Startup Grognard

The T Word

Back when I was raising a Series A during the last bubble I made one of a thousand presentations to a VC firm. The partner had foisted the meeting off on an associate. (It’s always nice to have your future in the hands of a fresh graduate.)   We had build a successful product with 350 enterprise customers, a consulting business doing about $1M/year, and had just rolled out what was to be our flagship product. We had a few initial customers and our price point was $250K. We were seeking a $5M investment.

At the end of the pitch the associate indicated that we were too early for their profile, but after we had some traction they’d like to talk with us. I asked him how many customers they would consider traction. His answer was “We like to see about 100 customers for enterprise tools to prove traction.”

There it was, the T word: Traction. It’s an excuse that VCs use when the bubble is deflating. When the bubble is going strong you can get a first round with a great idea on a napkin. But when they’re pulling back, it’s like borrowing money from a bank. You need to prove that you don’t need the VC money in order to get it.

I then asked “So, what you’re saying is that if a company with breakthrough technology came to you and had $25M in revenue you’d be willing to invest $5M? in a preferred position?” He just stared back blankly. Clearly the 100 number was just a knee jerk reaction — he hadn’t thought about our numbers. In case you’re wondering, that’s a valuation of 1x revenue.

The problem is that when money starts getting hard to get it’s because the risk profile of investors has gotten out of touch. I talked about the flip side of this in Is Your Risk Meter Broken? But it is easy for VCs to break their risk meters as well. During the height of the bubble it’s irrational exhuberance. During the pullback their excuse for just about everything is “not enough proof.”

The T word means No. They don’t believe in your business. They don’t believe in you. If they did, they’d be willing to take a risk, because that’s the business they’re in. If they believed as much as you do, they’d be willing to fund without the proof points because they’d want to be ahead of the other investors that will take a pass. Everyone is looking for the diamond in the rough that no one else recognizes.

Don’t kid yourself that there is any amount of traction you can get that will change the story with this investor. If you could get enough traction to change their mind you wouldn’t need venture investment. Just keep kissing the frogs until you find your prince.

The request for $25M worth of traction from the recent business school grad was a low point on the roller coaster ride. The next turn up is that a week later I was in a pitch with a VC who became our Series A. He made his decision at the end of the pitch. He knew the market, had done the research, and realized the opportunity. That’s what you’re looking for, not the gutless ones that want to remove all risk before they make a venture investment.

No, You Can’t Teach Yourself to Code This Weekend

It’s probably a result of the extremely tight market for technincal talent, but I’ve had several non-technical business types ask me for advice on how to learn to code. They’re fishing for a book along the lines of “Coding for Dummies” or something, as if it’s just a simple matter of learning a few secret incantations.

I usually answer with the question “Why do you want to learn?” The answer usually boils down to their desire to build the product they’ve got in their head and their problems with recruiting a technical founder or a “programmer” that will work for options on a small portion of their company.

As a technical person that has built several products and companies over the last 25 years, I find this perspective perplexing. Although well meaning, their question seems to have the flavor of Whartonite Seeks Code Monkey. Sure, just buy a book and spend a few weekends hacking and you’ll be able to do what took me years of formal education and decades of job experience to get good at. Hey, I’ve read several books and spent a lot of time on MS Flight Simulator — how about we rent a plane this weekend and you can be my co-pilot?

Ok, that’s a little harsh. Fred Wilson advises non-technical founders to “get technical:”

Learn how to hack something together so that you can get people interested in your idea, your project, your startup. If you can do that, then you have a better chance of success.

Fred’s point is that learning to code is a good thing. If you can get good enough to be able to understand the issues the developers are presenting you’ve done something useful.

But don’t kid yourself that you’re going to be able to do anything more than build a throwaway prototype. If you can build enough to get angel funding the first thing you’re going to need to do is bring in a technical co-founder to rewrite everything. Just like reading several books on the law and watching every episode of Law and Order doesn’t make you a lawyer, hacking together a demo product doesn’t make you a developer.

Back in the 1980s when I was a fresh CS grad in my first coding job I wrote a prototype for a new feature of a very mature product. My boss said “That’s nice, but what are you going to do when it’s a million records?” Today the question would be a billion or a trillion, but the idea is the same. It’s easy to build a prototype. Turning that into an industrial strength product that handles every possible load and corner case is something quite different. Building signficant products that will command large sums of money from enterprise customers is even harder. Sorry, but you’re just not going to learn how to do that without putting in the years of blood, sweat, and tears that the pros have put in.

Boiling The Ocean

A popular admonition given to early stage companies is “Don’t boil the Ocean.” The idea is that it’s a lot easier to boil a tea kettle’s worth of water than it is to boil the entire ocean, and if you approach the ocean one tea kettle at a time you’ll get the job done — eventually.

This is good advice and was expounded upon in great detail by Geoffrey Moore in “Crossing the Chasm” where he advises early stage tech companies to select a target market and establish a beachhead. These markets are usually verticals, although they could also be a segment. Once that market has been captured, it is much easier to expand into other markets.

Facebook is probably the best example of a recent success that followed this strategy. Their initial market was the Harvard campus. They then expanded to a number of universities, finally opening themselves up to everyone, everywhere. The nature of their product allowed them to concentrate on small markets first. If they had tried to go horizontal initially, the social graph of their customers would have been so spread out that they never would have hit critical mass.

The problem is that people often confuse the selection of a target market with the product feature set. Was the feature set that college students found so compelling with Facebook any different than what eventually appealed to the broader horizontal market? Sure, they added more features as they grew, but their product direction was applicable to the broader market from the beginning.

While the “Don’t Boil the Ocean” mantra is widely accepted as absolute truth, there are plenty of recent examples where companies have successfully boiled the ocean. Moore wrote his book in 1991. You were in the elite if you had email back in 1991. There was no social networking, no smartphones, no TechCrunch, or anything else that could lead to low cost rapid adoption. Knowledge about products spread by telephone or face to face contacts. The idea of providing software for free was heresy. Things have changed quite a bit, and boiling the ocean is actually a lot easier than it used to be:

• Google. Perhaps their beachhead was techies, but that’s more a definition of early adopters rather than a target market or vertical beachhead. Could Google have become a success if they had started off being the very best search engine for the needs of Auto Parts Stores (or any other vertical)? Of course not, their selling point was that they had a better index of the web and gave better results. If they had tried the vertical beachhead strategy we’d still be using the Yahoo directory.
• LinkedIn. This is a great example of a company that boiled the ocean due to the network effect. I remember getting an email back in 2003 from a friend that had joined. Within six months most of my business contacts were on it. What was useful about LinkedIn is that it wasn’t limited to a vertical — you could make contact with people outside of your area.
• Twitter. Nothing about Twitter was vertically targeted. They boiled the ocean from the beginning.
• Netflix. Here’s a B2C play that boiled the ocean from the beginning. If they had tried to focus on a segment such as people who like horror films it would have failed. The essence of their proposition was that they had a huge library at a low cost.

See the trend here? If your product is super low cost or free then you can have a sales process with a minimum amount of friction. If your feature set is horizontally targeted instead of vertically you can hit the maximum number of early adopters in each field. If your product has a built in network effect, these early adopters will actively help to spread adoption. What used to take years during the time of “Crossing the Chasm” can now take weeks or months. There is no cost difference between going horizontal or vertical.

The key is that there are some products where being horizontal is the essence of the product. The value of the product is that it covers everyone. If you try to solve the small version of the problem you’ll never get anywhere.

The problem for entrepreneurs is that going large from the beginning can be in conflict with going lean. Let’s say you’ve come up with an algorithm that delivers 100x better results than Google. Can you build that in a lean environment? Of course not — you’re going to need a pile of cash just to pay for the servers. Your development team and methods can be lean, but that class of problems just can’t be attacked by lean companies. Which means that in order to attack those problems you have to find investors with the capacity to put a lot of money to work before they see real results.

There are lots of great startups these days that have selected small and well defined target markets. They’re boiling a kettle at a time. But one really has to wonder if “Groupon for Dentists” will ever generate the 100x returns venture investors are looking for in a knock it out of the park scenario. (BTW, if someone out there is doing Groupon for Dentists, I’m sure your dream is real, don’t listen to me.) In fact, if you look at the companies that have really knocked it out of the park, very few of them in the last 10 years have done anything other than boiling the ocean.

Big Companies vs Little Companies

April Dunford, who is right about just about everything, had an excellent post on big companies vs small companies, mainly from the sales and marketing perspective. She’s spot on — most people at big companies have very little idea about what is and is not possible at small companies, and vice versa. Having worked in both giant corporations and small startups, I can verify everything she said in that article. Her article mainly talks about competition between the two. I’d like to add a few more items of interest to startups that are contemplating selling into a large enterprise.

Here’s what I’ve observed from both sides of the table:

• Big Companies Are Not Nearly as Coordinated as They Appear. The basic problem that large enterprises have is that once an organization reaches a certain size, it is extremely difficult to properly align incentives and behaviors to the needs of the business. Let’s say you’ve just spent six months selling a product to a Global 50 company. You’ve worked with stakeholders in the business, IT, and executive leadership. They’ve said “Yes, we’ll take that.” Now you get to meet the people in purchasing. Here’s the problem: Everybody you’ve worked with so far is incented to improve the business. If your product is really great, they’re going to want to make it happen as long as they can stay within budget. But most likely, the people in purchasing are not incentivized as to how quickly they can close a deal, they’re measured on how much of a discount they can pound out of their vendors. From their standpoint, they could care less that your wonderful Gizmotronic 5000 will cut operating expenses by 50%. Their next performance review will depend upon how much of a percentage they were able to negotiate down from the vendors. Taking longer to do that doesn’t impact them in the least. It’s the same with accounts payable — they aren’t evaluated on how quickly they pay their vendors, they’re incentivized to manage cash flow. It doesn’t matter how badly the business needs your product or relationship — different departments have completely different definitions of wining.
• People in Big Companies Don’t Know Each Other. It seems that everyone I meet from a small company says “You work at Oracle? Then you must know ….” Nope, sorry. There are 105,000 people here. That’s a mid-sized city. I suspect there may even be other groups at the company that have the same mission as my team, we just haven’t run into each other yet. Just because you’ve made inroads into a specific group at a mega-company doesn’t mean you have a relationship with that company.
• Big Companies Will Use You for Research. I had a conversation with the founder of a startup a few years ago that informed me that he was about to make a deal with Oracle in an area that I’m heavily involved in. I was a bit shocked that I didn’t know anything about it, so we played the “who do you know” game. I got a few names of people that he claimed were driving the deal and looked them up. Nope, not even remotely involved with anyone that had real budget or power to make it happen. Turns out he was talking to someone in a group that was just doing research in the area. Big companies play that game all the time with small companies — it’s so cute when the little companies are so forthcoming with free consulting.
• Stability is an Illusion. I had a guy working at one of my startups whose wife was very down on our company. The roller coaster ride of the startup life just wasn’t for her. He loved what he was doing, but she wanted the safety of a big company so he left. Six months later he was unemployed — the giant company had cut his division. While big companies may be too big to fail, it is also extremely easy for an executive 6 levels up to change a single entry in a spreadsheet and RIF 100 people between sips of coffee. The same is true for selling into large companies. I saw a deal that was 98% done evaporate because a re-organization hit the department and the budget was moved. In the morning it was a deal, by that afternoon they were starting over.
• Big Companies are Not as Cost Sensitive as You Might Think. One of my startups had a product that was priced at 25% of our primary competitor. We had better features, better performance, new technology, everything. And they kept beating us. It was extremely frustrating. I became so exasperated that after losing a deal in a Global 50 company I called the VP and offered him our software for free, free installation, free customization, and 2 years worth of free support. Nope, no deal. It wasn’t about price. The other company had gotten to that account first, built the relationships, and guided them into budgeting for the purchase. Had the VP taken me up on my offer he would have looked stupid for first requesting the huge budget amount. People at big companies don’t build their careers by taking risks. Over the long term, getting a bigger budget, more people, and building out the fiefdom is the route to raises and promotions, not saving money. While people at big companies may talk about how price conscious they are, in reality the other factors are far more important.
• The Approval Limit is More Important than Your Cost. There’s a magic number for the amount that a person at a certain level can approve at each company. The higher the amount, the higher up in the organization you have to go. Find out what that level is for your target customer and set your price a little below that. To a Director with a $25K approval limit and $25K in budget, there’s no difference between a $5K product and a $24,999 product. In fact, spending less just means that next year’s budget won’t be as much. The sweet spot is pricing your product at a level that your buyer can just put on their Amex card each month and avoid the procurement cycle entirely.

There are 1,000 other differences between big companies and little companies. If you’re going to try to go after the big fish, know how to play them.

Is Your Risk Meter Broken?

A while back I was talking to a 20-something entreprenuer who had a neat idea but it just didn’t seem like it would ever turn into a multi-million dollar company.  I asked him what his exit strategy was and his response was “We’d like to build a business that will pay us well and have a lot of fun.”  I pressed him further on being paid well and he thought $100K/year would be a great job.

Yesterday I read an interview with Jacob Brody where he said:

“People are quitting their jobs for what should be side projects. I love finding a great microbrew at my favorite bar, but how many of these are really making money? How many of these are really turning into businesses? People are quitting their jobs for startups like this. that are maybe cool apps that make a couple thousand dollars or get a lot of downloads.”

Your risk meter is your ability to analyze risks and make rational decisions.  The problem with most entrepreneurs is that they have a broken risk meter. And that’s also true for a lot of non-entrepreneurs in the other direction.

Most startups fail. It’s hard to keep that in mind during the middle of a bubble, but anyone that was around for 1999-2003 knows that the odds of success are very low. In general, the odds that my young friend will get his business to where it will pay him his $100K/year salary are about 1 in 20. Let’s assume that on the open market he could be making $50K/year and that it will take him 5 years of blood, sweat, and tears to build his target business. He’s investing $250K on a 20 to 1 long shot.  He has to get a $5M return just to justify his investment. His goal is to increase his salary by $50K/year, so let’s say he’s a success and gets another five years of his increased salary in his success state.  He’s investing $250K to get a return of $250K.  He’d be better off working for someone else and putting all his proceeds into a savings account making 0.75% — at least he’d be risk free and positive on the deal. If he just took a job today and learned on someone else’s dime he’d see his salary ramp up as he gained experience.  Five years from now he’s way ahead.

That’s not to say that people shouldn’t do startups, but you have to understand the risks and make reasonable decisions.  You have to value your time the same way a VC values their money, because they’re interchangeable except that you know your capabilities.  In other words, you know that you’re contributing more value than just exchanging labor for cash.  Once a VC makes an investment the cash isn’t increasing, but your opportunity cost increases every day.  It really makes no sense to take a huge risk in order to build a business with a small return.  Anyone that would invest in a startup would expect a 20x ROI — you have to think the same way. Don’t take huge risks on things that should just be side projects.  Swing for the fences.

In the other direction, there are people that won’t take any risks at all, seeking the illusion of safety.  It’s easy to find yourself safely ensconced in a nice corporate job making a nice income and unwilling to take any risks.  At my last startup I spent a lot of time trying to recruit “professional talent” at the C-level from the ranks of VPs at places like Oracle, Siebel, SAP, etc. These were people that were making $250K/year and wanted $300K/year plus a huge slug of equity to join a startup in its third round of funding.  They were basically so risk averse that they wanted a gigantic premium to join a startup that had already made it through the first tough years.  Most of those people are no longer in their “safe” corporate jobs because conditions in the industry have changed. Safety is an illusion.  Their risk meters were just as broken as the people that bet everything on a side project.

So if you’re considering becoming an entrepreneur, take a good look at your risk meter.  Is what you are contemplating a big enough return that it justifies the risks you’re going to take?  Or are you so focused on safety that you’re not willing to make the jump for anything less than a sure thing?

My first job was as a salesman.  My boss told me something that has stayed with me my entire career: “Business is about making money and having fun.  If you’re not doing one, you have to do a heckuva lot of the other.”  Are you going to have enough fun with your side project as a full time job to justify not making a lot of money?  Or are you making so much money as a corporate drone that you don’t need to have any fun?

Venture Outlook 2011

I went to Venture Outlook 2011 this morning after reading about it on Jason Caplain’s Blog. It’s been almost 8 years since I’ve even thought about the VC/Startup world, and there was a lot of interesting ground covered. I’ll leave it to others to rehash what happened, but here are some nuggets I took away:

• VCs invest in people they know. Or at least in people that come recommended by someone they know and trust. John Burke from True Ventures used the phrase “triangulate within our network” several times. In other words, if they don’t know you and there isn’t someone they know that knows you, forget about it. This matches with my experience, although I did once do a round as a complete bluebird so it happens.

  This presents some unique problems for RTP entrepreneurs because 1) It’s a small community, and 2) Bandwidth is limited — you can only “know” so many people if you’re one of the trusted. That makes it hard to break into the “club” if you’re not already there.

  If you’ve got an idea but haven’t turned it into a business plan yet, start working on socializing the idea. Get to know as many people as you can. Select your targets of who you want to eventually pitch to and get your idea in front of the people on the periphery. The more smart people you can talk to, the better. Your idea will get better, and people that have had an influence on shaping that idea will be more willing to pass it on.

• Speaking of business plans, nobody mentioned them. Back in the stone age the business plan was the vehicle for pitching your company. Entrepreneurs slaved over financial projections and distribution models for months. I had one that was 80 pages and my investors had questioned me on every page. Now it seems like the pitch deck is superfluous. A couple of cocktail napkins and a whiteboard and you’re ready to go, or so it seems. Yes, we’re in a bubble.

• Picking Between Angels and Seed Stage VCs. This question was asked and I didn’t hear an answer other than that there are good reasons on each side. From the entrepreneurs perspective, I think it breaks down into the angel route will get you funded quickly without too much interference in your company. The average angel investing in $25K chunks just has too many companies to watch to get too deep into your world, while a seed stage VC firm ponying up $500K will be able to devote more attention to you but will take longer because they’ve got a more formal process. The problem with the angel route is that no one angel has much skin in the game. When it’s time for the next round of funding, while they’d like to see you succeed, it’s not going to change their world much if you don’t make it. And they don’t have the deep pockets necessary to ante up for the next round anyway, while most of the seed stage VCs can also lead a Series A. On the other hand, VCs need you to swing for the fences and won’t be interested when an acquisition offer for a 3x return comes along 6 months after you started, but your angels may very well take that deal.

  I think a lot of companies are going the angel route now because it appears to be fast and easy, but when this bubble pops they’ll wish they had some investors with deep pockets to lead the next round.

There were a lot of other things to think about from this presentation and as I digest them I’ll put up further posts. It would be bad form to use up every idea in the inaugural post anyway.