Class V

Entrepreneurship: What I Was Not Taught at Harvard Business School

With my recent career transition, I've taken on two challenges at once: something akin to a GM role, and something that is very entrepreneurial.  Here are just a few things I've either learned or come to appreciate in a primary way, that I was never taught at HBS or in my years as a professional advice giver (read: strategy consultant, venture capitalist, etc.):

• Entrepreneurial leadership is a 24 hour a day challenge.
• That being said, these are some of the most rewarding 24 hour days imaginable.  Every call or email I return, or task I check off, has a very direct connection to the success or failure of my business. 
• The only way to prioritize all of these tasks is to rank them as they relate to degrees of separation from my top line (revenue).  And then in the case of a tie, further prioritize between revenue now versus revenue later.
• There are 37 new decisions to be made every day.  What boggles my mind is that these decisions are evenly divided between stuff that is in the weeds and stuff that is 30,000' strategic.  I am constantly having to switch modes in this regard, which is both dizzying and perfect for those with short attention spans.

Technorati Tag: entrepreneurship

Update / Professional

So last week I wrote that there would be two update blog posts during the week.  Well, the fact that it's taken me a bit longer than a week to get to this more work-oriented update out is an update in and of itself: I'm busy.  Especially in comparison to my previous firm.

I've contemplated the reasons for this, and believe they are the following (in order of importance):

1. Smaller investment professional team means fewer resources to do the work.
2. Dramatic increase in high quality deal flow.

Thought hard about (2) over the last 45 days, and so want to be careful about how I phrase the following.  I still believe strongly that there is tremendous potential in Texas, especially with regard to outstanding technical talent and a generally strong entrepreneurial spirit that is imbued in the culture (think Dell, Inc. or Southwest Airlines).  But the lack of real diversity among capital sources to support that entrepreneurial ecosystem ... essentially represents a drought that is preventing a true blooming from taking place.

What it comes down to, is that any given organization develops its own syntax, unwritten rules, jargon and shorthand, etc.  That is natural.  Dominant organizations influence the systems around them as much as they influence their members inside: outsiders may be unwilling to question or challenge what is effectively the status quo.  While this may be the correct decision from an immediate survival perspective to the individual or outsider, it is unlikely best for the larger ecosystem over the long run. 

With a process as challenging as picking the right teams / markets / solutions, and then nurturing those investments into large sustainable companies ... it is simply my opinion that there is more than one way to do this well.  Monopolies generally do not benefit consumers, and monopolies among capital sources similarly do not benefit entrepreneurs.

For example, here in Northern California, it is to the ecosystem's benefit that some VC firms emphasize people when evaluating potential investments, and others emphasize markets.  It is also to the ecosystem's benefit that an entrepreneur could utterly fail in her first startup, but know that there are several other firms who would be willing to give her a second chance (assuming she can demonstrate her ability to learn from mistakes.)  An entrepreneur could burn one set of bridges, and at least not find himself stranded on his own island.

Something as qualitative as chemistry or compatibility is impossible to define.  Organizations have their own unique chemistry or culture, as do individuals.  And it is inevitable that some organizations and some individuals will simply not click, just as two individuals may not connect nor may two organizations.  It is to the ecosystem's detriment if an individual must leave the ecosystem simply because he or she did not gel with a single organization and its naturally unique culture.  (And by "individual" I am decidedly not referring to myself, but rather thinking of any given entrepreneur.)

Fundamentally, an ecosystem's vibrancy in part is determined by its diversity.   I believe there is great potential for large entrepreneurial successes in Texas.  But I am also of the equally strong opinion that this vision will be unrealized until there is greater diversity among the capital sources (and by capital sources, I mean locally present, institutionally funded VC's).  I would love to be proven wrong on this second assertion, but so far the data only confirms my hypothesis.  Here are the 2007 Q1 IPO's of VC-backed companies, and note the companies' locations:

Accuray (Sunnyvale, CA)
Aruba Networks (Sunnyvale, CA)
BigBand Networks, Inc. (Redwood City, CA)
Glu Mobile (San Mateo, CA)
GSI Technology (Santa Clara, CA)
Mellanox Technologies Inc. (Santa Clara, CA)
Molecular Insight Pharmaceuticals (Cambridge, MA)
Oculus (Petaluma, CA)
Optimer Pharmaceuticals Corp. (San Diego, CA)
Salary.com (Waltham, MA)
SenoRx (Aliso Viejo, CA)
Sourcefire (Columbia, MD)
Switch & Data Facilities Co. (Tampa, FL)
Synta Pharmceuticals (Lexington, MA)
Xtent (Menlo Park, CA)

Of course, where there is a problem, there is an opportunity.  The good news is that there is truly an awesome opening here for the right institutional investors who have the vision and the risk tolerance to support new firms and new funds that address this drought issue.

Technorati Tags: venture capital, organizations, monopolies, ecosystem

Greetings from TED 2007

I know it's been a while since my last post ... trust me when I write that there are many things going on in my life at the moment which have created a To Do list whose item number is beyond count.  Will have more details about all that shortly.

In the meantime, I am in Monterey, California for TED 2007.  For those that may not recall, I was supposed to attend my first TED a year ago, when other events obviously prevented me from making it.  I was floored by the generous response that Chris Anderson and the TED team made at that time, and was overjoyed to be able to meet Chris in person last night at the Welcome Party and thank him directly. 

Summing up my first full day of TED is done as follows:

Coolest.

Conference.

Ever.

Personal highlights on Day One were:

• Carolyn Porco, who opened TED 2007 with astonishing images such as this one from the ongoing Cassini Mission.
• Singer, songwriter and guitarist (and to label him as just those three seems completely unfair given the range he demonstrated live) Raul Midon.
• The visual presentation of economic and standard of living (e.g., health, environment) data by Hans Rosling, some of which can be seen here.  As for the sword swallowing ...
• The Flight Patterns work of Aaron Koblin, on display as we took our seats in the Main Hall.

One criticism is the largesse and general excess of the TED Gift Bags.  And bag is not the right term here, as the schwag came in a large shopping bag and a suitcase.We are fortunate for all of the companies that want us to try their products and services, and Tom Rielly has clearly put in a great deal of effort to foster all of these relationships.  That being said, I wonder how many of these suitcases are going to end up in landfills, along with at least some of the content inside.  In the spirit of constructive feedback, my two cents would be to line up the gifts as a buffet, and allow TEDsters to move down a line, filling bags with the items that each is interested in.  Ideally, most TEDsters would bring their own bag for this exercise ... but for those that do not, bags would be provided of course.  And my faith in the goodness of human nature compels me to believe that each TEDster would know to take only one of each item ... but controls could easily be put in place if greed became an issue.  For those that are curious as to what could possible fill a suitcase, please check out the picture on my Flickr stream here, where additional pictures from the conference are posted.

As I told some colleagues and friends yesterday, TED 2007 is proving to be one of those experiences that inspires me to feel blessed and fortunate.  Fortunate to be invited, fortunate to be able to participate.  Mind expanding and life changing.

Technorati Tags: TED, TED2007, conferences, schwag

Enough to Move Me

I am not a huge video person ... part of that may stem from just never having been a television person, either growing up as a kid or later as an adult.  Honestly, between reality television and local network news and cable shopping channels, I just never felt like I was missing out.  But I do feel handicapped now when it comes to understanding video as a medium for content delivered through the Internet.

In any case, one of many good things about being inundated by business plans, startup pitches, and entrepreneur meetings is that when I step back to evaluate the general level of noise (an exercise I try to engage in on a weekly basis) ... there truly does exist a high threshold to help focus in on those ideas or people that warrant further diligence. 

It's clear even if it sounds banal: the idea, or the person, must move me.  For example, inspire me to download the software and spend more than thirty minutes on my own exploring it.  Entrepreneurs (and Limited Partners) may be surprised - or discouraged, even - by how infrequently the average venture capitalist actually does this.

The video above compelled me to finally establish a YouTube account.  (I know ... like I said, not a big video person.)  But this performance moved me.  How cool is this fingerstyle guitarist, Andy McKee?  Television is not completely dead yet: it was McKee's performance on tonight's Last Call with Carson Daly that drove me to YouTube; Daly mentioned something about two million views.  Turns out there are also over 17,000 ratings and 4,000 comments on this one video alone.  Many have apparently been moved.

Technorati Tags: YouTube, Andy McKee, fingerstyle guitar

Taking Portfolio Theory One Level Further

Peter Rip, a General Partner at Crosslink Capital, wrote a thought provoking post on his blog on Sunday.  The post was initially sent to me by one of my Partners, and I in turn distributed it to the fledgling community of B2C or consumer oriented tech entrepreneurs here in Austin.

(One of the most rewarding parts of my job is meeting the best and the brightest, and I especially enjoy the enthusiasm and energy of my generational peers or those even younger than I.  So I am doing what I can to make sure that all in Austin who are committed to building a landmark B2C or consumer oriented tech success story at least have the support of each other.)

My e-mail started a very interesting thread that reveals the perspectives of both an investor (or at least, an Entrepreneur in Residence ("EIR") type at a large (greater than $1B total Assets Under Management ("AUM") VC firm) and of a set of consumer oriented startup founders.  Struck me that a blog is really the more appropriate medium for a thread-type conversation, so with everyone's permission, am reposting the entire thread here.  Specific names and firms are mentioned only when the entrepreneur gave me his approval.  When I have time, I am going to add a Comment with my thoughts as well.  (Although this post's title should hint at what I think ...)

Original Piece: Fail Fast, Fail Often
link to original blog / post here

There was an article last week in the Wall Street Journal talking about an apparent change in the entrepreneurship/VC funding model.  Riya, Meebo, and others were cited as poster children for the new restraint.  The core idea was that entrepreneurs are taking advantage of the availability of capital to fund for long periods, often several years, rather than the traditional 12-18 months.  So why does this make sense? Why raise a bucket of money when a thimbleful will do?

The classic venture model has been to fund to milestones 12-18 months out.  In consumer web services, there are only two meaningful milestones --  (1) are you getting a lot of users and (2) have you figured out how to make money?  We use other metrics in other sectors (like management, product, etc.)  as proxies for real economic progress.  We also use them because (we believe) they would have residual value in an asset sale or merger.

None of this is true in consumer web services. You're either hot or not. Second place generally sucks.

The problem is that it is hard for entrepreneurs and VCs to know a priori if something is going to be a hit. The only way to know is to try, and trying takes time and money.  So here's the real rationale for what it makes sense for these companies to raise "a lot of money" and not blow it.  They have to run lots of experiments.

By now we are all well-acquainted with the observation that software is cheaper than ever to produce.  But that is only half the story.  The other half is that it takes several iterations -- several trials -- to hit it big.   

Imagine you have a low-burn consumer internet company and you think you can do your next build for $2M (offshore, open source, etc.)  Imagine further that there is a 1 in 20 chance that you could be the next [insert fantasy outcome here]. Angels are lining up with $2M in hand.  VCs are waving $5-20M checks at you.  Everyone says this is a $10M pre-money company and you own 50% today.

Assume you have a 5% chance of Being Big on the $2M raise, and a 95% chance of nothing.  The chance of Being Big if you raise $4M is 9.75% (1-.95*.95).  This is because you can iterate twice at 5% probability each.  The chance of Being Big after raising $20M is 40.1%.

Of course, each $2M has a dilution to you as the Founder. As the graph below illustrates for this hypothetical example, the risk-adjusted ownership (diluted ownership x probability of success) increases as you raise more money.  (This conclusion is not universally true in all situations.)   

The key to this thinking is to resist the temptation to spend like a lottery winner. Raising the big VC round isn't winning the lottery; it is the purchase of a deck of weekly lottery tickets.

This is how Munjal Shah described the move to Riya 2.0 in the WSJ article.  It was the realization that the first experiment, while a success by many measures, wasn't enough of a success relative to other options.

The larger-than-expected VC rounds in consumer internet deals are perfectly rational outcomes, for the entrepreneurs who understand the trials of consumer marketing.  Failure is baked into the calculus of the opportunity.  The key is to fail fast.  Set metrics ahead of time and be decisive. Because time is money -- literally.

Entrepreneurs who practice this discipline are just doing what VCs do every day.  Venture Capital is a hits business, too.  Companies often fail.  Time is money here, too.  Failure is part of the process.  We, too, are looking to fail fast and expect to fail often.  That's why funds are getting bigger, too.

Feedback From Austin Entrepreneurs and Investors
in chronological order

CEO/Founder of VC-Backed B2B (Consumer Oriented)

Great read, thanks for sending.

It is true that an entrepreneur gets few chances at the bat and that more capital helps them fail fast and recover with a new angle on the business.  The trick is that there are very few VCs that I know that will back companies in this way.  I wish there were more - but VCs are risk adverse and saying you are going to try 10 different business models with $15 million in funding won't fly.   If anything, it seems like some VCs are moving to seed models where they can test out a bunch of concepts without putting a lot of capital at risk.

How do you reconcile these two?

Consumer Oriented EIR at Large (>$1B AUM) VC

I’m fairly new to Austin and haven’t met all of you yet (actually, I think I’ve only met [Class V's author] and Ryan).

I completely agree it would be nearly impossible to raise $15M from VC’s on the premise of trying 10 different models. I think in part the VC community would see it as their job to handle diversification rather than the entrepreneur. That said, I hear often the VC business is all about banking on people and what bolder way to make that statement than to invest X million in an entrepreneur.

While I’m hopeful of getting my own startup going here in the near future, I’ve been fortunate to attend the [large VC firm] weekly partner meetings and see some of the world through their lens. I think giving an entrepreneur X million and letting him innovate wouldn’t work for them given the uncertainty of where it might end up. It could end up competing with an existing portfolio company. It could end up in an industry their limiteds don’t want them investing in. from what I’ve heard so far, the partners don’t seem overly distraught when they invest $250-$500K in a seed deal and it doesn’t work. That’s a sharp contrast to how VC’s feel when a Series A or B of millions doesn’t work. I infer from that (but haven’t got to witness it) that [large VC firm] would be fine with betting on an entrepreneur in $500K chunks and having some of them not work out – but only within the constraints of the seed financing model.

Ryan Pitylak, CEO/Founder of Excellent Suggestion

Thanks for sending this along!

This truly highlights the B2C investment dilemma for start-ups and VCs.  As both [Large VC EIR] and [CEO/Founder of VC-Backed B2B] mentioned, there is not a lot of experiment money floating around.  So, there is an expectation to have it all figured out beforehand or with the seed investment.  However, predicting consumer behavior patterns can be tricky.

I think an important question is:  Why do certain big angels and VCs invest big dollars to get it right?  Is it the team?  Is it the market?  Is it an expected repeat success from an adjacent market?  Is it the 5% who didn’t fail after the seed investment? 

Regardless, this is an interesting topic that directly affects every VC and entrepreneur in the B2C space.  Thanks for starting the dialog.

Jason Reneau, CEO/Founder of MindBites

I reconcile the two this way.  The media likes to glamorize startups and they do some crazy investing in California.  $19M for a photo site that then becomes a comparison shopping site???  Wow.  I want the guy who sold that deal.

Some VC's seem to have started looking at small seed rounds and I think its because a lot of early startups can get a beta up with a small amount of funding and they either don't want more, or the team isn't strong enough to warrant the big bet.  In general, though I think VCs are happy to leave the seed stage to Angels.  They have too much cash to invest and they'd rather wait and see what gets early traction.  In the end though, venture investing is like any high-risk investment -- take a portfolio approach with the smallest bet possible to get the option value for the big potential win.  Other high-risk industries like video games and movie studios, are like this, and Cisco followed this strategy in terms of acquiring winning network technologies as they emerged. 

Once you move away from the ridiculousness of raising $19M for a photo site that becomes a shopping comparison site, I think the key message are:
-  Determine how much $$$ you think you need and double it
-  Raise money like a visionary with the big plan to justify the cash
-  Implement like a bootstrap entrepreneur to make it last
-  Be ready to change directions and/or clamp down on spending if things start to go awry

In the words of one of my business school profs, no one wants to give you money when you really need it (and you will need it at some point). 

That all being said, if any of you would like to give me $19M on a say $50M pre, I'd consider it.

Thanks for the article.

CEO/Founder of a Consumer Oriented Online Business

Here's my attempt to reconcile the two based on my recent fundraising experiences:

There are two kinds of "seed/early stage/angel/first round" investments that seem to be going on right now:

#1 investments in companies with customer traction

#2 investments in proven entrepreneurs

#1 these are typically bootstrapped companies that figure out how to build a user base of raving fans and get customer traction (and pay their own way for product development and early sales)

#2 follow Peter's advice and get big early funding and fail carefully quickly so they can find success

The folks in group #2 are basically handed a set of lottery tickets to figure out the business and then execute.  The folks in group #1 are the lottery ticket.

So my take is that you CAN get an investment after you figure out how to build customer traction, get raving fans, have a defensible business, etc... BUT you're being paid to execute and scale.  Until that point the job is to get customers.  Which in a sense gives you infinite iterations to figure it out depending on your own patience, burn rate, savings, and spouse's tolerance.

So to me, this suggests there are two distinct early stage investing strategies at play:

#1 pick a portfolio of companies that are ready to scale

#2 pick a technician to manage experiments within certain boundaries

PS: In my opinion the drawback to all of this is that there are probably some worthy bootstrap companies that require funding to get sales channels that work, but cannot get funded because they lack customers because the sales channels that deliver the requisite CPA are cost prohibitive.

Consumer Oriented EIR at Large (>$1B AUM) VC

Profitability definitely isn’t the goal of a seed round. The goal is to prove out a few key milestones and then raise a Series A VC round. Charles River has recently formalized their seed process (publicly). As with [large VC firm], the goal of the seed is to prove out a handful of assumptions and then invest more $$. The way the larger funds are organized makes it difficult (impossible?) for them to invest a small amount (like a $500K seed) without a view towards a total investment of $5-$10 million. 

Technorati Tags: Peter Rip, venture captial, startup, seed funding, Austin

Another Sign of Trouble in VC Land

This article from the Sunday New York Times three days ago is frightening for any number of reasons.  With all due respect to the professionals mentioned in the article, I personally do not support this particular method of due diligence ... even though I do look at and invest in the areas of technology that the article refers to.  Should I feel that I am at a professional disadvantage because I am an investor who explores these kinds of technologies, and do not have children of my own to solicit opinions from?

Someone once gave me a piece of advice when I entered the field of venture capital a few years ago: do not invest in technologies that you do not already understand or are unwilling to make the effort to understand.  So, for example, I tend to stay away from areas like semiconductors or pharmaceuticals. 

On the other hand, emerging business models that at least partially rely on blogosphere marketing are of interest to me, so I have taken the time and effort to immerse myself fully into this particular channel through this blog.  I find constant invitations from LinkedIn (and its European based equivalent, XING) and MySpace annoying, but put up with them in the name of understanding the social phenomena associated with these kinds of networks.  I have not created a supplemental income through my existence on Second Life, yet was still a relative early member of that community just so I could explore virtual worlds.  It takes time, it takes effort ... but I just assumed that this is part of the reason our Limited Partners pay our management fee.

It's not that I am opposed to primary research.  In fact, I think methodical, statistically grounded primary research with regard to target demographics and market acceptance is powerful.  What frightens me is the anecdotal nature of the kind of primary research that the Times article refers to, and the obvious fact that children of venture capital partners represent an exceptionally narrow demographic.

Technorati Tags: venture capital, due diligence, social networking

Dark Days

Know it's been a while since I've posted.  (Sorry!)  Was in Colorado for almost a week (and brought the first major snowfall with me; see Flickr picture here), and it turned out that the month was otherwise quite busy on the work front.

I can never decide if switching back to Standard Time (from Daylight Savings) is a good or bad thing.  But on the subject of dark days, here is an article in today's New York Times that does an excellent job of describing to a layperson, why the current industry in which I work (venture capital) is such a tough one at the moment.

Technorati Tags: venture capital, IPO

Right Brain Musings

Been noodling on this thought for a while, but returning to my usual travel schedule and demands in the last month or two has reinforced the point: not enough money spent on design, too much spent on marketing to compensate for poor design.

Case in point: the Dell laptop fire in Japan in late June that was broadcast all over the world.  It's easy for me to pick on Dell, given my previous exposure to the company.  But if there were ever an example of a tech company not spending enough money up front on good product design, and then having to waste money reactively in PR and spin and marketing ...

In the last year, I've interacted with at least four different Internet or software startups who are struggling with market traction in part because of poor design issues.  The functionality is there ... but it is only readily apparent to the developers and quality testers who designed the product in the first place.  I already wrote once in this blog about my opinion that for the many strengths of open source development, that in several cases, UI (user interface) remains its' Achilles heel against broad adoption.  As I've thought about this topic more, I am of the opinion that the increasing dependence on outsourcing to reduce overall project costs has led to poor user interfaces as well.  (Several of my CTO and Lead Developer friends agree with this assertion, and this topic is probably worth an entirely separate post.)  Finally, as big a fan as I am of consumer generated media, there is no doubt that most of us are not expert in how to apply the Golden Ratio to aesthetic issues or know the last thing about Goethe's Zur Farbenlehre.

Along the lines of constructive criticism, I am not sure what the correct proportion of developers to UI experts should be in any given software project, but it strikes me that a denominator of zero is too small.

Why has the recent uptick in my travel schedule brought on these ramblings?  When contemplating whether something is worth packing (and hauling thousands of miles), I often favor those objects that are well designed, whether or not I am consciously aware of using such a criterion.  And from my MacBook Pro to my new travel ready tea and coffee filter to the functional aesthetics of the W hotel at which I am staying today, I am currently surrounded by good design.

Am in the Bay Area this week in part to attend the Always On Innovation Summit at Stanford, where I can see aesthetics and design are going to be heavily discussed, even if they are not in any of the panel topic titles.  Wanted to give a shout out to one of my favorite blogs, metacool.  I've always thought of Diego Rodriguez as one of those rare left brain / right brain geniuses, since we were assigned seat neighbors in graduate school, and he will be speaking at Always On.  Can't wait to hear what is on his mind.

Technorati Tags: design, user interface, metacool, AO2006

The Fallacy Of Lemmings

Though this may be no surprise to readers of an older generation, did you know that every major record label in Great Britain turned down The Beatles, when their manager was shopping their audition recordings in the early sixties? I was watching a documentary on Sir George Martin this evening, and was struck by his quote, "If I had known that every other label, including EMI itself, had turned them down, I probably would have too." (Martin's label, Parlophone - which had the vision to sign The Beatles in 1962 - was an operating subsidiary of EMI.)

On a completely different note, Martin offered that he thought the best song Paul McCartney ever wrote was "Here, There and Everywhere". According to Wikipedia, both Lennon and McCartney agreed with this assessment. Again, this may not be news to some, but was still a fascinating piece of trivia to me.

Technorati Tags: George Martin, Beatles, lemmings

Brilliant: Lewis Gordon Pugh

TV isn't my thing ... except for sports and HBO. So it should come as no surprise that one of my favorite shows is Real Sports with Bryant Gumbel. I am not a big fan of Bryant Gumbel himself, but I do love how the show's correspondents, such as Frank Deford or Bernard Goldberg, pull larger observations on society or life out of stories on "just" sports.

The current episode features a story by Goldberg on cold water, long distance swimmer Lewis Gordon Pugh. From Pugh's website: "[He] has pioneered more swims around famous landmarks than any other swimmer in history." These swims include the most northern and southern long distance swims, being the first person to swim around the Cape of Good Hope, and the longest polar swim.

"I never do the same swim twice, unless it is for training. The next swim must be harder and more challenging, otherwise I am going backwards," Pugh says.  "Sometimes we set boundaries for ourselves in life, or even worse, we allow others to do so.  In many cases, these boundaries are just in our mind and need to be pushed away."

At the end of the piece, Goldberg quoted Dave Wienbaum, who wrote, "The secret to a rich life is to have more beginnings than endings." I was struck not only by how obviously appropriate this is to my own personal life, but also, to entrepreneurship in general. Especially when the IPO market remains as dismal as it is. According to the NVCA and Venture Economics, only ten VC-backed companies raised $540.8 million (a minuscule amount) through IPO's in Q1 2006. Very cold water indeed.

Technorati Tags: Lewis Pugh, IPO