"It was amazing to me that the people I trusted the most, I could tell them anything instantly from my phone [on Facebook or Twitter] and it would have an impact on them. And ... what they were saying would have an impact on me," Fernandez told Mashable in an early interview.

"I don't know if it was the pain relievers but I got really obsessed with the idea that, for the first time, word of mouth was scalable and the data was there to measure it."

For the first few years, Fernandez worked on the startup by himself. Friends didn't like his idea and refused to quit their jobs to join him. But Fernandez was determined. He shipped himself off to Singapore for four months and lived on a developer's couch while the beta version of Klout was built.

Klout now pulls data for half-a-billion people on Twitter, Facebook, LinkedIn and other social media sites. It crunches all of the information, highlights topics where people are most influential, and generates a score for everyone between 1 and 100. The higher the score, the more influential a person is. Marketers use these scores to target their ads to industry leaders, whether it is a mom who has pull in her town's PTA, or a CEO running a big-name company.

Controversy means headlines, not momentum

Justin Bieber used to have a perfect Klout score, nearly double that of President Barack Obama. He's still up there with a score of 95, four points behind Obama.

From the beginning, Klout's mission to rank people based on importance was controversial. Fernandez recalls presenting on stage at New York Tech Meetup one week after he launched Klout.

"I remember walking to the event and being terrified," Fernandez told Mashable. "I'm going to get in front of an audience of New Yorkers and tell them I've developed the algorithm that tells them how important all these people are."

As Klout grew, so did the controversy surrounding it. Klout scores created competition; everyone wanted to have a higher score than friends and colleagues. But in 2011, when bloggers learned Justin Bieber had a perfect Klout score of 100, the controversy exploded. President Barack Obama had a lowly score of 58. Klout's algorithms were unreliable, the media screamed.

"There was a point where I was like, 'The next person who asks me about Justin Bieber I'm punching in the face,'" Fernandez joked to Business Insider last year.

Klout tweaked its scoring algorithms to measure 400 signals, like Wikipedia pages and Bing searches, in addition to social media activity. It wrote a detailed explanation about how scores are created, and it got a big vote of confidence from investors to the tune of $30 million. Notable venture capital firms such as Kleiner Perkins Caufield & Byers, Venrock, and Institutional Venture Partners invested. Microsoft did too.

Finally, even its most vocal skeptics eased up.

"Klout has been one of my go-to punchlines for some time now," TechCrunch founder and CrunchFund investor Michael Arrington wrote in August 2012. "I've changed my mind. So much so that CrunchFund has now invested in Klout, and we're big believers in what they're doing...They've relaunched the product and a lot of the tricks that people used to game the system are gone. And better, Justin Bieber is no longer considered the most influential person in the world on Klout."

Once the controversy around Klout died down, so did much of its press.

"The controversy surrounding Klout is why it was in the conversation a year or two ago," Emil Michael, who served as Klout's COO until last week, told Business Insider. "Controversy does not equal momentum."

When buzzy startups vanish from the press it can mean they're heads down, working. Or it can mean they've died.

On The Struggle Bus

Instagram/Klout

"You hear anything about Klout lately?" I recently asked a source.

"Nope," the person replied. I didn't buy it.

"I understand they're on the struggle bus a bit," I prodded.

A "struggle bus" is a now-common phrase for a difficult situation.

The source knew what I meant and my cool-kid slang made the person cave. Yes, this person said, the struggle bus assessment was fair.

Part of Klout's problem is that it's two businesses in one. First, it has a consumer business, the Klout scores that you're probably familiar with. Then and it has a lesser known enterprise business. With enterprise clients, CMOs can use Klout as a Customer Relationship Management (CRM) tool. They also use it to offer advertising promotions to influential people through "Perks."

The combination means Klout has massive business potential. But Klout needs to focus, and it's hard to know which opportunity to pursue first. Investors are torn too.

"Everyone thinks they have the idea for the perfect business model for us," Fernandez says.

Some Klout investors think the company should focus on enterprise and charge CMOs for CRM tools or social media analytics. Their logic is simple.

More than 200,000 companies use Klout for Business, a suite of enterprise tools that rolled out in March. There are 10,000 businesses using Klout's API. There have been 500 Klout Perk campaigns. In addition, Klout has powerful partnerships with Salesforce and Microsoft.

Klout's API is an impressive story alone. Klout's database is pinged a whopping 60 billion times per month, or 2 billion times per day, and Microsoft's API calls aren't even included in that count. Gnip, a data reseller that has full-access to Twitter's archives, generates a lot of the API hits. It helps other companies integrate with Klout's public API.

The 60 billion number puts Klout's API usage up there with Google and Facebook. Only one person on Klout's staff works on the API, so there's room for the already-massive product to grow.

Companies are interested in Klout's data for two reasons.

1. Customer support teams use Klout behind the scenes to learn who they're speaking with. For example, an airline representative might route an influential caller to a manager based on his or her Klout score. A hotel might upgrade a powerful caller's room for free.
2. Klout is a good way to filter and prioritize people. Microsoft Bing uses Klout in its search results for example; Klout scores pop up next to a person's name and push results higher or lower. "The theory is, the whole world is changing from being page-based to people based," Fernandez says.

Others investors think Klout should buff up the consumer product, Klout scores, since it needs users to survive.

"Klout is very much like LinkedIn in that it will always need a consumer base," Michael says. While Klout can score people who haven't linked their social media accounts to the website, it unlocks infinitely more data once they've granted access to Instagram, Facebook, Foursquare and other profiles.

No matter which business Klout tackles first, some of its investors will be frustrated.

Fernandez admits his team hasn't found the perfect product to offer yet, but early revenue signs are promising. Even with an imperfect product, Fernandez says Klout will generate more than $10 million this year; it is expected to double that revenue next year and possibly break even.

Foursquare is a good comparison, because it's a data company that spent the past year testing a suite of advertising products too. In 2012, Foursquare's trial advertising solutions only generated $2 million. This year the tweaked products will generate $10-20 million, about as much as Klout's accidental revenue. Foursquare's staff is twice the size of Klout's 70-person team and it has raised almost three times as much money, $112 million versus $45 million.

Neither Klout nor Foursquare rival Twitter and Facebook's early revenue. Twitter was able to generate ~$45 million the first year it offered advertising, according to eMarketer. Facebook generated $150 million a year after it ramped up its advertising business.

A fresh $5 million and a closely-watched burn rate

For reasons unknown to even Fernandez, Klout has been experiencing sharp growth abroad, particularly in Japan. The sudden spike attracted a Japanese investor who was eager to introduce Klout to the market there. The investor led a small, $5 million round in the company less than two months ago.

Did the company need the money because it was spending too much and in danger of running out?

Fernandez says no. He took the investment for strategic, not cash flow, reasons, because he wants to beef up Klout's Asian presence.

He watches Klout's burn rate closely and feels confident that his company has plenty of millions left to run on. Fernandez also says there are no layoffs in Klout's near future. Klout has at least 18 months worth of money in the bank. That's healthy; startup advisor and blogger Martin Zwilling says investors like each funding round to last between one year and 18 months.

An Uber Large Offer Klout's COO Couldn't Refuse

Former Klout COO Emil Michael

While Klout still has kinks to work out, its business undeniably shows promise. It hasn't raised or burned too much money, it still attracts investors, CMOs are clamoring to use it, and its API traffic is massive.

So why did its COO, Emil Michael, leave last week?

Emil Michael joined Klout 17 months ago. Prior to joining the company, he worked with a number of startups on their business strategy, including Flipboard and GroupMe, which was acquired by Skype. He also worked alongside the Secretary of Defense.

A friend described Michael as a "business rock star." Those words could also be used to describe Uber CEO Travis Kalanick. Uber, an on-demand driver and logistics startup, is one of the hottest private companies right now.

Kalanick and Michael have known each other for more than two years. They were introduced by Bill Gurley of Benchmark Capital, who is also Michael's long-time mentor.

Uber spent six weeks pursuing Michael before he agreed to become its SVP of Business. Kalanick made Michael an offer he couldn't refuse.

The gossip is that Michael's package was extremely compelling. One source familiar with the situation says it could be worth as much as $20 million given Uber's current $3.5 billion valuation and promising future.

When I floated the $20 million figure to Michael he laughed. "No," he said firmly. Uber also says the figure is "way" off.

Michael wouldn't give a formal comment about his pay package but he did provide some color. His stock options will vest over time, just like any other startup employee. He also cautioned that Uber's current valuation can't be used to determine the worth of his stock options. Investors and employees are given different kinds of stock.

Plus, Michael is modest. He says he isn't a "count your chickens kind of guy."

"It is a really exciting deal," Michael said simply of Uber's offer and potential. "There's no other company I'd leave [Klout] for ... If Uber fulfills the promise that was exemplified by the last round they hit, lots of people will do well financially."

Fernandez isn't mad about the departure. If anything, he's proud Uber looked to Klout for talent; it also poached executives from Facebook and Google.

"As Emil's friend, if I could imagine the perfect job in the world for him, it's [the Uber one]," says Fernandez. "It's a bummer to lose him, but it was cool seeing our name up there with Facebook and Google."

Fernandez says he won't be actively hiring to fill the COO position. He did recently hire a CTO and a VP of Product, though.

Growing up in 2014

Fernandez knows the vision for Klout, even if his current product is imperfect. He wants it to become the ultimate conversation starter for brands.

"We think we have the opportunity to own earned media," Fernandez says. "Earned media" is essentially word-of-mouth advertising on networks like Facebook and Twitter. It's the ability to get people talking about brands because they want to, not because they are paid to.

"We put products in the hands of influencers and the influencers create noise around it," Fernandez says.

Klout ran an earned media partnership with American Airlines in May. People with qualifying Klout scores were invited to use the airline's 40 worldwide lounges, even if they were flying with a competitor. The offer was well received; the announcement post generated 61 comments and nearly 1,000 retweets from genuinely excited people. It was covered on numerous media outlets including Ad Age, CNBC and Yahoo.

Klout has run hundreds of these campaigns or "Perks." There are 30 brands testing a new earned media product too.

But Fernandez admits Klout is still fighting its way through a period Fred Wilson calls "the mess."

Fred Wilson is a partner at Union Square Ventures, a firm that invested in Twitter, Foursquare and Etsy. He likened startups to teenagers back in 2007.

"Startups come out of the womb with the same bright shiny hopeful optimism as kids do ... then they hit their ugly adolescent period," Wilson wrote then. "They start to doubt themselves, they get zits, they get distracted with other things ... [To survive adolescence] you have to face the doubts, you have to admit that some of the things you've done were wrong, you often have to cut back the ambition and focus on the little things that are working. That takes leadership."

Fernandez anticipates another 60 days of mess. Then Klout will be set up for a better 2014.

To Fernandez, a startup's figure-it-out period is nothing to be ashamed of. Creating a bold business isn't always pretty.

"The [adolescence phase is] painful," Fernandez wrote to Business Insider. "Our ecosystem loves to over-hype startups and then punish them for somehow not redefining how we think of growth trajectories.

"There will be the occasional Snapchat, Instagram and Pinterest, but these are like the kids we all knew in school who skipped a grade. Just because they are exceptional doesn't mean that everything else is a failure. There are a bunch of companies that are going to stumble through figuring things out but will eventually find their way to a big outcome.

"If your vision is to build something big and bold that has never been done before, it's likely going to take time. Any long journey can look like failure when you are only half way through."