Altos Ventures Musings

Start From the Heart

 
Every year at Altos we see thousands of investment proposals and meet hundreds of entrepreneurs.  We basically boil them down to two types: companies that start from the head and companies that start from the heart. 

“Start-from-the-head” companies are started by business types, often MBAs, who are motivated primarily by their interest in starting and running a company of some sort.  These companies often come in with slick presentations, fancy financial models and detailed business plans.  They talk about things like addressable market, segmentation, channels.  “Start-from-the-heart” companies are usually started by engineers and tinkerers who have a burning personal passion for solving a problem that they have struggled with – sometimes for years.  What they lack in formal plans they make up for in working products, paying customers and real passion.

We have a strong preference for the latter type of company.

That is not to say that MBAs don’t build great companies, but it comes down to a question of motivation.  We have found over time that the most enduring and successful companies are the ones created out of a founder’s deep personal conviction around solving a very specific problem.  And they’re usually the most fun to work with.

Sometimes these ideas arise from a personal passion.  David Baszucki is the founder of an online building world called Roblox.  After successfully selling his first startup, Dave chose to build a company that was near and dear to his own passion as a tinkerer (I’ve personally experienced his homemade ziplines and potato cannons).  Dave also wanted to build something cool and constructive for his four creative kids.  Roblox is now one of the most trafficked kids websites in the entire country.

Jeremiah Grossman was just a teenage computer enthusiast when he hacked Yahoo! and caught the attention of David Filo, who hired him within weeks.  Jer eventually left to start Whitehat Security, the world’s foremost web application monitoring company.  He’s one of many fortunate founders who’ve turned their hobbies into great companies. 

Many huge companies have been started as personal projects or academic inquiries.  Sun Microsystems was born after graduate student Andy Bechtolsheim cobbled together the Sun-1 as his personal CAD workstation.  Larry Page was fascinated by the mathematical structure of Web links when he wrote his Stanford dissertation and created BackRub, which later became Google.  Mark Zuckerberg’s predecessor to Facebook was Facemash, a Hot-or-Not site he hacked while drunk in his dorm one night.  I’m pretty sure neither Larry nor Mark were planning to become online advertising companies when they started off.

And sometimes these ideas literally start at the kitchen table.  Challenged by getting our young kids to eat their veggies, my wife Jennifer began playing a dinner game with them – points for eating colourful vegetables and fruits.  She eventually created a set of index cards and which turned into a card game that helps kids have fun eating a colourful, healthy plate of food.  Fast forward a few months and Crunch a Color has won a “Top 100” toy award, sold out its first production run in a week and been picked up by retailers across North America. 

My wife never set out to build a business, but she – like so many founders who start from the heart – might actually end up having a pretty good one.    

Replacing CEOs

I regret to say that I've personally served on a dozen boards of venture backed companies that have replaced CEOs. It's usually not a good sign. It doesn't mean those start-ups were doomed; but it does mean drastic change was needed.

The decision to replace a CEO is never taken lightly. Replacing any CEO is difficult enough. Replacing a founder/CEO is even more traumatic and fraught with risk.

Although I have never seen a case in which a CEO, even a founder, is indispensable, over the years, my partners and I have formed a strong preference for founders.

Most founders have never been a CEO. Some may have never even had a corporate job (Mark Zuckerberg, for example). Yet we prefer to work with them as they learn on the job. 

I won't get into why we prefer founders (not the main topic of this post) but I'd recommend checking out these articles discussing the merits of founder CEOs: 

• I first wrote about our preference for founders three years ago: Ousting the Founder 
• Ben Horowitz wrote this more recently: Why we prefer founding CEOs 
• Steve Jobs' Law: Why Founders Make the Best Leaders

When my partners and I first got started more than 15 years ago, we replaced CEOs quite often (though I'd esimate it was about average for the VC industry as a whole. I'll share actual data later in this post). In contrast, my eight most recent boards have yet to replace a CEO.

One data point which reflects the presence of founder CEOs in venture portfolios is CEO ownership. When we tell people that the typical CEO in an Altos backed company owns more than twice the equity of a typical venture backed CEO, they assume it's because we invest less money (resulting in less dilution). While this is true, the bigger factor is that most of our CEOs are founders.

On average, the minute a board replaces a founder/CEO, that company's CEO ownership percentage drops. For example, when Eric Schmidt was hired at Google, the CEO ownership stake dropped to 4%, far lower than Larry Page's stake. 

Another reason we replace CEOs less often is selection bias. We are less likely to invest in the first place if we believe a new CEO will be needed. I'm always surprised when a VC submits a term sheet that calls for the retained search for a new CEO from day one.

We'd rather not make an investment, if we don't know who the CEO will be. As the saying goes, "go with the devil you know versus the devil you don't." We must believe, at least in the beginning, that the person we're backing can develop into a great CEO.

In the case of backing a "professional CEO" we must believe that the person has what Warren Buffett calls "owner mentality" (it might not be as good as founder mentality, but it's better than most). 

Of course, this does not mean that we will never fire a founder or replace a CEO. We make plenty of mistakes. To see if we might learn from them, I decided to look at some data from our current and past funds.

After studying a data set of more than 60 companies, I found that the probability of a CEO change increases dramatically with each new round of financing, unless a company is already profitable. A CEO who can control her own destiny is much less likely to get replaced. 

Given that the companies in this data set have raised more than a billion dollars from over a hundred different venture firms, I suspect that there is a similar pattern for the entire VC industry, even if specifics vary from fund to fund. 

In the chart below, each bar represents a group of companies based on how many rounds of funding were required to get to profitability or exit. The height of each bar represents the percentage of companies that replaced CEOs. 

  In companies needing only one or two rounds to get to profitability or exit, CEOs were replaced less than 14% of the time. At the other extreme, if a company needed four rounds or more, the replacement rate sky-rocketed to 85%. For companies that required three rounds, the rate was 53%, which is about average for the industry (see article below). 

Given this data, I'd advise start-up CEOs to get their companies to profitability sooner. Control your own destiny. Otherwise, deliver an exit before you run out of money and have to raise another round. 

Other Factors:

When a CEO is replaced, the rationale is usually quite subjective. "The team has lost confidence" or "lack of leadership" are typical quotes from board members considering a change. 

For me personally, I've learned that my stress level about any particular company goes up and down with confidence in the CEO, regardless of how the company is doing. Let me try to explain. 

Even if a company is doing really well, if I do not have confidence in the CEO, I tend to worry a lot because things might fall apart; and sooner or later, the shit usually does hit the fan.

In contrast, even if a company is struggling, if my confidence in the CEO is high, I stress less because I know there is a smarter and more capable person staying up at night not only worrying about things but doing something about it. 

That said, other than obvious reasons such as lying, cheating or stealing, I believe the following are other, more objective, factors correlated with change in CEOs:

1. Time - eventually, all CEOs retire, die or get fired.
2. Lack of growth - a flat profitable business might be OK for some but not for VC backed companies that promised high growth to investors.
3. Employee turnover - higher than normal turnover happens for two reasons: great people are hired but are repelled or mediocre people are hired and must be replaced. Successful companies typically have turnover rates that are significantly lower than industry averages. 
4. Burn rate relative to cash balance (key metric we track is months of cash remaining)

More Data:

The following article has some interesting statistics. Out of 50 high-profile VC-backed companies in 2010, 54% had replaced founder CEOs: "Do VCs usually fire founder CEOs?" 

I'd also recommend checking out these questions on Quora for more info and discussion:

1. On average how often do founding CEOs get replaced by a VC controlled BoD?
2. How do VCs eventually come to the conclusion that they need to replace the CEO?
3. What skills does a CEO of a growing company need that a founder CEO might not have?

Final Note

I'd like to emphasize that the data points out a strong correlation, not causation. For example, it's possible that VCs are more likely to replace CEOs in companies that run out of money and have to raise more rounds. It's also possible (and very likely) that start-ups that hire professional CEOs tend to raise more money and go through more rounds of funding.

Founders are much more sensitive to dilution compared to professional management that are granted more options if a company goes through a massively dilutive round. Founders also want to maximize control. The biggest fortunes have been amassed by founders who have been able to retain quite a bit of control over their companies, sometimes decades after the IPO.

The punchline of the article should be "get profitable" rather than "avoid the 4th round."

They Can't Tell You How To Soar

Customers will always tell you they want better products and lower prices. They might even be able to articulate how much better certain products should be. But don’t expect them to be able to tell you how different those products could be. More importantly, don’t expect them to tell you how you should surprise and delight them.

This was an insight from a book called Different, Escaping the Competitive Herd written by Youngme Moon (I won't review the book but I'd recommend it for entrepreneurs and marketers fascinated by inconic brands such as Apple, Harley Davidson, IKEA and InNOut Burger). 

As Clayton Christensen explained in the Innovator's Dilemma, there is a predictable pattern in just about every product category. Innovation leads to products that improve to a point where customers are over-served (the web browser might be the latest category to reach this level).

From a vendor's perspective, the problem is that over-served customers become so skeptical about the differences between products and brands that differentiation is rendered meaningless. Most customers become not only bored but unhappy.

In category after category, over-served, bored and unhappy customers would love to discover something delightful, remarkable and refreshing. And marketers spend billions of dollars trying to rise above the competitive noise.

Ironically, intense competition only quickens the pace toward blandness and a herd mentality in markets. This trap is hard to escape. The herd phenomena is seen in self-organizing systems as disparate as ant colonies, bird flocks and stock markets. 

Paradoxically, the best way to stand out, might be to NOT focus on beating the competition. At the 1997 WWDC, before he rejoined Apple as CEO, Steve Jobs stated the following (32:43 of video):

"...the other thing I feel very, very, very strongly about is, it's incredibly stupid for Apple to get in a position where for Apple to win Microsoft has to lose. That's really dumb... Apple can win without having to have Microsoft lose."

Don't focus on being better. Don't fret over differentiation. Think Different. Be different. Transcend boundaries. Stand alone. Walk down a very lonely path. 

Something that every entrepreneur should keep in mind is what Jerry Garcia once said: 

"You do not merely want to be considered just the best of the best. You want to be considered the only ones who do what you do." 

What will you do? How will you be different? One place to start, is to be yourself. Be genuine.

To really, really soar, don't just be better, faster, cheaper. You can do better than that. And please, please, please, don't aspire to be "the Mint of XXX category" or "the AirBnB or YYY category" or the "Groupon of XYZ category."

Passion

Fred Wilson wrote a post yesterday talking about Mission Based Businesses and how critical passion is to building a successful business.

Which comes first? Passion for a great mission or a successful business?

Conventional wisdom is that passion comes first (or is more important). I have a different point of view.

For every great business, there are countless well meaning, passionate entrepreneurs who don't make it.

Even great entrepreneurs can lose their passion. Tony Hseih, CEO of Zappos, is a great entrepreneur. In his book, Delivering Happiness, he shares how he lost passion for LinkExchange, his first startup, before selling to Microsoft.

There are good businesses and bad ones. One saying we have at Altos is "it's hard to fall in love with a crappy business."

To remain passionate, it's critical that you build a successful business. You will find that it is easier to fall in love with the business and love what you do.

I've observed many companies start with great missions that go nowhere. I've also seen companies grow their aspirations and missions to something far bigger than they had imagined in the beginning.

Rather than spending much time thinking about a mission to inspire employees and customers you don't yet have, focus on delivering a great product or service. Build a successful business. It all starts there.

Entrepreneurs like Bill Hewlett and David Packard did not set out to change the world. They just wanted  to work together. They built a product and started selling. They had no business plan. No grand mission. They took it one step at a time.

One final word about passion and love. The love you feel for a startup is like the passion in a new relationship. Such passion is intense but it can fade away.

What you want is the type of passion that grows in a great marriage. Marriage is tough. You have to work hard at it and you will go through many ups and downs. But in the end, you just might find true love.

Another Bubble

There is lots of talk about a new bubble forming...countless blog posts and discussions over the past year which I won't revisit. 

The latest theory is that the DST investment in Facebook in 2009 was the Netscape moment of the Web 2.0 era, which means this year might be like 1997 (two years after the Netscape IPO and another 3 years before a crash).

The thing about bubbles is that no one knows for sure. That's why we have bubbles...and pops.

Assuming we are headed into another bubble, some people are giving advice. They say that you should act differently during this bubble.

They will say "it's different this time" - an addressable Internet market of a BILLION people, cloud computing, mobile computing, titanic shifts in ad dollars, unprecedented growth in real revenues and profits, etc. 

To be or not to be lean?

The lean start-up movement has been terrific. Following the crash of the Internet bubble, a new generation of lean entrepreneurs, building capital efficient companies, was born.

But now people are confused. They are again debating the benefits of going fat vs. staying lean. Even some leading proponents of lean are advising entrepreneurs to behave differently (see Steve Blank's post on "new rules for the new bubble").

The problem is that changing your behavior with the times could a recipe for disaster. It is not honest either - certainly, not genuine or authentic.

Strive to do something which might stand the test of time. Do something which will last beyond the next bubble (and the inevitable crash).

Don't worry so much about what others are doing. Let them raise lots of money and spend it on PR or advertising. Why worry about things you can't control? Focus on what YOU need to do.

This will be hard to do. The behavior of everyone around you will change. You will feel new pressures from all around, even from very smart people and trusted advisors.

Here is an example - pressure to raise more money than you need. One of our portfolio companies was approached by prominent investors who wanted to "get in." They tried flattery (a very high valuation). Then they tried a threat (they may invest in a direct competitor rumored to be raising more than $100 million).

Try to resist such pressures. Resist temptation; and above all, resist envy. It is the most insidious of sins. Envy feasts on bubbles even more than greed or fear (of missing out). 

Don't fret about timing. People who try to time it get it wrong. They invest when things get hot. They pull back when things look bleak (i.e. buy high and sell low, even though they were trying to do the exact opposite thing).

Trying to take advantage of the greater fool, means, by definition, that you are a fool. That said, I do have some advice.

If you are going to sell your company, this is a pretty good time to do it. Valuations are high, buyers have cash, they are hungry and they are moving quickly.

If you need to raise money, now is a good time to raise it - equity or debt - the terms are favorable. But remember to be careful when taking advantage of this environment. The time to be cautious is when everyone else is bullish. 

The next few years will be very interesting...

Don’t Drink Your Own Kool-Aid

 

In my twenty years of working in and with startups, I’ve continually tried to figure out what makes some work and others not.  There are myriad factors of brilliance, determination, luck and timing that go into the success equation.  One of the most important and overlooked characteristics of successful entrepreneurs is objectivity: the ability to see and deal with reality in making decisions.

By their nature, startups are driven by passion, optimism, persistence, hope and dreams.  All these traits are essential to fueling the process of inventing a product and innovating a business model.  The beautiful thing about startups is that they are emotional and intellectual creations brought to life through shared vision and hard work.  

Company founders and CEOs get employees, customers and investors to take innumerable leaps of faith on the way to fulfilling their entrepreneurial visions. Mixing the Kool-Aid is an essential part of building a company (see also: eating your own dogfood).  But drinking your own Kool-Aid is the enemy of sound decisions. 

Here are three signs that you might be doing it:

1. Illusion: Some would say that most of the factors that drive success are outside of an entrepreneur’s control.  But most entrepreneurs suffer from the illusion of control - “the tendency for people to overestimate their ability to control events.”  This is as true for CEOs of small companies launching new products as it is for large companies planning corporate takeovers.  It is critically important to understand the difference between things you control and the things you don’t – and be clear and objective about that.

2. Hope:  Closely related to the illusion of control is optimism bias, or the "tendency for people to be over-optimistic about the outcome of planned actions."  While optimism is a fundamental part of entrepreneurism, its evil twin is hope.  The more desperate a company’s situation, the more you hear the word “hope” driving business decisions.  In a company meeting last week, my Spidey senses perked up when the CEO described the company’s next product launch in all-too-hopeful language.  He was “hoping” for vast improvements in four separate metrics (traffic, registration, engagement and conversion) to click in just the right way.  Did I want it to happen?  Absolutely.  Did I think it would?  Absolutely not.  As the old saying goes, “hope is not a plan.”

3. Spin: Good spin is essential to marketing your product to the world, but behind closed doors with your team or your board, you have to be brutally honest about the facts.  Startups are all about learning, and if there’s even one degree of spin on the data, it’s hard to learn the right lesson.  If your board meeting agenda looks like an actuarial recitation of facts and metrics, you’re on the right track.  If your board meeting agenda looks like a pitch deck, you’re not being objective.  Beware of underestimating competitors.  Beware of prematurely declaring victory.  Beware the phrase “conservative projections.” 

How can you avoid drinking too much of your own Kool Aid?  Here are a few ideas:

1. Metrics:  My investor friend Dave McClure is piratically fanatic about metrics.  Follow his advice: get religious about metrics.  Bad decisions thrive on incomplete data, speculation and opinion.  My favourite companies post their metrics up on big screens for everyone to see. The more you can instrument your business, the fewer places there are for bad decisions to hide. 

2. Culture:  As a leader in a company, it is critical to create a culture that allows for open, fact-based dialogue and dissent.  Highlight team members who get it right while being honest and self-deprecating about your own bad decisions.  Celebrate unconventional ideas.  Designate someone on your team to take the devil’s advocate role.  Beware groupthink. 

3. Friends: Friends don't let friends drive drunk.  And your good friends, your real supporters in the entrepreneurial enterprise, should not let you fool yourself either.  Don't surround yourself with people who just reinforce your worldview.  Surround yourself with advisors and investors who are honest enough to call bullshit.  But don't confuse brutal honesty with a lack of enthusiasm for you or your business.  It is absolutely necessary.

Every entrepreneur needs to mix some pretty strong Kool-Aid to persuade employees, customers and investors to come along for the fantastic ride of building a new company.  But the really great entrepreneurs know not to drink their own.

Overused and Misunderstood - Capital Efficiency

"Capital efficiency" is such an over used term these days I don't even know what it means anymore.

Some startups think that burning $100k per month is too high while others think $100k/mo is close enough to zero that it's "near break-even."

Vinod Khosla has proclaimed that a company which burns less than $100 million is "capital light" (he was referring to clean tech). At $100k/mo, it would take almost 3 generations to burn that much money (each generation is about 30 years).

The problem is that the monthly burn rate or total funding doesn't say much about efficiency. The return on capital is the key metric needed to determine capital efficiency and most startups have no clue because they don't even know if they have a business (yet). 

Another problem is that startups are not efficient. In fact, they are so inefficient that their trajectories are often referred to as "drunken walks." 

Big companies are built for executional efficiency. Startups are built for innovation. It requires a certain mindset. A willingness to experiment, endure mistakes, allow for some slop and forgo efficiency. 

Steve Blank likes to describe startups as organizations formed "to search for a repeatable and scalable business model" (others might add a step - find product/market fit, then look for a business model).

While I like Steve's definition, it's important to emphasize that the goal of a startup is NOT to stay in a limbo state of experimenting, learning, pivoting, and searching for product market fit or business model.

The goal is to find something that works and scale it.

For some entrepreneurs, this is when the fun ends. For others, this is when the fun begins. It's funny how some entrepreneurs feel like they are just getting going long after they've built billion dollar companies (examples include the founders of companies such as HP, Intel, Microsoft, Apple, Oracle, Amazon, Google, Facebook).

As a startup grows, more and more parts of the company will make the shift from exploration/learning to execution mode. At first, it might be just the founders and engineers, then the sales team, then the marketing team and eventually the entire company. 

So, rather than capital efficiency, perhaps we should think about constraining the capital in startups...until they are ready to scale? For example, at Y-Combinator, founders are initially paid roughly the equivalent of a grad student stipend - barely enough to pay for meals and a shared apartment.

At the right right time, there is no question that a startup should raise the capital needed to take advantage of the opportunity at hand. In fact, I'd recommend raising a bit extra, to allow for ample cushion and a margin for error.

But until then, "capital constraint" or "capital restraint" might be better terms to think about than capital efficiency. 

 

Another Perspective on Yahoo!

Paul Graham published an essay about "the problems that hosed Yahoo" which got shared by many people via Twitter and Hacker News. Many people called it "customarily brilliant." 

I really enjoy Paul's writings but this one didn't sit well with me. I disagreed with key points and came away concerned that young entrepreneurs would learn the wrong lessons from history.

In the essay, Paul suggests that Yahoo failed due to two problems - 1) easy money and 2) ambivalence about being a technology company.

Money

Paul takes us back to 1998, when Yahoo was riding high, making money from big brand advertisers as well as over-funded, "fat startups" (a term popularized recently by Ben Horowitz). In Paul's words, Yahoo was "a de facto beneficiary of a pyramid scheme."

I agree that too much easy money, especially over-funding, can harm companies. Too much money can mask problems. That said, I don't think it had much to do with Yahoo's demise.

We can second guess how Yahoo could have re-invested profits but I would not fault them for pursuing it. They built a very successful company which beat every competitor of their era. 

Everyone benefited from the bubble. If Yahoo had not taken the money it may have been diverted to others and weakened its competitive position. You have to be in the game to even have a chance at riding the next wave. 

Maybe what Paul meant to say was that Yahoo management should have recognized that they were lucky or that their business model was not sustainable?

In hindsight, it's clear that Yahoo did not appreciate the potential for search and perhaps over-estimated the quality of their revenues. But, as Paul acknowledged, no one else, including Larry and Sergei, knew how big search was going to be, in 1998.

It's hard to predict the future and deceptively easy to come up with simplistic explanations in hindsight. Yahoo beat its competitors hands down and built a very profitable, growing business. I would not diss them for it.

Paul's second point was about culture and leadership.

Hackers 

Paul suggests that Yahoo was a technology company but either didn't know it or were ambivalent about it. He also seems to imply that if hackers had run the place Yahoo would have been fine (or at least would not have been hosed).

I disagree with both points.

Yahoo was never a technology company. They were a media company (albeit a "new media" company) from the day that Dave and Jerry started serving up pages from their trailer at Stanford.

When Mike Moritz invested in Yahoo, it was the emerging brand and traffic that impressed, not the technology. Unlike Google, there was no core technology from day one. Later on, Yahoo did develop many technologies - they had to in order to scale (Hadoop is one example).

Bill Gates would have also said that Yahoo was never a technology company. When Gates saw Google, he saw a company that reminded him of Microsoft. It was probably the only company that ever scared him. He never had that reaction to Yahoo.

The important thing is not to be like a Google or Facebook (or the early Microsoft). The important thing is to be yourself. Be authentic. Be genuine.

So maybe Paul's point is that Yahoo didn't know who they were. Perhaps, but I disagree that Yahoo had to be like a Google or Facebook because that is not who they were.

Pixar is a great media company. The fact that they were founded by technologists doesn't confuse them. They even sell rendering software to other companies, including competitors. It doesn't diminish their identity as a media company. 

Disney is another example. Walt Disney Imagineering has been inventing cool new technologies for decades. They were the "new media" company of their generation. You don't have to fit someone else's mold. Be yourself. Be unique.

Another key point Paul seems to make is that "adult supervision" is bad. Implication seems to be that if hackers had run the place Yahoo may not have lost. Again, I disagree. 

There is good adult supervision and bad adult supervision.

Amazon is an interesting case study that, on the surface, defies hacker conventional wisdom. Even as they delve deeper into technology, Amazon's management is stacked with MBAs.

Even their most technical businesses, Amazon Web Services and Digital Media (including Kindle), are led by a Harvard MBA and a Stanford MBA, respectively. Even so, Amazon continues to attract and retain plenty of good hackers. In fact, momentum seems to be increasing in the hacker community. 

There is nothing inherently wrong with adult supervision or non-technical management per se.

That said, I do think people can get seduced by the belief that there is a mythical "world class" management team that can fix your company. On this front, I think Paul and I probably agree. Don't count on someone coming in from the outside to fix your company (or, in the case of Yahoo, your stock price). 

When the bubble crashed, Yahoo looked for a savior. In contrast, Amazon stuck with Jeff Bezos even though their stock took a similarly huge beating. Bezos likes to remind everyone how the pundits called them "Amazon dot toast."

Terry Semel knew little about Yahoo or the Internet when he took over in April, 2001. It quickly led to the mass exodus of the future leaders of Yahoo. The fallout we are witnessing now may still be the after shocks. 

To conclude, I'd like to share a great story about how Nike is still shaking up the shoe industry. When Phil Knight retired after almost 40 years as CEO, he decided to bring in fresh blood and passed over the leading internal candidate for CEO. 

Luckily, Nike had such a strong culture that it quickly rejected the outsider. The new CEO, from S.C. Johnson (the makers of Pledge, Windex and other cleaning products) lasted only 18 months. The new CEO is a home grown prodigy - a former shoe designer who was the internal CEO candidate in 2003. 

With 33,000 employees, there is plenty of "adult supervision." It just happens to be the right kind. 

25 Heat Seeking Missiles (and 10 Key Lessons)

First Round Capital's Josh Kopelman recently wrote a great post talking about entrepreneurs as heat seeking missles. Here is an excerpt:

I've lately started to realize that our most successful companies are led by entrepreneurs who have a unique talent -- they are heat seeking missiles.  It doesn't matter where the missile is aimed pre-launch.  Successful entrepreneurs are constantly collecting data -- and constantly looking for bigger and better targets, adjusting course if necessary.  And when they find their target, they're able to lock-onto it -- regardless of how crowded the space becomes. 

At the end he says

You can't predict success based on where a missile is pointed pre-launch.  Instead you have to assess the quality of the targeting system (the team) and the density/size of targets (the market).

He makes a great point. If you want to read about many more "heat seeking missiles," I’d recommend a book called “Retail Superstars” by George Whalin (http://www.retailsuperstars.com/) which talks about 25 great entrepreneurial success stories.  

I LOVE observing and studying great retail entrepreneurs because there is nothing quite like the retail business. There is no other business which puts entrepreneurs in front of customers so close, so personal and so often. I grew up in a retail environment. My mother owned franchised Hallmark Card and Gift shops and I remember chipping in, working every Christmas season, helping customers and gift wrapping thousands of presents over the years. Depending on the person and who the gift was for, I often made small, last minute adjustments on the type of wrapping paper, ribbon or knot (also, I did it to keep it more creative and interesting).  

The book essentially describes 25 great entrepreneurs (and their families, since most are family-run) and the story of how they built fantastic businesses which have not only survived but thrived in this most recent era of retailing dominated by Wal-Mart and big box retailing. 

The assault on independent store operators (most of which are run by entrepreneurs) didn’t just happen with Wal-Mart (which got started in the mid 1960s). There is a book called “Chain-Store Retailing 1859-1950” which chronicles how chains such as Sears, Montgomery Ward and JC Penny began spreading across America putting local merchants out of business along the way. The chains were becoming so powerful that in the 1920s and 30s, some communities and even states enacted laws to limit the number of new stores by chains.

The "retail superstars" defy conventional wisdom and epitomize the “think different” approach that all great entrepreneurs take. They provide proof that great entrepreneurs can succeed, against all odds, in ANY market against even the toughest competition.  The book is truly inspirational (if you love and admire entrepreneurs).

The top 10 lessons and common traits across the 25 retail superstars are:

1. There was no up-front plan or even long term vision. “When asked whether their companies had been built based on a business plan or set of guidelines, they invariably answered no, their growth was guided by what customers wanted and expected from their stores, what the marketplace dictated, and how they could best serve their customers.”
2. They got started with no outside funding - and ALWAYS with very modest stores, or sometimes no store at all - like selling fruit out of a cart. They all became hugely successful, one modest step at a time.
3. They are scrappy survivors. Many suffered disasters, even death as some businesses moved from generation to generation, yet they all kept growing.
4. They hired great people (friendly, knowledgeable staff) and kept them for a long time (which is unusual in retailing). They took care of their people who, in turn, took good care of their customers.
5. They embraced change and instilled a culture within their companies to allow staff to innovate and adapt to the needs of their customers and communities.
6. Even as circumstances changed, they maintained long term relationships both inside and outside of their stores. Repeat customers and word of mouth advertising fueled growth in each business. They figured out viral marketing long before it was so hip.
7. Surprisingly, they used technology to their advantage. Technology is just a means to an end. Most used the Internet and social media to engage their customers and broaden their reach (before the Internet, they used catalogs and direct mail). Every single business in the book grew with an absolute focus on the customer. If technology is useful for that purpose, it should be used.
8. They all gave back. Each retailer were pillars of their communities and incredibly generous to various causes around their communities with not only money but time and thoughtfulness.
9. They defied conventional wisdom and showed that there are many ways to succeed. Some retailers had great selection and huge stores. Others were focused and had very small stores. Some retailers offered great value and led with price. Others catered to the very high end and would give you sticker shock! Some operated in very big cities and big markets. Others operated in very small towns in the middle of no where where customers would have to drive miles to visit - yet they all built very successful, growing businesses.
10. A company can lose its soul when hired guns (i.e.“professional management”) take over. Home Depot was a fantastic entrepreneurial success in its growth phase when it started out employing skilled carpenters, painters, plumbers and electricians to work in its stores. “They served their customers well and the company grew into the largest home center retailer in the country. When management changed and a take-no-prisoners, cost cutting approach was adopted, most of those full-time craftsmen got caught in the cross fire. Without skilled employees, Home Depot’s sales suffered and its sterling customer service reputation was tarnished.”

One great retailer not covered in this book is Borsheims in Omaha, which operates the largest jewelry store outside of Tiffany's in NYC. It's the place Bill Gates flew his private jet to to pick out a ring for Melinda (their buddy Warren Buffett owns it). Nebraska Furniture Mart is another great retailer, also in Omaha, and also owned by Warren Buffet's Berkshire Hathaway. 

Woodman's is one of my favorite success stories of all time. No book has been written about them, unfortunately. They are an employee owned chain of grocery stores in WI and IL and have built a $1B+ business that has been evolving and growing for decades and will continue to kill the local Safeways, Whole Foods and Wal-Marts (http://www.woodmans-food.com/). One can learn a lot about how to compete and run a defensible business by studying a company like that. 

One of my favorite retailer-entrepreneurs, Barnett Heltzberg, wrote a book called "What I Learned Before Selling to Warren Buffet." I've blogged about him in the past and it's worth a quick read if retailing or entrepreneurship fascinates you. His key lesson was "Focus on the Controllables" (http://www.blog.altosventures.com/vc/2007/06/the_controllabl.html).

Finally, one of my favorite entrepreneurs of all time is Sam Walton. There have been so many articles and books written about the man as well as his company but the one I'd recommend is "Made in America." 

Fat Startup Watch

I'd like to start tracking the best fat startups to see how they do over time. Please email me suggestions of the latest and greatest fat startups. You can also submit suggestions as a comment to this post (which is how I plan to update this list over time). 

To qualify, the company must raise at least $10mm before they achieve product-market fit. For example, companies such as Facebook, Twitter and Zynga would not qualify as fat startups since they raised the vast majority of their funding after they had significant traction. 

In contrast, a good fat startup example is Tom Siebel's latest company, C3, which is still in stealth mode. I believe they raised $10mm in an initial seed round from individual investors. Since then, they've raised a lot more funding from some great institutional investors at much higher valuations which I cannot disclose. 

Here is an article from the Washington Post talking about C3 closing another $26 million in funding and landing Condoleeza Rice on its Board. Such a high profile person joining a tiny company is not a surprise since one of the defining characteristics of fat startups is an impressive roster of "proven" and/or famous people on the management team and board. 

The second fat startup I'd add to the list is Workday, which is founded by Dave Duffield, former founder/CEO of Peoplesoft. To date, they have raised more than $150 million. I believe the last round was at around $400 million dollar valuation. Good for them.

Let's see what happens...

What Did Bill Gates Worry About? Lean or Fat?

I found this from the transcript of a Charlie Rose interview with Ken Auletta, right after "Googled" was published. It is interesting to hear about what Bill Gates worried about back in 1998, near the all time peak of his power (and the peak of the fat startup era). 

CHARLIE ROSE: And are they on the cutting edge of exciting stuff or are there two more kids in a dormitory room at Stanford that are about ready to come up with something that’s going to blaze new trails? 

KEN AULETTA: Well, we don’t know that. That’s the great thing. I mean, I think I may have told the story when I was on your show, I tell in my book that Bill Gates in ‘98, when I asked him what he worried about, he didn’t say the obvious, which is "My competitors, Netscape, or Oracle or Apple." He said "I worry about someone in a garage inventing something that I haven’t thought of." 

(LAUGHTER)

That year there were two guys in a garage. 

CHARLIE ROSE: Sergey and Larry in a dorm, yes.

KEN AULETTA: Google has the same reason to worry. What is that new technology? One thing they are conscious of is social networking and that could pose a problem for search. 

 

Now, I should also point out that Mark Zuckerberg started Facebook in a dorm room while Kleiner Perkins and Benchmark funded Friendster and Sequoia funded Plaxo during the very early days of social networking.

I feel like a broken record but this is something I wrote in 2006 in Venture Lotto:

The most sought after deals are led by proven managers. Especially popular are entrepreneurs who have made money before - they get investors lining up like sheep.

Ironically, the people who end up creating the blockbusters are usually unproven managers. They emerge from the fringes, and start small, in niche or overlooked markets. They take time to learn and iterate and burn very little capital before turning profitable. They follow a slower, but lower-risk path. In our own portfolio, the companies which raised less funding not only performed far, far better but had much lower failure rates.

Entrepreneurs can't count on a portfolio. The best ones we know are much more risk-averse than conventional wisdom might suggest. They don't take foolish chances. They spend money as if it were their own. They observe, listen and adapt; but fundamentally, they strive to control their own destinies, which is best done by generating profits. They do need a little capital, but they want help and advice even more. 

Ben Horowitz Makes Compelling Case for Lean

Like many of you, I've been following a fascinating and important debate between Ben Horowitz and Fred Wilson over the past couple of days. To recap, it all started with this post: The Case for the Fat Startup.

Fred then responded with Being Fat is Not Healthy which has received a lot of comments worth reading, including some comments from Ben. 

Then earlier today, Ben responded with the best post of all The Revenge of the Fat Guy.

After reading through the posts, I've come to the conclusion that Ben and Fred actually agree on the fundamental points. In fact, the most important point was already made by Steve Blank last year in Lean Startups Aren't Cheap Startups.

Steve, a key figure in the lean startup movement, felt the need make the case that you cannot confuse lean with cheap. He concludes with the point that if you confuse the concepts "when you do find a repeatable and scalable sales model, you will starve your company for resources needed to scale."

The reason I love Ben's latest post is that he helps debunk some myths about Product-Market Fit, which, according Marc Andreessen, is "the only thing that matters" Along the way, he also makes a compelling case (though perhaps unintentionally) for staying lean. 

Ben's post should be a warning for entrepreneurs and VCs who put too much faith behind the magical product market fit concept. Here are some things to watch out for:

1. Product market fit is NOT a discrete, big bang event. If you are fortunate to find product market fit, you will most likely get there through lots of hard work "through partial fits, a few false alarms, and a big dollop of perseverance...there’s no formulaic answer."
2. It's NOT obvious when you have product-market fit. "It’s usually not black and white."
3. Once you achieve product-market fit, you can lose it.
4. Once you have product-market fit, you still have to "sweat the competition."

All of these points should serve as a warning for people with too much money to spend (or invest) and eager to step on the gas once product market fit is found. Given all of the uncertainties, it would be prudent to maintain some humility even if you believe that you've found product-market fit (you can also reach the opposite conclusion - even when in doubt, step on the gas - it's just not the path I'd recommend). 

Ben's last point is important to consider because, on the surface, it makes a case for the fat startup. Since "the best markets are usually the ones in which competition is fierce" you should invest aggressively to make sure you win the market."

I would ask, how much should you raise/invest? How about a billion dollars as Webvan did?

In any huge new market, there is no question competition will heat up. But even a billion dollars is nothing when you are talking about competing against the big guys. 

Rather than focusing on how much money to raise, how about focusing on producing profits and creating a sustainable business model?

When I look at competitors, the ones that scare me are the ones that have found ways to make money and scale at the same time. The "fat startups" that are burning through millions or tens of millions of dollars a month don't scare me.

Ben says that you can't win the market by saving your way there. I totally agree. But conversely, you can't win by spending your way there either. Even if you raise hundreds of millions. For every Loudcloud/Opsware, there are dozens of craters. As David Packard liked to say, "more companies die from indigestion than starvation."

There is no question that Ben is a great entrepreneur who knows first hand how difficult it is to build companies. He knows that it often takes more money and longer than you'd like. So it would make sense to raise more money than you think you need. If someone offers to invest boatloads of money in your company at a great price, you should consider taking it. I agree. But even Ben has said that it should not be your plan A.

If you are one of the very fortunate entrepreneurs who is able to get boatloads of funding at a great price, you should be careful to resist pressures to spend that capital from excited investors. You need to also do your best to resist your own temptations to pursue every great idea that you and your great team comes up with to win the market. A company growing on profits just tends to be much more disciplined than one growing based on boatloads funding.

Just as Ben agues that Twitter is the exception, not the rule, I'd say that Loudcloud/Opsware is the exception, not the rule.

Even Loudcloud/Opsware is not a very compelling case for the fat startup. They raised $346mm in 15 months and went public in March 2001. By September 2002, market cap had fallen to $28mm, which was less than cash on hand and about 8% of capital raised to date. That sounds like value destruction to me. If you were an investor or employee, you'd be pretty bummed right about then.

Then an amazing thing happened. From 2002 to 2007, the company raised no more capital and created tremendous value - great job Ben! They exit for $1.6B in September 2007! I would guess that there was a lot of great technology created in the prior 2 years that helped. But I would also guess that the thought of running out of cash was pretty scary when you are at a $28mm million market cap. If I were in their shoes, I would have been more determined than ever to get to profitability so that I would never have to raise more funding. 

To recap, during the first era (Loudcloud), hundreds of millions are raised and return almost nothing. During the second era (Opsware), if you bought stock, which was publicly available, so any of you could have participated - you did NOT have to be a famous entrepreneur or a hotshot VC to get a chance to invest - you would have made a spectacular return.

Ben Horowitz just reinforced my belief that "fat startup" is not only a bad idea but a dangerous one. Just as the lean startup concept can be harmful if people misunderstand the key points, the fat startup concept can also be harmful. In fact, it can be a LOT more harmful to the VC industry. Entrepreneurs will also suffer from excessive dilution, recaps and wasted lives pursuing bubbles and false dreams.

I'll end with a concept Warren Buffet has repeated over and over again - don't count on the kindness of strangers to save you. Make sure you have enough cash on hand. To me, that is not an argument for the fat startup, it's an argument for the lean startup.

So What's With All This Talk of Failure?

Have you noticed all the talk and blog posts about failing? Here are some examples: 

• Peter Rip: Fail Fast, Fail Often
• Josh Kopelman: Failing Cheaper
• Brad Feld: The Best Entrepreneurs Know How to Fail Fast 
• Scott Wolfgang: Even VCs Should Learn to Fail Fast 
• Auren Hoffman: To Grow a Company You Need to be Good At Killing Things 
• Anthony Lee: Failing Fast 

The main message is this: it's not only OK to fail, but it might be the smart thing to do if you do it quickly and cheaply and learn from the experience. 

In a book called The Dip Seth Godin takes it a step further and advocates the idea of quitting or killing off something early before you even have a chance to fail. To be fair, he also says that - many times - the right thing to do is to keep pushing ahead (because you are just hitting "the dip" before you reach eventual success). But that's just conventional wisdom right? It would not sell many books or drive page-views.  

Mark Suster in his recent post called Why the 'Fail Fast' Mantra Needs to Fail calls bullshit on all this talk of failure. So does Jason Fried who wrote the following in Rework: 

“In the business world, failure has become an expected rite of passage. You hear all the time how nine out of ten new businesses fail. You hear that your business’s chances are slim to none. You hear that failure builds character. People advise, ‘Fail early and fail often.’

“With so much failure in the air, you can’t help but breathe it in. Don’t inhale. Don’t get fooled by the stats. Other people’s failures are just that: other people’s failures."

What people are talking about when they espouse "failing fast" is fairly basic. Before you become great at something you might stumble along for a while. If something's not working, try something new or different. As Einstein said, the definition of insanity is doing the same thing over and over again expecting different results. 

My 3 year old son seems to have no problem grasping this concept. He doesn't have fancy terms like experimentation, iteration or pivoting to describe what he's doing; and he certainly doesn't think he's failing. He's absorbing, learning, trying new things and having fun.  

To become good at anything, you need to give it a shot, experiment, practice, learn, iterate. No big deal. Let's NOT call it failure. Let's call it what it is. Mark's suggestion was "launch and learn" or something else. I hope people take his advice.

Having said all that, I'd like to provide an example of the best fail fast (or quit early) story I've heard in a while and explain why it does make sense to cut your losses sometimes. I also want to explain why I believe the "fail fast" meme took off in the venture community. 

The story was told to me over lunch last week by Glenn McGonnigle who recently started TechOperators, with other proven entrepreneurs and executives in Atlanta. I think they are one of the best VCs in the world in the security market (they are co-investors in a recent deal). 

In the mid 1990s, Glenn started an online backup company. I think you'd all agree that he was a bit early! After some struggles, one of his angel investors Kevin O'Connor approached him to have a little talk. Kevin hinted that the market might not be ready for what he's doing so perhaps he should consider joining a couple of other companies that he was working on. It was totally up to him to decide what to do (but read between the leaves, there will be no more funding).

After thinking it over, Glenn came to the conclusion that he was too early and decided to shut down his company and take up Kevin's offer to check out his other ventures. The first company was targeting the Internet advertising market, which was still in its infancy in 1995. The other company was also in a nascent market for network security and penetration testing software. Glenn decided that he didn't know anything about the ad business and joined the latter as VP Sales. The company had just $50k in angel funding from Kevin and had hired Tom Noonen as CEO (Tom is a co-founder of TechOperators with Glenn). 

In their first year of operations the company did $300k in revenues. The next year they sought their first round of funding. Glenn didn't know any VCs except for one guy he used to work for - Bob Davoli - who had recently joined Sigma partners. The other VC was Dave Strohm of Greylock, who happened to be the only VC that Tom knew. So, in 1996, a little company named Internet Security Systems (ISS) based in Atlanta raised $3.5M from Boston and Bay Area VCs. 

The following year they raised Series B from Kleiner Perkins Caufield and Byers (Ted Schlein, who was formerly with Symantec and knowledgeable about the security space, led the round). The year after that (1998) they completed an IPO and the stock shot up 70% the first day. The year after that ISS completed a BILLION dollar secondary offering. At its peak, ISS reached a market cap of $4B. Even after the Dotcom crash they continued to grow to $400mm in revenues and were eventually acquired by IBM for $1.4B in 2006.

It was an amazing return for everyone especially Kevin O'Connor who bought an initial 30% stake in the company for $50k. Given that Kevin recruited both the CEO and VP Sales that took the company public, I'd say that he deserved it (the technical founder, Chris Klaus, was a student out of Georgia Tech). 

BTW, the company that Glenn passed on is the company that Kevin O'Connor is better known for - DoubleClick, which also completed its IPO in 1998. They initially had a different name and were based in Atlanta before moving to NY where most of their customers were based. 

So, as it turned out, Glenn could have chosen either company and would have done great. The only wrong choice would have been to stick with his original company! 

The lesson in all this? Sometimes it is better to move on. However, as Mark Suster points out, when you take money from investors you have a moral responsibility. To just walk away and abandon customers, investors and other stakeholders would be "irresponsible, unethical and heartless" using Mark's eloquent words.  

Although I agree with Mark, I would like to point out something which helps explain why the fail fast meme took off in the VC world. In my experience, entrepreneurs are usually the last people to quit. VCs typically give up on companies long before entrepreneurs do! 

One example from my personal experience is the founder of Enwisen, one of our portfolio companies from 1996. Everyone gave up on the company except for the founder and his wife who were both in their 60s. They just refused to give up even with no more funding and no employees left in the building. 

The founder has since retired but the company lives on. All debts have been paid off and all VC and angel investors have a chance to not only get their money back but make a profit. The company has been profitable for years and grew 60% last year, even during one of the worst recessions in decades. The CEO gets calls all the time about potential M&A or growth equity rounds. Maybe one day they could even go public, like Financial Engines did today in the hottest IPO of 2010 (they were also founded in 1996). 

When you are working with true entrepreneurs, you don't have to encourage them to keep going. More often than not, you have to provide a different perspective, point out the realities and, as Kevin O'Connor did, provide some alternatives that might mean moving on.

It really should be up to entrepreneurs to decide whether to quit or to keep going. As a VC, if I picked the right person to back, I don't have to worry about him/her quitting on me. But, sometimes, I do have to have a little talk to point out realities that the ever optimistic and passionate entrepreneur might not see.  

Celebrity Investors, Board Members and Advisors

"The quality and quantity of the financial backing that HomeGrocer.com has received for this latest round of financing clearly indicates that we have a model that is both viable and sustainable." 

- Homegocer's CEO in 1999 Press Release announcing $100mm round 

Chris Dixon's blog post from today about how to select your angel investors talks about a common mistake entrepreneurs make - choosing an investor based on their "celebrity value (by "celebrity" I generally mean in the TechCrunch sense, not the People magazine sense)." 

The same is true for choosing VCs, board members and advisors. We've invested with plenty of famous VCs and board members who were extremely well connected to the CEOs and boards of companies such as Microsoft, Oracle, Cisco, Intel and many other Fortune 500 companies. 

In our experience, celebrity investors and board members do little to help entrepreneurs do what they need to get done. They offer little in the way of strategic or practical advice about hiring, firing, product development, closing deals and financing. Even worse, sometimes the advice can be out of touch with what is going on in the industry or company but due to their celebrity status, some off the cuff comments can carry too much weight. 

Perhaps the most value that celebrities bring to the table are connections (even Chris in his blog post applauded "connectors" who can "introduce you to key people when you need it"). In practice, however, most people with great connections guard their rolodexes. 

Even when an intro is made directly to the CEO of a BIG company, it will get passed down the organization (usually down several levels) to the real decision makers. If the company is well run, the CEO will let his/her people make the decisions. 

If you do choose to use high level connections to force a deal through you should be warned that such a deal can backfire. If you don't take the time to build real support with the right people in the organization, they can do many things on a day to day basis which can ultimately sabotage the deal down the road (and distract you from what you should have been doing in the first place). 

My advice to entrepreneurs is to build your own buzz, based on fundamentals (an excellent banker advised one of our companies to "build your own heat" - it was good advice). You have to deliver real value! 

Also, please, please, please focus on generating your own leads. No matter how big your board or how well connected your advisors are they will NEVER produce the quantity or quality of leads your own team (and sales/marketing engine) will produce for you if you are going to be successful building a real business. 

In my experience, the entrepreneurs who see the most value from celebrity investors/board members and "advisors" build nothing of real value themselves. On the flip side, the best entrepreneurs see little value from celebrities (in fact, they probably find them distracting, if not somewhat annoying). 

Ironically, celebrities begin to embrace entrepreneurs once they think they are going to be successful anyway - with or without them. As it turns out, most celebrities need you more than you need them.

As far as I'm concerned, the real stars are entrepreneurs who create something from nothing.

Disclosure: As Chris D. admitted, as a non-celebrity but hard working small investor, this post is almost entirely self serving.

Overcommitted

Hard working entrepreneurs and their companies often feel over-committed. There are always too many things to get done and not enough resources.

One of our companies that is growing at 200%+ this year was feeling that way and we had a serious discussion about various options. One was to do a better job of account management so that expectations of customers and partners do not get ahead of our ability to deliver. Another option was to raise more funding and hire more people. A third option was to make tough decisions about what to cut (this is not an exhaustive list but will give you a flavor for the discussion).

The third option is a hard one to swallow, especially when things are going well. We have customers lining up and a window of opportunity that may close if we don't go for it - NOW! An easy answer would be to raise more money and ride the momentum.

After much discussion/debate, we made a decision to cut. We did not cut people. In fact, we will continue to hire. But we cut some very promising initiatives and we will have to turn away customers that are ready to pay (or have already paid).

Cutting can be scary, but it can also be liberating. It is not 100% clear that we made the right decision but here are two interesting quotes to think about, if you ever find yourself in a similar discussion with your board/investors:

"The essence of commitment is making a decision. The Latin root for decision is to 'cut away from,' as in an incision. When you commit to something, you are cutting away all your other possibilities, all your other options."
    -The Lombardi Rules, Rule #6 - Be Totally Committed 

"A great company is more likely to die of indigestion (from too much opportunity) than starvation (from too little)."
    -David Packard ("Packard's Law")

Twitter Envy

After what seemed like the biggest PR week ever for a start-up, I did a Google News search this morning on "Twitter" and found 1,612 news articles. It was more than twice the Google News results for Facebook, Google, Microsoft, Amazon, eBay and Yahoo! COMBINED.

Last month, Seth Godin wrote a blog post talking about the difference between PR and publicity. If great PR is the strategic crafting of a compelling story...just what is the Twitter story? Can there be a credible story without customers (not users) and how they make money?

Before you get Twitter envy and start doing dumb things (like Facebook did changing its homepage) be sure you understand what your true mission is as an entrepreneur.

An entrepreneur's mission is not to get publicity or to become famous. It is to build a company. Without revenues and profits, you cannot have a viable company.

There is no doubt that Twitter has innovative product people and great engineers to be able to handle scalability issues. But let's just see if they will still be around when their venture funding runs out and the hype dies down.

In the meantime, don't learn the wrong lessons from Twitter. Don't rush out to hire a new PR agency. I've seen plenty of companies get hyped, raise huge amounts of funding, and land speaking gigs and magazine covers all around the world. It doesn't mean they will make it. In fact, it might decrease their chances (don't confuse cause/effect).

Yes, they might get lucky and flip the company for a princely sum (as Youtube did). But I doubt they will build a successful business or a lasting company.

What is your definition of success? PR or publicity? Build your company or your reputation? Build to last or build to flip?

Burn the Ships!

The past 6 months have been two of the toughest quarters in decades. Almost every company is struggling - but some are surviving and some are not. What separates them?

I want to share an observation. There seems to be one common theme across every Silicon Valley company that I've seen go out of business. For some reason, the management of companies that abruptly shut their doors thought that they would get more funding. It could have been VC funding, debt financing or some other source of outside capital. That was their back-up plan. They were counting on it.

If you are an entrepreneur, you should have the attitude that there will be no-one to save you. There will be no outside capital. You have to generate revenues, cut costs, make the business model work - or find some way to survive until you do.

This doesn't mean that entrepreneurs should not raise any debt or equity financing. It just means they should never, ever count on it.

In Silicon Valley, it almost seems as if entrepreneurs count on VC as a business model. They aspire to become adept at raising VC money and "exiting" in a few years. What ever happened to the idea of building a real business, funded by paying customers? How about building a company that can stand alone, built to last?

In a book called Predictable Irrational, I found a story that every entrepreneur should think about.

In 210 BC, a Chinese commander named Xiang Yu led his troops across the Yangtze River to attack the army of the Qin (Ch'in) dynasty. Pausing on the banks of the river for the night, his troops awakened in the morning to find, to their horror, that their ships were burning. They hurried to their feet to fight off the attackers, but soon discovered that it was Xiang Yu himself who had set their ships on fire... With their ships gone, the soldiers had no route of retreat. Winning was the only option. 

They won 9 battles in a row before defeating the mighty Qin forces.

If you are an entrepreneur and you think that you will need some more funding to survive - or thrive - I have one piece of advice for you. Burn the ships.

Fat and Happy

One of the biggest challenges that start-ups face is inertia. When you hear comments like “things are fine the way they are” or “there is no interest in making a change right now,” entrepreneurs, or any pioneer, will have a very difficult time making headway.

If you're an entrepreneur, I have good news for you. Fat and happy people are in short supply these days.

The world is ready for change. This means that you will be able to accomplish things that were simply not possible before. Isn’t this is one of the reasons that someone like Barack Obama got elected President of the United States?

Entrepreneurs are not only the agents of change, they are the beneficiaries (see creative destruction).

This is not a time to panic. This is the time to act and to take advantage of the great challenges and opportunities that lie ahead.

Over the past few months, I’ve sensed a subtle but real change in attitude. The ones who are not paralyzed seem more determined than ever. People seem more hungry, more creative, more open minded. They are also more realistic. They face problems with new resolve.

Of course, not all start-ups will do well during tumultuous economic times. But I also believe that it is during times like these, when everyone is NOT fat and happy, that the conditions are most ripe for great new companies – and perhaps great new industries - to come out of nowhere and help change the world.

The Death of Tech and Entrepreneurship?

I had an interesting chat the other day with a former venture capitalist who is now doing private equity (i.e. managing larger funds than ever before). He has given up on venture capital. Too difficult to make money, he said.

He observed that the technology industry has matured. Just look at a company like Oracle. Are they innovating or have they turned into another Computer Associates? Hard to believe that not long ago Larry Ellison used to make fun of CA for not innovating but growing by acquiring maintenance revenue streams. We also talked about the semiconductor and EDA industries. Very grim. Cadence is now trading at far below 1x revenues, yet the technical problems they have to solve are getting even harder as geometries continue to shrink.

One of the characteristics of mature industries is that it takes a lot of capital to start new businesses. For example, you cannot bootstrap a new auto company. It could take hundreds of millions, if not billions of dollars. In our own back yard, Tesla Motors is learning that lesson now (Tesla recently asked for $400 million from the government).

So, since the technology industry is maturing, his new investment thesis is that the only way to make the big bucks in high tech is to write big checks. That certainly fits well with his larger fund size that allows him to invest a lot in each company. It helps justify bigger management fees too.

That whole discussion reminded me of a quote from 1899 attributed to Charles Duell, the former commissioner of the U.S. patent office, who said "everything that can be invented has been invented" (actually, the quote is part of an urban myth. The story has been told so many times that even Ronald Reagan once used it in a speech).

I know that we are living through some difficult times, yet I remain optimistic about our future - the technology industry, entrepreneurship and venture capital. Before talking about the future, let's step back for a moment into the past.

Once upon a time, the railroad industry was thought to be "high tech." In the 1830's, rail road entrepreneurs in the U.K. were followed around by the media much as Larry and Sergey are followed around now (or Marc, Meg and Jeff during the Internet bubble).

Many decades later, the auto industry was thought to be "high tech"...and then there was the aerospace industry...the "electronics" industry...these thing called UNIVACs and Mainframes, etc.

Who would have thought that a college drop-out with no funding would hobble (if not topple) IBM, once the most admired company in America? IBM was so powerful that the U.S. government tried for years to break it up, just as it tried to do with Microsoft. It may try it with Google at some point too.

Sometimes, it doesn't even take a high tech wave to create enormous new companies. UPS and Wal-Mart are examples of companies that would require massive amounts of capital to compete against today (they are the two largest employers in America, not counting the government). They were both bootstrapped companies. Neither company raised any outside capital to get going and to reach profitability. They had modest beginnings...but kept growing for decades and rode various technology waves along the way.

The common theme is that entrepreneurs, over hundreds of years, have defined and re-defined what is - and what is not - the latest and greatest. "High tech" or not, entrepreneurs change the rules of the game. They help create waves (or just ride them) to help topple once dominant corporations.

It seems that great companies of every era get toppled by the next generation. Typically, the next gen seem to rise out of nowhere because they start very small, often without much fanfare. They are too small to notice - until it's too late for the incumbents. It takes less time for the average Fortune 500 company to drop off the list than it takes to grow big enough to make the list.

Destruction is all around us these days. Even companies well established for decades are dying right before our eyes, sometimes evaporating in a matter of days. We are also seeing once great, fast growing industries and once innovative, entrepreneurial companies stagnating, perhaps dying slowly. However, this doesn't mean that we're at the end.

Entrepreneurs, even those with venture funding, can't possibly match the resources of large corporations. Yet, entrepreneurs always seem to figure out ways to do the what conventional wisdom thought was impossible. I'm more optimistic about the future than ever because, as venture capitalists, we see exciting developments all around us. Let me provide a few examples.

I'm on the board of a company which saw an announcement that had strategic implications late last week. On a Friday night, the team got together and hashed out a strategy. They came up with new specs for a product. About 48 hours later, the CTO came up with a new product release (apparently, he doesn't sleep). Unbelievable. Such a thing would not be possible without the Internet infrastructure and the innovations that have come before us. A few years ago, even a team of engineers spending months may not have been able to do what a single engineer can do now in a matter of days.

Another example is a company which is using Amazon's cloud services. As they closed major deals, they were concerned about scalability. They had great software engineers who knew little about configuring routers or managing large farms of servers. Now, a software engineer can put out a new release without leaving his bedroom. The company has increased its ability to scale by 1,000x with less work than ever before. An added bonus was that this required no more up-front capital - which really helps in today's environment.

I have so many more examples. It is easier than ever to bootstrap companies. Salaries are coming down. It is easier to find people. Real-estate is getting cheaper by the week (we've seen office rental rates drop 30-50% in the past 2 months alone). In a meeting with Kanwal Rekhi this morning, he told me that the "fear of God is back. This will lead to better companies. More cost conscious. More disciplined."

I continue to be utterly amazed at what a few good engineers can produce these days. But there's more. It's not just about technology. We are seeing unexpected innovations in business models. New revenue and cost models are being created that were not possible even a few years ago (this should be a topic for a future blog post).

The bottom line is this. The pace of innovation is quickening, not slowing down. It's getting cheaper, not more expensive. Yes, if you want to start a new oil company, it will be expensive. A new auto company? Forget about it. A new ERP company? Workday is finding out that it's pretty expensive. Such ventures are not for us because we bet on entrepreneurs who bootstrap. By necessity, they don't go after opportunities that huge competitors with deep pockets go after.  

As long as I'm a venture capitalist, I will continue to bet on entrepreneurs who can do a lot with very little. They surprise us every day. They are our heroes.

The entrepreneurs we see all around us are very hungry. They will struggle - but they will not stop dreaming. They will not stop innovating. They believe. They will endure.

RIP Good Times? A Different Perspective

Rip Good Times A Different Perspective

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I put this presentation together to encourage a group of entrepreneurs I was to speak to at a conference in Reno, NV last week.

It's funny how times change.

People who have been following our blogs over the past 2 years know that we've had a more pessimistic, contrarian view of the venture business, even as the number of VC investments, fund sizes, deal sizes and valuations had been going up.

Now, of course, the world is totally different. Whether or not you believed that we were in a Web 2.0 technology bubble, Sequoia declared that the good times were over and it's now time to hunker down and fight for survival. In their widely publicized "RIP Good Times" meeting, they extolled the virtues of cash conservation to all of their CEOs and told them that they had to change in order to survive.

Now, we are contrarians again.

Our companies did not need Sequoia to tell them cash is king. They had been operating that way for years. In fact, more than a third of all of our companies are on track to be profitable this quarter. Many have been maintaining profitability while growing for many years.

The reason that we feel like we are contrarians again is that we have not seen such a good environment for building companies in years. Entrepreneurs are more focused on getting to profitability and building companies based on solid fundamentals. Before, we felt like lonely voices in the VC world, which seems to be filled with people working toward billion dollar exits for money losing companies.

Over this entire year, we've noticed a trend. Some of our companies started seeing a steady flow of high quality resumes from competitors. I think it's now about to turn into a flood! It will be much easier to hire great people who are more hungry and realistic about compensation and how long it will take to build shareholder value.  

For entrepreneurs in it for the long haul, this downturn just bought them more time. Impatient VCs won't be hounding them to take more risk, to grow faster, to get more aggressive. Remember, as an entrepreneur, you have one company. You don't have a portfolio of companies. You can't afford to play venture lotto.

Remember what we said back in 2006 about Foxes and Hedgehogs in Silicon Valley?

"Foxes are great at raising capital - they thrive in bubble markets. Hedgehogs would rather bootstrap - they do far better during the inevitable crashes."

For all you hedgehogs out there, this is your time to shine!