Category Archives: Startup Advice

Entrepreneurship Lessons from Steve Jobs

I have been reading many eulogies of Steve Jobs over the past few days. Even though Apple is the highest-valued technology company in the world, Steve Jobs’ story and style re-emphasized for me many entrepreneurship lessons that I’ve learned…and perhaps forgotten…over the years. Here are my favorites:

1. Customers don’t usually know what they want

You can’t just ask customers what they want and give that to them. By the time you get it built, they’ll want something new. – Steve Jobs

Early in my career, whenever I started a new project, I would make the mistake of asking the customer’s program manager to provide a specification. The program manager would, of course, dutifully do his job by dreaming up some impossible “reach goals” and a long list of features.

I would then have to push back and try to “manage” the customer’s expectations. It was a losing battle. Too often, we would sign off on the spec and, from then on, the customer’s random wish list became gospel with our engineers. We’d spend hundreds of man-hours designing, developing, testing, and debugging. We’d run late…we’d run over-budget…we’d finally cry “uncle!” and ask to either “de-scope” (simplify) the project or receive additional funding. It became a mess.

I’ve learned that customers don’t know what they want. They’re just as busy as everyone else, so they typically don’t take the necessary time to really study their options. They’re not the experts in the field…you are! Instead of analyzing the tradeoffs, it’s easier for them to request everything and the kitchen sink.

I’m not saying you shouldn’t engage in a dialogue with your customers, but definitely be the one to make the final decision on what goes into the product and what is ripped out. Your customers will thank you for taking the decision off their hands…and for delivering something simple, elegant, and functional on time.

Remember that critics in the technology press declared the iPad “DOA: Disappointing on Arrival”. Little did they know.

2. Simplicity and focus

I’m a big believer in boredom. Boredom allows one to indulge in curiosity, and out of curiosity comes everything. – Steve Jobs

Technology tempts us with countless avenues for distraction. Finished responding to all your email? …then surf the web while video-chatting on Skype, check out photos on Facebook, discuss on LinkedIn while simultaneously tweeting your latest thoughts and texting your spouse. If, instead, you’re in the mood for some thoughtful writing, then you can publish a blog with the click of a button! ūüėČ

In observing my mentors and other successful people, I’ve noticed that they make room in their lives for “boredom”, or undisturbed time for thought. They make space in their schedules for quiet time alone in their office, with the computer off. They read a lot. They make an effort to have frequent lunches and dinners with their colleagues.

Most of them constantly try to simplify, simplify, simplify. They avoid unnecessary complexity, they have tricks that block out all the digital noise, and they focus intently on what’s important.

Not only did Steve Jobs products’ design epitomize this simplicity but he was also a “designer” of his daily life. He focused on his role as CEO without pontificating on politics. He decided to end his philanthropy efforts to focus instead on Pixar. He blocked out all intrusions into his personal life.

Keep things simple.

3. Price isn’t everything

In one of my previous companies, we had a couple sales people who would never hit their sales targets. It was always one excuse or another. “The product just needs one more feature,” or “I can only make this sale if we offer a 20% discount.”

My partners and I decided to not engage in a “race to the bottom” with our competitors who had established manufacturing operations in China. We continued to manufacture in New Jersey. Our products were more expensive, but we made up for it in application engineering services and advanced software.

Steve Jobs demonstrated that customers don’t always make their final decision based on price. Offer them something well above the average and they’ll pay the justifiable premium.

4. Don’t limit your thinking with dogma

Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma – which is living with the results of other people’s thinking. Don’t let the noise of other’s opinions drown out your own inner voice. – Steve Jobs

Entrepreneurs can take two lessons from this quote. First, don’t believe your competitors’ press releases. Your competitors look ugly when they stand naked by the mirror, too. Out of their very nature, product press releases emphasize a product’s benefits and ignore its flaws. Similarly, the technology press rarely has the inside scoop necessary to report on the challenges that companies are really facing — the employee defections, the spaghetti code, the internal politics. They usually report the good stuff that’s fed to them. Don’t believe the dogma you read in the press.

Second, don’t look to the press to show where your next breakthrough product will be. As Wayne Gretsky said, “skate where the puck is going, not where it is.” Press releases and most news stories cover products that have been under development for at least six months, usually longer. They’re “old news.” If your product development efforts imitate what you read in the press, by the time you’re done building it you’ll be two years behind everyone.

Instead, focus on “your own inner voice;” figure out what it’s saying about the future you want to build, and then work like mad to build it better than anyone else. I’m not saying that you should stick your head in the sand and ignore your industry’s press. Stay technically informed and expect occasional sparks of inspiration from others…but remember that conventional wisdom is outdated.

5. Execution is more important than being a first mover

In a similar vein, don’t believe that “It’s all been done before.” Just because one company is already working on a similar idea to yours doesn’t mean that they’ll succeed. It doesn’t mean that they’ll develop a good product or build the right team or raise the necessary funding or capture your market share. I’m not saying that you should build another Groupon copy-cat service — there are thousands of those already — but you definitely should not be scared into inaction if competitors are attempting to build similar products.

I hate the phrase “first-mover advantage”. I believe that first movers usually end up with nothing except arrows in their backs.

Apple didn’t build the first computer. They didn’t build the first digital music player. They definitely didn’t build the first smart phone. Apple was the second-mover, and it dominated all of these markets. Execution is what made the difference.

Steve Jobs’s ability to inspire, cajole, and scare excellent performance out of his team is what made the difference. Apple learned lessons from its predecessors’ mistakes, found novel solutions for its competitors’ problems and shortcomings, and then executed perfectly.

Apple’s slogan was “Think Different.” A more accurate version, I think, is “Think Better.” Over the next few weeks, whenever I use an iProduct created by Steve Jobs, I’ll try to remind myself to do just that.

——

Thanks to Nicole Quiterio for the idea that sparked this article.

Photo credit: www.gizmowebs.com “Life of Steve Jobs in Pictures”

Advertisements

Engineers Forget to “Stand on the Shoulders of Giants”

If I have seen further it is only by standing on the shoulders of giants.     РSir Isaac Newton

All technical innovation has come from building on what came before, by using the building blocks provided by engineers who came before us. While its easy to recognize this is true for big innovations, engineers forget this principle way too often in their daily work.

[If you don’t have the time to read the rest of this post, then skip straight to this article about a disastrous example — Netscape v5.0 — of what happens when engineers and managers decide to build from scratch instead of building on what came before. I consider it required reading for all engineers working for me.]

A Shortcoming of Engineering Education?

Consider for a minute how engineering education teaches students to approach problems:

  • Professors always go back to first principles (and rightly so).
  • Problem sets force students to start their analysis from the ground up…and usually by themselves.
  • Copying others is considered cheating.
  • Students must finish all the coursework within one semester, which prevents them from building up a “toolkit” of solutions for solving more complex problems.
  • Project management and risk management are rarely taught.

Engineers are taught to reference the textbook when trying to solve a difficult problem; they are not taught where to look on the web for a pre-existing solution since that would be considered cheating. They’re definitely not taught the social skills necessary to cold-call a subject-matter expert to pick his brain. (To read more about this, see my post from last week on Emotional Intelligence.)

Fortunately, some professors are starting to change their teaching methods to account for the wealth of information on the web…and to teach students to solve problems as they would in the “real world.” This is easiest in computer science, where a solution can simply be copy-and-pasted, as opposed to disciplines that involve hardware.

For example, computer science Professor Adrien Treuille at Carnegie Mellon encourages his students to use code available for free online in solving their problem sets, as long as they cite the source. He explained to me, “This approach allows students to develop much more complex and interesting programs than they could if everything were coded from scratch, and they become familiar with the coding style…and the best sources for free code…that is typically used in industry.”

Information Asymmetry in Engineering

In addition to their academic training, “asymmetric information” also entices engineers to start from scratch, even when an existing solution is available. Let me explain what I mean by “asymmetric information” in this context…

There are usually several ways to solve a problem, each with its own advantages and disadvantages. Frequently the choice is between modifying an existing implementation versus building a new one from scratch.

The Existing Solution (warts and all): If an engineer has an existing solution in front of him (or her), all the hacks, bugs, and shortcomings are totally apparent. Documentation is frequently lacking, so reverse-engineering is necessary. If multiple people have worked on the project, the solution is frequently a messy mix of various coding and design styles.

Building It from Scratch: In contrast, when the engineer considers a new, fresh approach, the advantages are much more apparent than the disadvantages. The engineer sees the final solution in his mind’s eye as a gleaming, flawless example of engineering perfection. Of course, as the saying goes, “The devil is in the details.” Without the opportunity to work through the details on a new solution, the devil, Murphy’s Law, and shortcuts necessitated by project deadlines have not yet impacted the work.

For these reasons — the apparent shortcomings of an existing solution and the undiscovered shortcomings of a brand new implementation — engineers are tempted to scrap an existing solution in favor of doing it their (presumably better) way.

As I mentioned earlier, the best and most disastrous¬† example I’ve seen of this is the re-coding of the v5.0 Netscape browser. I consider this article REQUIRED READING for all engineers, regardless of their specialty. Please…think twice before you start rebuilding something from scratch!

On the Shoulders of Giants

There is a great scene in the movie Flash of Genius. Greg Kinnear plays Dr. Robert Kearns, the inventor of the intermittent windshield wiper. The scene shows him in a courtroom, cross-examining an expert witness called by the defendant, Ford Motor Company, which stole his invention. The expert had just testified that since Dr. Kearns did not invent the capacitor, the transistor, or the variable resistor and just bought them out of a catalog, that he did not create anything new.

Dr. Kearns starts his cross-examination by reading from A Tale of Two Cities by Charles Dickens: “It was the best of times, it was the worst of times. It was the age of wisdom, it was the age of foolishness.”

Kearns asks the expert witness,¬† “Did Charles Dickens create the word ‘it’?”

“No, he didn’t create that word,”replied the witness.

“Did he create the word ‘was’?”

“No.”

“The?”

“No.”

“Best?”

“No.”

“Times?”

“No.”

Kearns continues, “I’ve got a dictionary here. I haven’t checked, but I would guess that every word that’s in this book can be found in this dictionary. Do you agree that there’s not, probably, a single new word in this book? All Charles Dickens did was arrange them into a new pattern, isn’t that right?”

“Right.”

“But Dickens did create something new, didn’t he? By using words. The only tools that were available to him. Just as almost all inventors in history have had to use the tools that were available to them. Telephones, space satellites all of these were made from parts that already existed, correct, Professor? Parts that you might buy out of a catalog.”

“Technically that’s true, yes, but that does…”

“No further questions, your honor.”

Don’t invent a new language and write a new dictionary before starting your work. Even though the English language is an imperfect work-in-progress, it is still used successfully every day to communicate, and sometimes even to create beauty and inspiration. Use the tools, resources, and existing solutions you have available to you, even if they’re not perfect…and build on the shoulders of giants.

—–

Image credit: The original source and artist are unknown to me, otherwise I would provide credit. Link to Google search results for this image.

P.S. While people are listening, I want to publicly shame ūüėČ Mark Schultz for skipping out on the Hightstown Triathlon last weekend.¬† No excuses in 2012…start your swim training now so nobody has reason to worry about you drowning! ūüôā

Emotional Intelligence – What Makes Star Engineers

In a college final exam, you’re on your own. If you can solve the problems fast enough and without help, you’ll pass.¬† If you’re caught copying from the smartest kid in the class, you’ll flunk…or be expelled.

Originally, I applied the same mentality to my professional development: in order to be a successful engineer, I reasoned, I had to know everything well enough to develop engineering solutions by myself. Big brain = success, or so I thought.

Frustrated Engineer

Most of my real-world engineering projects were larger and more complex than I could handle by myself, of course. Fortunately, I read a passage in the book “Emotional Intelligence” by Daniel Goleman that fundamentally changed the way I approach my work as an engineer:

Researchers Robert Kelley and Janet Caplan¬† studied star performers at Bell Labs, a renowned research lab near Princeton, New Jersey. The telecommunication systems the Bell Labs engineers developed were highly complex…more than any one person could understand…so everyone worked in teams, ranging from 5 to 150 people.

While everyone at the lab had a high IQ, only some stood out as stars. At the beginning of the study, managers and peers were asked to pick the top 10% of their colleagues.

The assumption was that those with the highest IQ or best academic performance would also excel in this highly technical environment. That assumption was wrong…by standard cognitive measures such as IQ, standardized tests, and academic performance, and even social measures such as personal inventories, there were no discernible differences between the stars and everyone else. The researchers had to dig deeper.

By performing detailed interviews, they discovered the critical difference was the stars’ interpersonal skills and how their professional relationships impacted their engineering work performance. The star performers put time into cultivating good relationships with people whose services might be needed in a crunch. When faced with a challenging problem, they were able to pick up the phone, call the right person, and get a quick answer that was usually correct. The average engineer, on the other hand, either struggled mightily to develop a solution on his own — and frequently an inferior one — or wasted his time with unreturned calls and unanswered emails.

The researchers summarized it this way: ‘The formal organization is set up to handle easily anticipated [and routine] problems. But when unexpected problems arise, the informal organization kicks in. Highly adaptive, informal networks move diagonally and eliptically, skipping entire functions to get things done.’

– Paraphrase of Daniel Goleman in Emotional Intelligence, p. 161-162

Image credit: Amazon.com / Bantam Books

An engineer I worked closely with for several years, Keith, embodied the lessons I took of the Bell Labs study. Keith wouldn’t initially strike you as a straight-A braniac student. I never saw his transcript, but I would guess that he enjoyed socializing as much as he enjoyed studying. But, man, he is one of the best engineers I’ve met. Whenever he’s faced with a challenging problem, he’s able to research it quickly and thoroughly enough to be able to ask the right questions. He then tracks down the best subject matter experts he can find, calls him them up, picks their brains, and, if necessary, visits them in person that same week. That’s usually enough to rapidly solve most challenging problems, but if not, he’ll contract them to see a solution through to completion. He repeats this day after day. The result is an ability to solve engineering problems that have vexed his entire industry for decades.

Based on the lessons from Goleman’s book and Keith’s example, I make a concerted effort each day to stay in touch with other bright people in my industry and pick their brains on a regular basis. I still code and design hardware, but it’s the continuous, informal expert input that allows me to incorporate best practices and lessons learned, and minimize the risk of the schedule delays and budget over-runs that typically kill projects.

In my post next week, I’ll write about what I see as the “corollary” to the emotional intelligence problem with engineers: what happens when engineers — including myself at the start of my career — undervalue outside feedback and ignore lessons learned. It’s a problem of “asymmetric information” that leads to costly efforts to re-invent the wheel. Stay tuned.

Special thanks to Mark Kasrel for teaching me about Emotional Intelligence and its importance.

Photo credit: iStockPhoto

Walt Disney’s Advice to Engineers

“We don’t make movies to make money;
We make money to make movies.”¬†– Walt Disney

Techies are usually the ones who start companies. There’s a big problem with that…we techies (I’m one of them) love our technology too much. That love of technology and the realities of business — developing viable products; selling, selling, selling; staying on budget and on schedule; surviving to fight another day — frequently don’t go well together.

I’ve seen it time and again, we let our love for the technology get in the way of making sound, logical, calculated business decisions. If you think this doesn’t apply to you because you’re not on the leadership team, think again…the same holds true for the engineers working in the trenches as they make their product design and development decisions. Being in love with your technology leads to bloatware, unnecessarily complex designs, distracting features, and the associated schedule delays and cost overruns. Keep it simple, stupid (K.I.S.S.)

I saw a classic example in one company I worked with. A brilliant inventor came up with a new idea. The team developed it into a commercial product, which was DOA because its cost was 80% higher than the existing commercial products…and the customers were only willing to pay 25% more for the solutions the new technology provided. The inventor and the team had sold themselves on the technology, so they modified the product for military use. The technology solved even more problems for the military, but even they weren’t able to pay the cost premium. The team finally decided on a two-pronged approach: they’d use their patented technology for niche applications and long-term product ideas but would use the industry-standard technology for their “bread and butter” products.

This company built a decent, recurring revenue-generating, profitable business using industry-standard products, combined with a few niche plays using the new technology. Despite these business successes, the inventor’s impression was incredibly negative. He felt that the team had “abandoned” his idea and gone down the wrong path by using an “inferior” solution. He ignored the important fact that the profits from the standard products allowed the company to grow its research team. He also overlooked the fact that having real products out in the field — instead of continuing to slave away in the lab — taught the company invaluable lessons, allowed it to hire a manufacturing team, and attracted additional customers. The inventor had difficulty accepting that revenues, profits, and viable products had to come first before the company could afford to take additional risks with its new technology. You need to make money to make movies.

This behavior doesn’t surprise me. People who invent something new, especially something that goes against a conventional approach, face huge hurdles in gaining acceptance. Skeptics repeatedly tell them their baby is ugly. They have to develop thick skin. They spend years telling themselves that their solution is the best for certain applications. At some point, however, they risk making the leap in logic that they have a solution for every customer problem.¬†“When all you have is a hammer, everything looks like a nail.” This perspective, combined with mental toughness, ends up getting in the way of sound business decisions.

Not only do techies love their technology, but we love the scientific method. We love questioning, debating, analyzing, and playing devil’s advocate. Sometimes, unfortunately, we’ll do that right when the sales guy is near the end of a sales cycle and the customer is reaching for his wallet. For the sake of argument, we might mention that one technical risk that only has a 2% chance of actually occurring…and we’ll kill the deal. We think too much. PhD’s, in particular, are accustomed to the pontificating of academia. We’re thinkers who have lots of ideas and long-term vision but might be short on execution. In my first company there were four co-founders, all fresh out of school. We thought the best way to work together was to debate until we had some consensus. WRONG! The best way to make progress is to have someone make a freakin’ decision, have everyone charge forward in the same direction, expect that half¬†of your decisions will be wrong, and to be OK with that because you can quickly learn from your mistakes and pivot in the right direction.

Another reason techies struggle with cold business logic is because we can’t get it through our thick skulls that “better” is the enemy of “good enough.” Even after the product is done, we love “polishing” it. If someone else wrote the code, we think we have a better way of doing it, so we’re tempted to rewrite it from scratch. We give this process a fancy name — “refactoring the code” — in order to bewilder inexperienced project managers. For an excellent lesson-learned from Netscape on why you should never start something from scratch, read this article.

What Treatment is Available?

We need to remind techies that in order to keep playing with their toys, the company first and foremost needs to make money to keep making movies. How do we do that? Three simple steps:

  1. Set Immovable Deadlines РDefine deadlines based on the resources you have, and then make the deadlines absolutely immovable. Be aggressive in de-scoping your projects in order to eliminate the fat. Make there be hell to pay if a deadline is missed and celebrate the small victories when the deadline is hit.
  2. Provide Financial Insight¬†– I think startups have too much internal secrecy surrounding their financials. This decouples engineering performance from the company’s financial performance. Management should set revenue through an operations plan at the beginning of the year, share the financial forecasts with the team and update the team on a regular basis, and show how delays impact the bonus pool in a real way.
  3. Discourage Professorships¬†– Foster a culture biased towards action. Cut debates short. Don’t let meetings last longer than an hour. Make sure someone has the authority to make executive decisions and that they’re competent. Tell people who come asking for approval to JFDI.

That didn’t work…what else can I try?

Keeping a team of engineers focused is a full-time job — it’s the reason for project managers, who are worth their weight in gold if they do their job well. Here are some other mechanisms that can help. (As I write more about these, I’ll link the articles.)

  • Have engineers interact with the real world. Send them to conferences and customer meetings. It’ll make them realize that (a) the competition isn’t standing still and (b) the customers really only care about price and a couple of key features, not the kitchen sink.
  • Create small, focused teams and give them budget authority. Matrixed organizations create chaos…avoid them.
  • Track project spending vs. actual milestone completion.
  • Create a “parking lot” for good ideas so that they don’t become distracting tangents.
  • Don’t over-specify. Figure out what the customer really needs and have everyone focus on that. Big specs can easily become distractions and make-work exercises.
  • Celebrate small victories.
  • Exercise management by walking around (MBWA) in order to keep your finger on the pulse of the engineering team and correct people going down a tangent.
  • Reward on-time delivery.
  • Get expert input to prevent engineers from re-inventing the wheel.
  • Do weekly company-wide demos of people’s work. Peer pressure and interim milestones are wonderful motivators.
  • Implement agile development, especially scrum.

Remember what Motivates Us

Nobody wants to waste time. Everybody wants a sense of accomplishment. Nobody wants to toil on useless features. Everybody wants¬†to see their products released into the wild. Unfortunately, there are countless distractions along the way…distractions that make us lose sight of what the customer actually wants.

As you get closer to your product release date, remind your techies that “we don’t make movies to make money; we¬†make money to make movies.” The¬†customers are the ones who pay the bills…and the bills are what allow them to continue developing cool, new technologies. Or, in the words of Walt Disney’s¬†Mickey back in 1928.

This is it guys, when these doors open, we got to make a very first impression.

…and it better be a good one.

Want VC Money? Think Twice

I was in college during the first dot-com boom. ¬†It was nuts. Billboards would advertise a new, different, supposedly-world-changing dot-com every week. Brainstorming ideas for new companies was a campus pastime. The news was full of IPOs. English majors were switching into computer science (shocking!) to get in on the action. ¬†Everything I read and heard at the time was that the only way to start a business was to raise VC dollars — tens of millions of them. Bootstrapping was a second thought and considered riskier.

That message is still being preached today; just this morning I read the following passage in Entrepreneur magazine (see the footnote for a warning about this publication):

“To maintain control over Gonzo Game’s intellectual property, van Gool wants to grow with little or no outside funding, which means he has to plug revenues right back into the company, making growth slower and business riskier.”

Based on my own entrepreneurship experience, I argue that the opposite is true:¬†Raising VC funding is far riskier than bootstrapping.¬†By “riskier,” I mean “lower expected value.” I’ll explain this more later.

Isn’t the goal of starting a company to make a lot of money…or at least to make enough money to enable you to change the world with your idea? If money and/or executing your idea are the goals, why would you give up equity and control on day one?¬†I’ll go on a limb and argue: Raising¬†VC funding could signal failure for the entrepreneur. Too many people see raising money as the sign of success. Movies and other media reinforce this fallacy. Here’s why raising several million from a VC could be a bad thing for you as a founder:

  • You’re “selling low.”¬†The average VC-backed company takes $7.5MM in investment…usually before the company had much of an opportunity to build value. This means that founders give away huge chunks of equity.
  • You’ll typically lose control over your company’s destiny. Together with huge chunks of equity go board seats and voting control of the company. The strategy is no longer driven by the founder’s schedule, the market’s dynamics, or the maturity of the product idea…it’s driven by the VC fund’s need to exit within a set number of years and show a high return.
  • You’re no longer your own boss. I can’t say enough about the importance of this issue. Founders have to be passionate about their business. They frequently choose entrepreneurship as an alternative to cubicle-dwelling and reporting to a boss. Those who actually make the leap are typically driven, opinionated, and frequently stubborn. I’ve seen two examples first-hand where these personality traits didn’t play well when investors started changing the path of the company or exercising their voting rights…and a founder ended up being sidelined because he became too much of a pain in the arse.

I haven’t met him, but I have a feeling that Mark Pincus from Zygna has that type of personality:

“I would fight to the end for control, because if you do not have control of your company; you are an employee.” – Mark Pincus

Even consider Facebook, which raised VC money. Think about how different Facebook might be if Sean Parker hadn’t helped Zuckerburg retain control and thereby implement his vision for the company.

That said, however, if you don’t have the business savvy to run a company, sell, and make the tough calls, then you either don’t belong in the startup world or you need a VC-picked CEO.

We Need Some Balance

It could be that I have too small of a data set (1 VC-backed company went bust, 1 angel-backed company fizzled, 1 bootstrapped company is doing well, 1 VC-backed company is just getting started). My perspective might also be skewed because all these companies have built large, expensive, industrial-scale hardware products where cost and margins are important, not web software products where “eyeballs” and “freemium” are part of the vocabulary.

I do know, however, that:

Young and prospective entrepreneurs are not given a balanced perspective on their funding options, nor the necessary exposure through case studies, books, articles, and videos to execute a bootstrapping strategy based on best practices.

If you’re aware of good resources on bootstrapping, please leave them in the comments section for everyone to see.

Why VCs are Considered “Evil”

I’m not one of those who categorically hates VCs. They have an important role in the startup ecosystem and all the good ones create value in the work they do.¬†There is a reason, however, that the industry has earned a certain reputation.

Let’s do a quick back-of-the-enveloped calculation. Say the VC general partners raise the average fund size of $150MM. The average investment per company is $7.5MM. Funds last for about 7-10 years and the LPs aim for an annualized 20% return on their investment. The partners want to avoid spreading themselves too thin, so they limit the number of companies to, on average, 20. (data from the NVCA)

Given these numbers, how much would the portfolio companies have to return? Let’s take the two extreme cases….

  1. All exit: Assuming that all the portfolio companies exit successfully (virtually impossible), they’d each have to sell for $15MM for the fund to return 20% annually.
  2. Only one exits: Assume, instead, that all but one of the portfolio companies go bust. That means the one survivor would have to sell for $300MM for the fund to return 20% annually.

It should now be obvious why VCs push founders to swing for the fences…and why they brush the founder aside when the company stumbles or doesn’t execute the strategy aggressively enough. The VCs themselves are under incredible pressure to deliver four one home-runs within 7-10 ¬†years, and preferably at least one grand slam. VC’s actions resulting from this pressure and these financial realities are what have earned them a certain reputation.

I’m not saying that the VC industry is “tricking” entrepreneurs to take their money, dilute themselves, and enter a losing game. VCs do provide value…and in some (limited) cases big money is needed to win in a market. Venture capitalist Mark Suster has several interesting blogs and videos showing that he, for one, understands the risks founders face when raising VC funding and respects the founders’s perspective:

Bootstrapping

There are hundreds of considerations when taking the bootstrap route. Here are just some of them.

  • Learn to pivot. The main advantage to controlling your destiny is not being forced to hit a home-run during your first at-bat. You can change directions until you find the right product…as long as you don’t run out of cash. Always be looking for potential customers and solve their problems for them with your ideas.
  • Win “free” funding, where you don’t need to give away equity, like SBIR and OEM product development contracts.
  • Get loans, especially low-interest ones from state economic development agencies.
  • Partner with universities for incubator space, lab space, specialized equipment, skilled technical advisors, and energetic entry-level hires.
  • Hire entry-level employees…and cross-train so you’re not stuck when they leave in 3 years for a higher salary.
  • Be stingy in spending cash…but not so much that you alienate your employees. Barter.¬†If you’re not frugal at heart, don’t bother trying to bootstrap, go raise $20MM in VC money.
  • Be generous with your equity. You’re bootstrapping in order to preserve equity, so be generous in giving some of that extra equity to all of your employees, especially the ones that are key to your success. Vest.

Doing these things is difficult, but we all knew startups are hard work, right? ¬†Guy¬†Kawasaki, one of the early employees at Apple, said about¬†startups: “If I had known how hard it was to start a company, I¬†wouldn’t have done it.”¬†Doing these things without a large infusion of VC cash makes them even more difficult.

However, taking VC money can limit your options. If your initial product idea is wrong (which it will likely be) or if your market isn’t yet ready for your innovation (which is also likely), then the VCs might not give you a second chance.

Which Route to Take?

Econ and finance majors learn about future expected value. Assign a dollar value to each possible future end-scenario and estimate the probability of each scenario happening. Multiply the probabilities times the dollar values and —¬†voil√†! —¬†you get your expected value. (Learn why humans are inherently bad at doing this exercise from Dan Gilbert).

When you start your company, try this exercise for the following cases:

  1. The VC-funded route, where you manage to hang on to 5-10% of the company.
    – 20% probability: You earn a decent salary and in 7 years you get 10% of $50MM.
    Р40% probability: You have a moderate exit and in 7 years get 10% of $10MM.
    Р40% probability: You earn a decent salary and in 7 years the VCs shut you down and you leave with zero.
  2. The bootstrapped route (possibly with angel support), where you retain 30-70% of your company.
    – 30% probability: For the first 3 years you earn only 25-50% of market-rate and occasionally go without pay before being able to afford a full salary. After 8-15 years you sell the company for $10-20MM.
    Р 30% probability: You find a good niche and decide not to sell the company. Instead, you make being your own boss a lifestyle. You max out at around 50 employees and pay yourself a $150k+ salary for the rest of your career.
    – ¬†40% probability: You struggle to find your product niche. Since you lack the business skills and aren’t getting advice from an experienced VC or angel, your business runs out of cash within 1-5 years.

There’s much more that goes into this decision than just an expected value calculation…the people you partner with and those you hire, market timing, accuracy of your product focus, ability to correct your strategy, your desired lifestyle, etc.

At the least, I hope it makes a new entrepreneur think seriously about his options.

[Footnote:¬†Bloomberg Businessweek¬†recently reported that¬†Entrepreneur magazine, which¬†has the trademark on the word “entrepreneur,” has been actively protecting its trademark by suing any young company or entrepreneur-support organization that uses the term. They have ¬†driven founders into personal bankruptcy. This will be my last issue of¬†Entrepreneur…I’m cancelling my subscription. It’s a¬†hokey¬†magazine, anyways.]