Altos Ventures Musings

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

View SlideShare presentation or Upload your own. (tags: venture capital)

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!

Financial Weapons of Mass Destruction

The events of this past week made me scrap the article I was working on to write about the crisis in financial markets.

Warren Buffet first wrote about "Financial Weapons of Mass Destruction" in Berkshire Hathaway's 2002 annual report. When it was published in March of 2003, there was quite a bit of press coverage, as there is every year after he publishes his annual letter to shareholders.

In an article written by the BBC, Buffet warned of "time bombs." It seems like the first of many bombs went off a couple of years ago, with the decline of the housing market (and housing stocks), leading up to many more bombs in the past few weeks.

If you read his words, Buffet is quite vivid. His warning was not about the housing bubble or sub-prime loans or even the trillion dollars in CMOs (Collateralized Mortgage Obligations), the pass-thru assets which helped create the mess in the banking industry. Buffet was criticizing ALL derivatives.

Warren Buffet thought some derivatives contracts must have been devised by "madmen." Charlie Munger would say it was sheer lunacy. Buffet talked about "mass destruction" and "spirals that can lead to corporate meltdowns" such as the one which took down LTCM in 1998. Buffet warned of "huge scale fraud" and compared the ENTIRE derivatives business to "hell...easy to enter but almost impossible to exit."

Despite the simplicity and clarity of Buffet's words, few people listened. Even now, people don't seem to understand the magnitude of the potential problems that lay ahead in the global financial system. The derivatives market has grown exponentially since 1998, the year LTCM blew up. The global derivatives market is now more than $500 TRILLION, up more than 10x since Buffet's initial warnings.

So my question is this: how is a $700B or even a $1 Trillion bailout by the US Government in the mortgage market going to make a dent in the overall $500 TRILLION dollar market of even more complex, esoteric derivatives contracts???

How depressing. This is why, as a VC, I don't usually think about or comment on macroeconomic issues. Entrepreneurs and VCs build one tiny little business at a time...and once in a while some of those turn out to be winners that impact the lives of millions of people.

Believe it or not, I'm still quite optimistic about our future. We will get through this. This is nothing like disease, famine or war (at least, there is no war on our soil). There are many companies that are still growing and generating profits and cashflow here in Silicon Valley and around the world.

Most start-ups have no exposure to derivativew contracts and little exposure to the overall financial markets. Yes, the IPO market is closed (for now) but if you have a company which generates cash, you will be fine.

For example, one of our companies - one which has been private for more than 10 years - recently issued a cash dividend which paid out more than our entire investment, just as they did last year. They generate multiples of that dividend in free cashflow every year. Every acquisition they've ever made was paid in cash so I'd suspect that they can continue to fuel organic growth as well as future acquisitions. If they continue to generate cash and pay out more than invested capital every year, it would not be so bad, would it?

If you are counting on bubbles or "madmen" to pay crazy prices for your company when you raise capital or when you try to "exit" you will be sorely disappointed in the coming years. You might even wind up in unemployed lines along with those well educated investment bankers. But if you have a real business, one which delivers value to customers who will keep coming back over and over again, I suspect that you will do just fine. Just keep focused on what you are doing and don't get distracted by the macro issues that seem to swing paper valuations wildly day to day.

The macroeconomic problems we face today are issues that even Warren Buffet can't figure out. That hasn't stopped him from going about his business every day. Those hedgehogs just keep moving forward one step at a time. Since that BBC article in 2003, Buffet has increased his net worth by more than 50% to overtake Bill Gates as the wealthiest person in the world.

Ousting the Founder

I was shocked to learn this week that Diane Greene, the co-founder and CEO of VMWare was ousted. I was not alone. Except for senior management (who found out very late, the night before) the employees of VMWare read about it, just like I did on Tuesday morning.

I guess $1.3B in revenues, $14B market cap, 50% growth rate and market dominance was not good enough for the board/EMC. One slight miss in one quarter and BANG! You're out. Perhaps the board believed industry pundits and worried about competition from Microsoft. So they brought in a "heavy hitter"...former Microsoft exec Paul Maritz as CEO.

I'd guess that the more likely reason was that Diane Green was a difficult person to deal with. There is no doubt that she was a controversial CEO. It was her way or the highway and she churned through senior execs (especially in sales and marketing). She never gave much respect to the folks at EMC either (who owned the vast majority of the stock - and controlled the board).

Some other hard-headed, "controversial" founder/CEOs that come to mind are Bill Gates, Larry Ellison, and Steve Jobs. These founders may be difficult to deal with but I'd rather go with them than take my chances with a new hired gun CEO.

Over the years, we've observed that it's difficult, if not impossible, to match the passion and commitment that founders bring to their companies. It's not just a job for them. It's deeply personal. The difference in commitment is akin to the differences you might observe between missionaries and mercenaries (or hedgehogs versus foxes).

Look, I have nothing against Paul. I'm sure he's a very smart, capable and hard working guy. But this whole situation reminded me of the time Steve Jobs was ousted from Apple more than 20 years ago.

As co-founder and CEO, Diane Green built one of the all time great successes in Silicon Valley. Very, very few companies ever reach $1B in revenues. Even fewer in the technology industry. Even fewer in the software industry. And even fewer ever exceed $10B in market cap.

Why the hell would you fire her?? No, don't tell me...I've heard all the reasons. VCs oust founders all the time. I've been in plenty of board level discussions around this topic!

It's almost a rite of passage in Silicon Valley. As a founder, you start a company, get VCs to fund you, recruit a "world class" management team...and eventually, find your replacement (or get ousted).

What people seem to miss, however, is that just about every great company ever created - in technology as well as low-tech, was built by a founder (or a CEO who happened to join the company very early in its growth phase) and a team of dedicated people who grew with their companies.

I don't believe in "world class" management in the generic sense. "World class" in what??

What I believe in is people who learn on the job and become - over time - the best at what they do. Along the way, they make plenty of mistakes. But that's part of the learning (and perhaps the luck of it - because the mistakes happen to be not fatal for the survivors).

Think about it. Some examples of great companies led by founders for decades are GE, UPS, FedEx, Wal-Mart, Southwest Airlines, HP, Intel, SAP, SAS, Apple, Oracle, Microsoft, Adobe, Sun, Dell, Qualcomm, Broadcom, Nvidia, Dolby, Amazon.com, Salesforce.com, etc.

There are some great companies where the original founder(s) did not grow the company but the CEO who grew the business to $1B+ in revenues joined very early on in the life of the company (typically below $10mm in sales): IBM, McDonald's, Starbucks, Veritas, Cisco and Google are examples.

It'll be interesting to see what happens. Even a founder hanging on to the bitter end won't save some companies (i.e. Wang, DEC). But I'd rather take my chances with the founder who built a $1B business from scratch than go with someone new.

The average tenure of the CEOs in our three largest companies is 9 years. They learned on the job. None of them had been CEO before we started working with them. None had much experience in their industry - the market did not exist, and the technology and business models had not yet been invented. But they are guys who took us this far (average sales of nearly $90mm this year) and we will gladly stick with them as long as they still want the job.

I'd rather take my chances with the people who built the business and grew their companies than the "professionals" - the hired guns - the mercenaries - coming in, after the fact, to "fix" things or to "take it to the next level."

We tell all of our companies this - if you want to build the leader in your industry, you have to have the world's leading experts in your field working for you. But do NOT expect to find them outside of your company. Someone senior from the outside won't come in to show you the way. They won't save you.

Think about it. If you can go outside and hire a CEO or other very senior executives to come in to YOUR company and tell you what to do and how to do it - better than you - then you've created nothing special. There is no secret sauce and you have NO CHANCE of building a truly great company.

We like to tell all of our companies this - the world's leading experts in your business will be the people you develop. The young people you hire today will be your future leaders. Five to ten years from now, they will BE the world's leading experts in your business. You will have to figure it out - together - along the way.

Don't count on those mythical "world class" managers to come in to save the day. Not only are there no guarantees, I believe they will end up hurting your chances of building a special, lasting company. If you do try to hire them anyway...good luck. What I will guarantee is this - they will negotiate HARD for a nice severance package.

Failing Fast

Lately, I’ve been telling all our companies to fail.  Fast.

It’s not that I’ve decided to throw in the towel. Quite the contrary. After doing startups for a dozen years, I’ve come to believe that the best way to maximize the chance of a big success is to fail often and fail fast.

Thomas Edison was one of history’s most successful failures. He failed more than a thousand times before inventing the incandescent light bulb. When Edison finally figured it out, he famously said: “I didn’t fail a thousand times. The light bulb was an invention with a thousand steps.”

The idea of taking a thousand steps is core to our investment philosophy here at Altos.  We’ve come to understand that every company goes through a series learning processes – about new markets, products, distribution strategies, etc. My partner Brendon wrote a great post on the fact that there is just no substitute for time when going through these learning cycles. Sometimes, the outcome of learning means tweaking the product to meet unforeseen customer needs; other times it means completely scrapping the business model and starting fresh. In fact some of our most successful companies started with one business and ended up with something entirely different. Put a smart, tenacious team against a big market opportunity with enough operating runway, and you have a decent formula for success.

Failing fast is even more imperative in the world of Web-based software and services. Back when I was a rookie product manager, I’d spend months perfecting product requirements documents (PRDs) that would disappear into an engineering organization only to emerge months or years later as a finished software product. Nowadays, that one-shot, monolithic approach is just not a competitive option.

Failing fast requires companies to think about perfecting their products differently. To quote LinkedIn founder Reid Hoffman, “If you are not embarrassed by the first version of your product, you’ve probably launched too late.” Perfecting a product the first time out is impossible, but getting it out and iterating a thousand times just might get you close.

Some of our best development teams cull user feedback into new priorities to build/test/release on a weekly cycle. It doesn’t really matter whether they are using newer lightweight tools like Ruby on Rails and Adobe Flex or “heavier” Microsoft-centric stacks. The key is to obsessively listen to and incorporate feedback from Web users who aren’t afraid to tell you if their release sucks (or not). Keep what sticks, toss what stinks.

Of course, just failing a lot is no guarantee for success. There are plenty of teams that just fail all the way to a big fat zero. These teams either spend too much time and money failing or don’t fail in the right ways. Let me elaborate:

One corollary to failing fast is failing cheaper. Josh Kopelman has a good post (and investment model) on this, so I’ll let that him tell you all about it.

A second corollary to failing fast is failing well. Systems that fail well compartmentalize and minimize a failure so that it does not impact the whole system – for instance, a sealed chamber in the hold of a cargo ship that allows a single area to absorb damage without flooding the entire hold. Failing well is a lesson most of us learned in high school chemistry lab: isolating experimental variables by using a scientific control. Similarly, start-up teams that fail well run multiple experiments to get small, controlled failures. These teams understand that failure is a desirable and necessary byproduct of the learning process. They are humble, smart and fast.

So don’t be afraid to fail. Don’t even be afraid to be embarrassed. It’s all just part of being successful.

No Substitute for Time

"People say sometimes, 'You work in the fastest-moving industry in the world.' I don't feel that way. I think I work in one of the slowest. It seems to take forever to get anything done."
- Steve Jobs, Rolling Stone Magazine, 1994

Like many things in life, there is no substitute for time. A solid enduring company takes time to build for a number of reasons.

Markets take time to develop. How many times have you encountered venture-backed companies that reminds you of startups that failed years ago? These companies were too early to market. The infrastructure wasn’t there the first time around. The experience wasn’t right the first time around. The customers weren’t ready the first time around. Startups, by their nature, are early to the market and they have to wait for the market to catch up. Many startups try to push markets to develop faster with evangelical selling and marketing, essentially substituting time for money. But, success is rare and certainly expensive. More often than not, they pave the road to riches for companies that follow them.

Companies take time to develop. Look at the history of “overnight successes” and you’ll find that they actually took many years. That’s certainly true of many of the larger and enduring companies in Silicon Valley. On average, venture-backed startups take seven to eight years before an exit of any kind. Looking at IPO’s over the past several years (post-bubble), companies take an average of eight to nine years to exit. Products take more time to perfect, business models require more experimentation and sales take more time to ramp than expected. Some of the best companies we have backed have taken several years and several course corrections before finding success.

Managers take time to develop. Nothing beats learning from experience, but this takes time. You can try to learn from others, but nothing leaves as strong an impression as personal experience. Over the years and over the dozens of companies we have backed, we’ve come to recognize that certain pitfalls develop time and time again. We’ve found that no amount of cajoling or arguing can keep management from avoiding certain types of mistakes and that in some cases we shouldn’t try.

There’s no better teacher than reality. We try to minimize the impact of mistakes and help avoid repeating them. Many companies seek to circumvent the need for time by throwing out the founders or current management and parachuting in "proven" people with built-in experience who have “done it before.” Unfortunately, they’ve done it before elsewhere. Each company, especially at startup, is unique and offers different lessons to learn. And by jettisoning existing management, the company can lose valuable experience and learning that has already been acquired.

That solid businesses take time to build seems obvious. Yet again and again, we see entrepreneurs who present business plans that show growth from zero to $100 million in five years or less. Again and again, we see investors who want or expect such growth and dismiss companies with smaller numbers as unsexy, unambitious, niche opportunities.

All of this is not to say that a startup need not move fast or that we'll wait around forever for people to learn from mistakes. Let’s not confuse the fact that some things take time with a low sense of urgency, moving slowly, or tolerating inept management. A startup should always move as quickly as it is able. It is the ability to move quickly and nimbly that gives a small company an advantage. But if a startup is moving so quickly that it is years ahead of the market, or never has a chance to develop a sustainable business, or allow its people to develop the skills to run the business, it will not develop into a solid enduring company.

All of this is to say that entrepreneurs and their businesses should be pragmatic even as they keep pushing harder and harder, trying to do what may seem impossible to those with less faith. Decisions should be made understanding that some things just take time. A startup should be capital-efficient. The cash burn should be low so that you can wait out immature markets, so that you can experiment with the business model, so that you can change course when necessary, so that you can learn from experience, so that missteps are less costly. Managers should question the rate of growth, especially in the early years. How ready is the market in reality? Do plans account for the time necessary to tinker with the business, the fact that people need time to learn, the reality that many of the new hires won’t work out?

As they say, you can’t put nine women in a room and deliver a baby in a month. The process can’t be rushed. The same is true of a truly good company. We back entrepreneurs who appreciate this and plan for it.

The Ramp Phase, Jack Welch and a Coin Flip

The "ramp phase" is a period that my partners and I define as a hyper-growth phase somewhere between $10mm and $100mm in sales. It is perhaps the most exciting period in a young company's development. After years of hard work and tinkering, getting the product, packaging, pricing and positioning right (or at least good enough), you think that your company is finally ready to scale. By the time you reach this phase, you have a business model that is starting to work and lots of raving customers. Most companies don't even make it this far, so you are feeling great about things...

At this phase, most VCs are ready to invest big dollars and encourage entrepreneurs to be aggressive. They say, it's time to break through or get left in the dust. VCs don't invest in lifestyle businesses, you have to go for it!  Don't sand bag. Shoot for the moon! Those projections are not exciting enough...it's not BIG enough...the stakes are getting bigger...yada, yada, yada.

Let's get real.

Something that we see all the time when we drill down into sales projections of start-ups is a failure to take into account hiring mistakes that inevitably occur as companies ramp a sales-force.

Sales is typically the department which has the highest turnover in companies going through the ramp phase. Over the years, we've seen hundreds of sales reps get hired (last year alone, our companies hired 200+ sales reps) only to see most of them struggle, get fired or quit at some point along the way.

Based on our experience, less than one out of two new sales reps end up working out. Whether you have voluntary or involuntary turnover, the end result is the same - you end up with fewer sales reps than planned.

Given the time spent on each hire (plus recruiting fees) a lot of precious start-up resources are wasted. Some of this waste is unavoidable. It's just the cost of doing business. However, we believe that most of the waste can be avoided if companies apply some realism.

For example, when it comes to making sales rep or any other types of hires, the sobering reality is that many mistakes will be made. In fact, it's a virtual coin flip according to Jack Welch (who recently discussed this issue with one of our CEOs).

What exactly did he mean by this?

Basically, Welch thought that he was no better than 50/50 early in his career. Half of the hires he made were good and half were mistakes (which he tried to correct as quickly as possible).

Think about it. If Jack Welch (one of the most respected and talented businessmen of his generation) thought that his hiring decisions were no better than a coin flip, what are your odds?

Over the course of his career, Jack, of course, did get better (he was a learning machine and tried to mold GE into a learning organization). How much better?  Well...after 40+ years of hiring and firing people, Jack thought that he got to 70/30 for really important hiring decisions - such as a CEO hire.

In other words, even at the end of his career, he was very aware of the fact that he can (and would) make hiring mistakes a large percentage (at least 30%) of the time - no matter how hard he tried to avoid them.

The bottom line is this - making good hiring decisions is extraordinarily difficult to do. It's a super high risk activity. The risk level is higher, of course, when you're looking to fill critical positions (like CEOs) but even for lower rank, more "cookie cutter" hires (like sales reps) the risk is high (at least much higher than most people perceive).

So, as a CEO or VP Sales of a start-up projecting that "shoot for the moon" sales ramp, you have to ask yourself this question....are you going to be much better than Jack Welch at sizing people up?

If not, you had better plan for at least one in three new hires NOT working out. If you want to be realistic, plan on every other sales rep not producing for you (and try to correct your mistakes ASAP). If you actually planned for this, how would you modify spending in the rest of the company? How would you change your plans on ramping marketing, customer support, R&D, etc?

If you are indeed a superstar (or just super lucky) and you end up making better hiring decisions than Jack Welch...good for you. Use the extra cash-flow generated by your sales-force to reinvest for even faster growth.

But for planning purposes...I would not count on being much better (or luckier) than Jack.

Fear of The Living Dead in Venture Capital

It was not until I got into the VC business that I found out about the terrible, dreadful "living dead" - a term used to describe companies that merely survive, without future prospects. Normally fearless VCs fear the living dead. So do our LPs (the people who invest in VCs) who worry that we might waste our time (and their money) on a bunch of little companies that go nowhere.

Venture Capital is a "shoot for the moon" - go for the homeruns - business (for more on this topic see Swinging For the Fences). Most deals won't work out but great VCs bounce back quickly and easily. They focus on the winners and waste as little time as possible on the losers. When you think about it, the living dead might be far worse than the total losers because they continue to go on and on...potentially sucking up valuable time, energy and resources...indefinitely. Yikes! No wonder VCs fear the living dead!

The bigger you are (whether in size of wallet or ego) the more you will think that wasting time and money on little ideas and small deals is not worthwhile. For example, Larry Ellison believes that there will be only a handful of survivors in the software business - Oracle, Microsoft, SAP and IBM. To Larry, all others in the software business are as good as dead (or the living dead).

BUT, if you're really dead, then you have no chance.

In the VC business, all of our companies, even the very best, follow a rather bumpy and windy road. In the beginning, every company looks like a struggling little company with uncertain prospects.

The best approach to take in venture capital is to relish in uncertainty and to have a little humility.

There is no way to control outcomes in the start-up game. What you can control is whether or not you do your best and make sound decisions (like spending your time and money wisely) and just deal with problems (and take advantage of opportunities) as they come. If you stay hungry and learn along the way - and just manage to somehow survive - you give yourself a chance to make course corrections, take advantage of changes (often unexpected) in market conditions, or just get plain lucky once in a while.

So let's get back to basics...if you really want to have a chance at a homerun, you have to, first and foremost, make sure that your company survives.

Surprisingly, this is not obvious to some people.

One prominent LP once told me that he would rather have us return NOTHING than to play it safe. He was serious - dead serious. He wanted "volatility" because that's what is expected from the so called VC "asset class."

When I first heard this advice I was a bit shocked!

At Altos, rather than worrying about the dead, the living dead or the homeruns, we focus our early stage companies on getting to 1st base - typically around $10mm in revenues - without burning through a lot of capital.

If we can get to 1st base, then we might start to believe that there could be an interesting business forming. In our experience, most companies don't even make it that far, especially if people get obsessed with creating the next BIG whatever.

After reaching 1st base, some companies might go out of business (the equivalent of getting tagged out at 1st), or get bought out, or start slowing down. Only a minority of the companies that make it to $10mm, make it to 2nd base, or $40mm in revenues. At that level, we start to be fairly certain that we will have a winner...but we still don't know whether or not we have a homerun.

At this stage, some more companies might get acquired and others will start flattening out in growth (start-ups rarely go out of business at this stage but, as in baseball, you CAN get tagged out from 2nd base). Again, only a minority of companies break through to the next level...this time to 3rd base, or $100mm in revenues.

Once 3rd base is reached, VCs will typically get a 10x return on investment (sometimes 100x-1,000x, depending on market froth/timing). By that time, we also know that management is competent, scrappy and adaptable, through multiple iterations of products, strategies, business models.

By the time a company gets to 3rd base, at least 5 years (sometimes 10+ years) have passed. In the technology industry, that's an awfully long time! Whether or not a $100mm company can become a much larger company depends on countless factors that are largely unknowable at the time of investment.

We will submit that there is no way to know - a priori - which company will turn out to be a homerun at the time a company starts out (or when VCs invest).

Here is a thought experiment.

If you were really great at predicting the homeruns (and the losers), what would happen if you abandoned the VC business and started a hedge fund? If you can predict the winners and losers when companies have insignificant revenue streams, then you should be even better at predicting when companies reach $100mm (around the time of an IPO). Hedge fund managers can invest tens or even hundreds of millions of dollars at a time - buying or shorting public companies.

If you had invested in companies such as Oracle, Microsoft, SAP, Dell, Cisco and dozens of other companies shortly after their stocks were publicly available, you could have made 100x or more on each deal. So why waste time investing single digit millions in puny little companies?

As VCs, we love investing in tiny little companies started by passionate founders in interesting, dynamic markets. They always start as small, obscure, insignificant little companies that struggle along the way. The path is NEVER smooth!

It is a fact that most VC backed companies won't even make it to 1st base let alone home plate. But if we build solid businesses, based on sound fundamentals, we've seen that some do break through...to 1st, then 2nd, then 3rd, before reaching for home. We just don't know which ones will break through, often for many years after we invest.

We have ten year funds because it takes time as well as a great deal of hard work and suffering, enduring the ups and downs that come along for each and every company as they grow.

But hey, I'm not complaining about all that suffering (didn't Buddha say that "life is suffering"?). We actually love the bumps and bruises we get along the way. Some might say it builds character. But that's not the real truth. To actually LOVE IT, I'd say that great entrepreneurs, as well as VCs, are a bit quirky (some might even say that they are mentally imbalanced).

Rational or not, it has taken me a while to get over my fears...I fear not, the living dead.

The Peter Principle

The Peter Principle is often cited as a cynical view on management. Basically, it says that people are promoted until they reach a level of incompetence after which further advancement is not possible. Taken to the logical extreme, at some point everyone will be incompetent - it will only be a matter of time!

The funny thing is, I actually view the Peter Principle as an optimistic view on  management. Reality is worse (which is why Scott Adams came up with the Dilbert Principle, but I digress).

I would love to see the Peter Principle at work. In the old days, you had to work your way up from the bottom. For example, at UPS, you might start at the loading docks and if you were successful, you would become a truck driver. Eventually, you might get promoted to management - at first, managing a single warehouse, then a district, then a region, etc. The CEO and senior management have decades of experience from the bottom up.

Successful entrepreneurs (the ones who actually build their companies long after the start-up phase) are the ultimate bottom up guys. I've seen entrepreneurs goto Fry's Electronics to buy parts, crawl under desks to install wires, move furniture, clean up conference rooms,...heck, they might even scrub toilets. They do whatever it takes. 

A good friend of mine (and experienced serial entrepreneur) once remarked that "80% of the work at a startup is mundane & inglorious, and exactly the type of work that most people will put off for months in their daily lives (the equivalent of balancing the check book)."

Perhaps making progress one step at a time is not so glorious. These days, young people are in such a hurry to take short cuts that it's hard to find people who actually did demonstrate competence before they were given a chance to take the next step.

How many times have you met a manager who had no clue what their employees did? If companies followed the Peter Principle, at least a former programmer would manage programmers so that they would understand technology and be able to mentor young programmers. If companies followed the Peter Principle, at least a guy managing sales reps would have carried a bag before and would know what it felt like to handle rejection after rejection.

Unfortunately, as we enter yet another bubble (at least in certain sectors of the venture economy), we're seeing people with scopes of responsibilities far beyond even their Peter Principle level of incompetence.

But the problem isn't just caused by MBAs and young whipper snappers looking to skip a few rungs of the ladder as they climb to the top. It's also caused by investors, boards and corporations looking for quick fixes.

In corporate America high profile mercenaries are hired into businesses with obscene compensation (and severance) packages. It seems that even if they destroy value, they can walk away with millions of dollars (hundreds of millions in the case of Bob Nardelli and Home Depot).

The same goes for investors. How many VCs and other money managers are handling large sums of money far beyond what they are capable of managing? It seems that every Joe who has a decent track record with a small pile of money tries to raise much larger funds.

The world might be a better place if the Peter Principle were really true.

At our best companies, we avoid mercenaries who enter from the top. We try to hire smart, young people, challenge them, nurture them, and develop them over many years. It takes great patience, dedication, and commitment (on both sides) but it's well worth it. These people will become the future leaders of our companies.

Even if every hire doesn't work out or even if many of them eventually reach their levels of incompetence, to me, the Peter Principle doesn't seem all that bad. We're never at that theoretical "end point." We're always in transition, striving toward the next goal. If people are actually competent and have the patience to demonstrate competence at every step along the way, we might be much better off.