Dispatches From The Dark Side

Yahoo!-Tumblr: Not So Great for the NYC Tech Scene

For year's we've been hearing about how the ascendant tech startup scene in NYC is going to rival Silicon Valley's tech-hegemony.  It's a story the MSM has run with hard because, after all, NYC is the apex for the main-stream media and, who doesn't like rooting for the home team.  For those NYC cheerleaders (I'm talking to you Bloomberg and WSJ), Yahoo's purchase of Tumblr was solid confirmatory evidence of the momentum-shift they've been trumpeting.  Yet, while the acquisition was clearly a good thing for Tumblr's founder and early backers, it was at best OK and at worst a bad thing for NYC's quest to challenge Silicon Valley's tech-dominance.

The confluence of elements at the core of Silicon Valley's vibrant tech scene have been long discussed - fantastic universities, access to capital, and access to a strong startup support system.  NYC long had great universities and human capital (although not as much tech-DNA), but somewhat surprisingly for the financial center of the world, NYC just didn't have a strong startup funding culture.  To be clear, there is plenty of wealth to be invested in NYC - somewhat ironically there are 5-NY-Metro-Area hedge-fund titans who each made individually more in 2012 than the entire purchase price of Tumblr.  Lots of money, just not lots of it going to tech startups.  Another way to put it is that there are lots of billionaires, just no tech-billionaires.  In the last 10 years, at least the money side of the equation has been looking better for NYC.  According to the PWC/NVCA MoneyTree, NYC's share of venture investment dollars grew from 5.8% of the US total in Q1 2003 to 9.8% in Q1 2013.  NYC is taking venture investment share from other markets.  But it's not taking it from Silicon Valley.  Over that same period, Silicon Valley's share of US venture investment dollars went from 32.5% to 37.9%.

So what is NYC missing and in what alternate universe could the Tumblr acquisition be bad for the NYC tech ecosystem?  What Silicon Valley has in abundance that no other tech-center rivals is what I will refer to as the anchor-tenant companies.  Anchor-tenant companies are those that become large independent and growing tech leaders.  They continue to generate wealth; their alums continue to spawn new companies; and and they continue to buy interesting startups fueling the cycle.  There are tech giants in places other than Silicon Valley (Microsoft, Amazon, IBM), but no area rivals the valley for the sheer number of these tech titans.  Silicon Valley has them in every corner of tech and continues to create them.  Just since the tech bubble burst, we've added LinkedIn and Facebook (started post bubble) and Google and Salesforce (IPO post bubble) to name just a few.

This brings me back to Tumblr.  A great company and a great outcome.  But now that the music has stopped and Tumblrhas taken a chair, the company has stopped playing for the big leagues.  Tumblr may ultimately become as meaningful toYahoo as YouTube has become to Google as Yahoo CFO Ken Goldman implies, although I'm skeptical.  But even if it reaches that lofty status it will be bitter-sweet for the NYC tech community.  Because instead of having a large independent tech giant around which an ecosystem can flourish, NYC will have a large satellite division of a Silicon Valley based company.

The Silicon Valley Diaspora

I wrote the following piece after returning from a trip to India in 2004.  This is as urgent an issue for Silicon Valley and the competitiveness of the US Economy today as it was then.  While I wrote this about India, we need to be just as concerned about China and Eastern Europe.

February 23, 2004 

Silicon Valley is suffering a brain drain that is just going to keep getting worse.  Historically the valley has been the beneficiary of brain drains from around the world.  The diasporas of China, India, Russia, etc, all came to sunny California to start their companies and make their fortunes.  Companies like Juniper, Q-Logic, Exodus, and Silicon Labs are among the hundreds of companies that have generated billions in sales and wealth started by the best and brightest from around the world.  Now some of those great minds are packing up and heading home.

I spent the first week of February in India with a TiE delegation of other venture capitalists and TiE Charter members.  Everything you’ve heard about how exciting and dynamic things are in India today is true – if anything, it’s understated.  Politicians and labor unions who are expressing concern about US call center and SI jobs going to India are focusing their energies on the wrong problem.  The problem is not the inevitable transfer of certain business functions to where they can most efficiently be performed, but the migration of the entrepreneurs and experienced workers who create the companies (and the wealth) to their ancestral homelands.

We’ve all heard the stories about the quality of the Indian workforce.  They’re smart, they’re well educated, and yes, compared to engineers in Silicon Valley, they’ll work for peanuts.  But there are two critical pieces of human capital that India (and countries like it) lack that Silicon Valley has in spades.  The first is years of relevant experience – each new generation of technology building on the successes and failures of the one that came before it. The second is the high-tech entrepreneurs – the people who have worked in an industry for long enough to know how things are done and to know where the problems are that are worth solving.  But there’s nothing genetic that leads these shores to produce more entrepreneurs than anywhere else.

For the last 30+ years, the best and brightest from around the world came here.  They first came here to get educated.  That’s why the graduate programs at our top engineering schools are filled to overflowing with the best and brightest from India, China, Russia, and everywhere else around the world.  The world’s Diaspora came to the US to get educated.  And then once educated, they realized that the companies that would put all that good education to best use were companies right here in the good ole U-S of A.  If they happened to be in an area where companies are started as fast and furious as they are in Silicon Valley, they may have gotten the idea and tried to start one themselves.  They built up that critical experience and some even became one of our most treasured natural resources: the entrepreneur who innovates, creates jobs, and creates wealth.

Now some of those people are heading home.  So now those bright engineers who graduate from IIT with arguably the best engineering education in the world won’t be forced to reinvent the wheel.   They’ll have mentors who learned their trade through years of hard work in the valley and elsewhere.  And some of those that head back will be the entrepreneurs with the ideas and the initiative to start high-tech companies that are ready to compete on a global scale.

We now have our own Silicon Valley Diaspora to moan about - the best and the brightest leaving these shores for bigger and better opportunities elsewhere. So watch out.  While the first wave of Indian high-tech startups was dominated by call-center and IT outsourcing firms, the next wave is likely to be dominated by software and hardware companies that build their entire companies – not just their call-centers and back-office – somewhere other than Silicon Valley.

The JOBS Act Is Good, But SarbOx Shouldn't Get All The Blame

The JOBS Act is a good thing for Silicon Valley and the whole startup ecosystem.  Josh Kopelman is correct when he points out that IPO's over the last 10 years have happened later in companies' development than was previously the case and this has taken from public market investors the opportunity for tremendous value creation.  Dan Primack also makes a valid point that VC's have three options for exiting their portfolios: sell them, take them public, or shut them down.  But making SarbOx the sole scapegoat for why IPO activity has been anemic since 2000 is just as wrong as claiming it's the savior that has kept the public markets from suffering losses from failed companies that manage to go public.  Like @pkedrosky, I still believe Groupon will end up with gnashing of teeth and tears for investors of all stripes.

It's an oversimplification to blame the IPO market of the 2000's on SarbOx.  To understand the market during this period, you have to first remember what happened before it.  Anyone who was a part of the startup ecosystem during the bubble was, at least up until now, permanently formed by their experience.  It's like my grandfather, a child of the great depression, who 60 years later was still untrusting of banks and more frugal than anyone 10 years his junior.  The memories of public market investors aren't quite as long, but the hangover from the crash certainly lasted well into the 2000's.  When you think of how high the bar was for tech companies to go public post the bubble, just remember how big Google was when they finally went public – they were almost $1B in revenue in the fiscal year before their IPO.  A size that was completely unheard of in the venture-backed IPO world prior to Google.  In fact, the year that SarbOx passed, Google's revenue was $348m – a number that was well beyond what was needed to go public for any venture backed tech company up until that time.

At the time of Google's IPO, many were hopeful that it would usher in a new era of venture-backed IPO's.  Sadly, it did not.  And while the hangover was partially to blame, and SarbOx played a role, there was more to it than that.  Three other major transformations of the landscape, both before and after the bubble, have helped to make early venture-backed-IPO's more than a little challenging.

The first of those challenges was the "death" of the Four Horsemen.  During the 80's and early 90's, the bulk of venture-backed IPO's were done by four west-coast boutique investment banks – Robertson Stephens, Alex Brown, Hambrecht & Quist, and Montgomery Securities.  These banks made a great business out of doing smaller IPO's and the then denizens of Sandhill Road didn't see using them, versus a bulge-bracket firm, as a sign of weakness.  The late 90's changed all that with the larger IPO's that were able to get done during the bubble.  Once the fees got bigger, the bulge-bracket firms swooped in.  As they did, it became a badge of honor to have a bulge-bracket firm lead your IPO squeezing out the boutiques.  Over time, the Four Horsemen were all bought and no boutique-banks have managed to fully take their place – at least not to the extent that the Denizens of Sandhill road will allow them to lead their companies' IPOs.

The next two challenges were more structural changes to the market.  The first of those was the Global Settlement between Elliot Spitzer and the 10 largest investment banks, a topic Henry Blodget is all-too familiar with.  In an attempt to remove the inherent conflicts of interest that existed between investment banking and research at these firms, they managed to throw the baby out with the bath-water. What small IPO's need is marketing, and research is marketing.  If you try to take a company out and no one is talking about it, no one will trade it.  That tends to tilt the field towards companies going public only after they have become household names which usually implies much larger companies.

 The last nail in the coffin (not necessarily in chronological order) of smaller venture-backed IPOs was decimalization.  In late 2000, the NYSE started to move from trading in 8th's to trading based on decimals.  The biggest impact of this was on the spread between the bid and the ask.  If you're trading in 8ths, the spread scale can be 12.5 cents at a minimum and go up from there and when you trade in decimals, the spread between the bid and the ask can be as little as a penny.  Market makers, the guys who keep a stock trading, make their money on the spread between the bid and the ask.  And when that spread is squeezed, they make less money.  This is all good and well for a company like Apple who trades upwards of 20m shares a day, but for a small-cap stock that trades <100k shares a day, what they really need are market makers.  And if you can't make money on the spread, who wants to make a market in the stock.

 There's a lot there, and I'm sure there are other subtle changes in the market and landscape that I've missed. But on the bright side, we're finally getting over the hangover and the JOBS Act may have come along right at the perfect time.  There are more and more players every day who got into the game after the bubble.  What we need now is for a few of them to take their companies public early and be successful for public market investors.  Once that happens, all these challenges will wash away and we'll have a healthy venture-backed IPO market again.

 

Bubble 1.0 -v- Bubble 2.0

While there certainly are some frothy valuations in certain parts of techdom, it's difficult to call it a bubble -­ at least not when compared to the Internet Bubble.  The Bubble 1.0 tide rose all boats.  It didn't matter what sector you were in, if you put “.com" at the end of your name, you immediately achieved valuations that you wouldn't have imagined in your wildest dreams.  It didn't matter if you were selling low margin products like aspirin or pet-food; Dot-Com-it and you were a darling.  Bubble 1.0 was also characterized by an obscenely large amount of venture capital.  At the height of the Dot­Com mania in 1999, venture firms invested $100B. As a result of this flood of investment dollars, every good idea had 10 well-funded companies chasing it.

As has been often pointed out, a large portion of Bubble 1.0 companies didn't even have business models.  They were valued on such esoteric metrics as eyeballs, clicks, or page-views.  For the few who actually sold things and generated revenue, their values seemingly were higher the more money they lost, as long as they could spin a story about how losing even more money allowed them to grow faster.  I remember well a conversation I had at the time with Pat Connolly, the CMO of Williams-Sonoma who was bemoaning the fact that Wall Street measured him on boring things like gross-margins and profits, but all of his startup competitors weren't held to the same standard.

Finally, during Bubble 1.0, public market valuations were bubblelicious even for large non-Dot-Com companies.  Cisco, Microsoft, and Oracle had P/E ratios of 150+, 78 and 120 respectively (I can't say how high Cisco actually was because my reference source stops at 150!).  Even GE, hardly a fast growing tech company, sported a PE north of 45.  For large-cap companies, those are impressive valuations indeed.

Fast forward to the "Bubble" many commentators are claiming we're now in, Bubble 2.0.  By virtually any measure, if you use Bubble 1.0 as your yardstick, we're not in anything close to a Bubble.

 The primary argument that is being made for a new bubble are the fantastic valuations that the big 5 ­(Facebook, Twitter, Groupon, Zynga, and LinkedIn) ­are getting on the secondary market.  In these markets, buyers and sellers don't have access to the same information.  For most of the buyers, it is a momentum bet on the assumption of the existence of a greater fool.  That said, unlike the last time, with the exception of Twitter, these darlings all have business models that are generating tremendous revenue growth and, if the buzz is to be believed, are incredibly profitable.  We'll see when their numbers all become public whether these secondary market buyers were all "greater fools" or savvy trend pickers.

Go beyond those 5 and the signs of a bubble are pretty weak.  Starting with the amount of money that venture firms are investing, today it is fully 1/5th of what it was the last time,­ a "mere" $20B. As a result, there aren't 10 well-funded companies chasing every great idea. What about all the "super-angels" you ask?  They certainly make getting capital to start a company much easier, but once the company starts growing, in all but the rarest of cases, it still needs capital to grow. With less venture capital going in, there are fewer competitors with the capital to effectively scale their businesses.

Aren't VCs paying crazy valuations again?­  What about FourSquare's rumored $400m valuation, or Quora's rumored $85m valuation for their first round when they had just a few people and an idea.  Heady valuations for sure, and not having been a part of the partner discussions when those decisions were made, I don't know what arguments used to justify them - but I can guess. Heady valuations for "Hot" and "Darling" companies are nothing new in Silicon Valley.  And sometimes they even pay off.  Google was a "hot" company with a seemingly outlandish valuation at the time and that seemed to work out just fine for everyone.  There are always a few companies that, based on the charisma or track record of the founders or some particular set of stars aligning correctly get fantastic valuations.  There are always the exceptional startups that generate the exceptional venture valuations.  As I discussed previously, this sort of exceptional valuation is far from a guarantee of investment success.

Finally, look at public market comparables: they aren't even close to flashing red, I don't think they are even yellow.  Back to the big three last time around and their average P/E, today the three highest profile public tech companies (who also happen to be the largest by market cap) are Apple, Google, and Microsoft, which together have an average PE ratio of 17.6.  Far, far below the levels reached during Bubble 1.0.

Silicon Valley has been built on a series of major innovation waves.  With each new wave comes some new mega-winners.  We're in the opening stages of waves in social-media, hand-held computing, the consumerization of IT, Infrastructure 2.0, and the move of many IT functions and services to the Cloud.  We haven't even scratched the surface of these opportunities so it seems a bit premature to be calling it a bubble.  So for all those people paralyzed in fear of a Bubble, stop being a Chicken-Little and go out there and innovate!

Legacy Will Kill You

I previously wrote about how having fewer resources was actually a benefit that startups have over their larger entrenched competitors because it forces them to do fewer things better - to focus. Another counter-intuitive benefit that startups have over large companies is their lack of existing customers. Not having an installed base frees a startup of the burdens of supporting old products and enables them to focus all of their resources on new innovation.

Sometime in the year before EqualLogic sold to Dell, Paula Long, the co-founder and VP of Product Development, presented to the Board a very sobering projection of where our precious product development resources were going.  Two years before, when we only had hundreds of customers, we dedicated well over 90% of our product development resources to new features and only ~10% to supporting the base.  At the time of the presentation, we had grown from 100's of customers to 1,000's of customers and our ratio of new features to support went from 90/10 to close to 50/50.  But what was truly sobering was her forecast for the future.  Just a couple of years out, nearly 90% of our product development resources would be focused on supporting the base.  It's no wonder we were able to sneak-up on the big-boys of the storage world and create the market-leader in iSCSI.  They were too busy supporting their base to effectively go after the opportunity.

It's not just with product development, legacy can have a detrimental impact on almost every part of a business from go-to-market to the core business model - name a successful enterprise SW business that is also a leader in SaaS.  When I was in marketing at Apple early in my career, one of the constant debates about opening up new channels of distribution was about the problems of channel conflict with our then existing "legacy" channel partners.

This challenge is something every successful organization goes through - Paula Long referred to it as our "success-tax" at EqualLogic.  If not actively managed, the very things that make a company successful can be the achilles heal that hobbles it's growth later.  Most disruptive innovations are made possible because incumbents, like EMC and NetApp in the case of EqualLogic, spend all their time on servicing their legacy customers, updating their legacy products, and supporting their legacy partners.  This leaves the door open for startups to put their foot in, but startups need to make sure they aren't making decisions that will hamstring them and burden them with premature legacy.  

Rarely does the life of a startup travel along a straight path.  With most of the opportunities a startup faces, come a set of tradeoffs, some obvious, and some not so much so.  These tradeoffs need to be weighed carefully and not taken lightly.  The no-brainer decision today - "They're paying us $X and it will only cost us half that to deliver." - could end up having tremendous legacy costs down the road.  One of the ways I evaluate how good startups are at focusing their limited resources is by hearing how they weigh the tradeoffs they see in some of these decisions.  If they truly understand the opportunity costs associated with a particular decision they have made, then that will be evident in their discussion of it and in how they worked to minimize those costs.  If they don't understand the opportunity cost associated with a decision, then chances are they have made plenty of other decisions like it and all of those decisions are setting the boat-anchor of legacy that the company will be paying the price of for years to come.

 

 

 

Forget About Being a Lean Startup, Focus on Building a Lean Company

Much has been written about building lean startups.  It's certainly possible today for many startups to get to a minimum viable product and early customer validation with a lot less than was possible 10 or even 5 years ago.  But ultimately if you want to build a significant company versus having a flash-in-the-pan that you sell quickly, it takes time, work, and more than a few people.  All of these resources take money.  

The world has changed for many an aspiring entrepreneur.  No longer do they have the largest market in the world to themselves.  With the secret out, Silicon Valley entrepreneurs now have to compete against extremely capital efficient startups from the many other "Silicon Valleys" around the world.  They also have to contend with a significantly higher cost of capital driven in part by the shrinking amount of capital being committed to venture firms.  Simply put, there are too many companies chasing too few venture dollars.  It's no longer good enough to be just a lean-startup.  To be globally competitive, and confident you can raise the capital you need to grow, Silicon Valley entrepreneurs need to focus on building lean companies.

Thankfully the rise of the social internet, globally ubiquitous broadband, and the always-connectedness provided in the new era of smartphones is enabling many Silicon Valley startups to start with the necessary foundation to grow into lean companies.  Collectively these advances minimize the importance of geographic proximity in establishing, building and sustaining relationships that are at the center of any business.  These virtual and remote interactions don't provide the same level of high-bandwidth communication that face-to-face interactions do.  But the disruptive innovation they provide is giving an important edge to a new generation of leading-edge startups.

The Rise of the Social Internet: In Silicon Valley, businesses are started and built on relationships.  Startups are famously a relationship business going all the way back to the Fairchild Eight.  Like the Fairchild Eight, many a Silicon Valley company was started by a small group of engineers who worked together at a previous company.  With the rise of the social internet, more and more people are comfortable building and sustaining these types of relationships virtually.  When I talk to young entrepreneurs, the people they describe as their friends, co-workers, and partners can just as easily be someone they met and developed a relationship with online.  We are already seeing teams assembled in this way.  More than one company has come in whose initial product architect was someone the entrepreneur "met" through his or her contributions to an open-source project at the core of their offering.  The fact that he or she happens to live and work in another country is largely irrelevant.

Globabally Ubiquitous Broadband: Much of the innovation in Silicon Valley has been created by small teams working on crazy ideas in very close quarters.  This type of environment facilitates "high-bandwidth" communication between team members which is necessary to enable a startup to get a minimum viable product to market as quickly as possible.  Ten years ago startups began dipping their toe in the water with outsourcing.  For the most part, this was through contracting with or hiring entire teams that were located in a single remote location.  Co-located teams were necessary because the only way to get the desired level of "high-bandwidth" interaction was to have the team members sit side-by-side.  Over the last 5 years, services like oDesk have taken advantage of the myriad of communications technologies enabled by globally ubiquitous broadband to enable "high-bandwidth" communications to individual remote end-points.  This has allowed startups to build and manage remote teams where each member of the team can be in a different location.  Today it is quite common for me to meet with a startup team that has a couple of local people and 5-10 people on their remote team from around the country or around the world.

The Age of the Smartphone:  Finally, in the age of smartphones we are all always connected.  This means we can have "water-cooler" conversations with our co-workers at any time.  We can exchange ideas, thoughts, questions, or opinions from anywhere.  With smartphones and other similar mobile computing/communications tools our work is untethered to a physical desk and less impacted by timezones.

These disruptive innovations promise to change the way organizations are built.  We are seeing that change already happening among the startups we meet with regularly.  They realize that for many of them, the cost of capital is too high to fund a startup team of 20 - 30 people in Silicon Valley.  This means fewer Silicon Valley located jobs in the short term.  But in the long term, being  more capital efficient and globally competitive will enable these "lean companies" to become the next generation of locally based global-market leaders - the HP's, Apple's, Oracle's, Cisco's, Google's and Intel's - that are at the heart of Silicon Valley.

How Glee Reminds Me of Silicon Valley

Glory days well they'll pass you by
Glory days in the wink of a young girl's eye
Glory days, glory days

OK, I admit it, I'm a HUGE Glee fan.  There.  Now I've said it.  I'm officially out of the closet.  I've always been a bit of a geek, so the transition to being a Gleek has been a natural one for me.  My wife, who unlike me actually can sing, is always having to shush me as I sing along.

The show's portrayal of the trials and tribulations of high school certainly resonates with the former high-school geek in me.  The "in-crowd" of cheerleaders and jocks, while a bit over-the-top in their depiction, shares traits with every other in-crowd you weren't in that you can remember from high school.

How can this possibly remind me of Silicon Valley?  Well in the 18 years I've been a part of the startup scene in Silicon Valley I've seen a lot of startup classes come through.  And like the makeup of your high school class, there's the startup "in-crowd" and everyone else.  Lots of entrepreneurs aspire to be recognized as a part of the "in-crowd".  To be a Techcrunch darling; to be on stage with Walt Mossberg at D; to have venture capitalists calling you regularly to find out how they can get in to your next round.  Who wouldn't.  The failure comes when you confuse being popular with being successful.

Think back to the in-crowd when you were in high school.  How many of them are successful now?  A few, certainly not all.  Now think of the rest of your class, how many of them were successful?  Again, a few, but not all.  The percentage of people who are now successful in each group is probably similar, but you never would have imagined that would be the case when you were in high school.

I've witnessed a similar dynamic in the different classes of startups I've seen in Silicon Valley.  For every Google (a high flyer from the beginning), there's an eBay (not a high-flyer until they had the numbers).  There are plenty of examples of companies that were fixtures of the in-crowd that vanished - remember Pointcast anyone?  Friendster?

To be sure, being high-profile can have it's advantages and for some companies, it may even be a necessary prerequisite at some point along the way.  It can certainly be helpful if you're marketing directly to consumers.  But it's not the end-game and courting lots of attention, especially when you're not yet ready for it, can have dire consequences. 

So if you're a part of the startup "in-crowd", enjoy.  Make the most of the free PR.  But don't lose sight of your true goal which is building a valuable and sustainable business.  And if you're an outsider, don't sweat it.  Relish your outsiderness and use the time flying below the radar to build a solid foundation for your business.  If you focus on that and get it right, your glory days will be in front of you and you'll be the center of the in-crowd that everyone wants to join.  Trust me, there's no better entry into the real cool kids club than a successful IPO.

Just sitting back trying to recapture
a little of the glory of, well time slips away
and leaves you with nothing mister but
boring stories of glory days

Don't Drop the G-Bomb

One of the classic venture pitch mistakes is overselling.  Overselling your idea can take many forms, but one of the more humorous occurs when the entrepreneur shows you a set of projections that are wildly optimistic and then drops the G-Bomb as a way to claim that the projections are actually quite realistic bordering on being conservative.  The entrepreneur will usually say something like:  "Our business has many similarities to Google, so we took an X% discount to their growth rate and plugged it in to our model.  We were conservative in taking the discount so we think our model is actually conservative."  Really?  And you're going to build your plan around that?

I've had the G-Bomb dropped in relation to startups doing ad-networks, the semantic web, and vertical search when that was all the rage.  Today I'm seeing a switch to entrepreneurs using the F-Bomb for startups in the social networking or social shopping markets.  Unless you're already at a point where you are seeing never-before-seen leading indicators, don't do it.  And even if you are seeing something special, remember, a venture capitalist's job is to connect the dots and your job is to bring them close together.  Putting wildly optimistic projections into your plan doesn't help me connect the dots to an enormous outcome, it causes me to question whether your feet are planted firmly on the ground or not.

Every few years Silicon Valley mints one of those iconic companies that defines a category and rides a growth trajectory that has never been seen before.  It's part of what makes the valley so great.  It's a great thing to believe that your startup has that potential.  But there is a big difference between selling the dream and setting a realistic and achievable plan for your startup.  If you build a culture around lofty unachievable expectations then you're going to have a very difficult time making it through the ugly adolescence that most good companies go through.

I'd Rather Be Lucky Than Smart Any Day

In a comment to my recent post on Focus, Ray Hood pointed out that VCs often overlook the importance of luck, chance, and serendipity in favor of a belief that everything is formulaic.  I violently agree with Ray but I also violently disagree.

As I mentioned in my response to his comment, I am a huge fan of Nassim Nicholas Taleb's books - The Black Swan and Fooled by Randomness.  In Fooled by Randomness, NNT expounds at great length on how often times people confuse the fact that they have been lucky with a belief that they are really just smarter than everyone else.  As he says, randomness plays a much bigger role in how successful you can be at some professions than others.  For example, the degree of success of a nurse or a doctor has much less to do with randomness than say that of a venture capitalist (his example).  It's difficult to argue with luck playing a part in the magnitude of any win.  Anyone who was a part of the startup scene during the bubble knows well that there were many >$1B exits that in any other market may not have been able to make any money at all.

But luck isn't an investment strategy and it isn't a viable strategy for building your business either.  Despite the popular perception, venture capitalists by and large are not in the business of buying lottery tickets.  What venture capitalists do, at least the good ones, is invest in great people who have a vision and a plan and then work with them to turn their vision (through it's many iterations) into a success.  I've been on a mission to try and understand who are the great investors in the venture business and what traits or characteristics, if any, they share.  Through that quest I was able to unearth a pretty interesting statistic.  Out of a sample of more than 900 General Partners who had each been in the business for more than 10 years, for those who had generated more than a 3X return, fully 1/3rd of their investments managed to generate more than a 3X return.  That's not luck.  That's good investing and a great batting average.

I'm sure I can find a similar statistic on successful repeat entrepreneurs.  The great ones follow a similar playbook and focus on execution.  They don't build their plans based on being lucky, but they are smart enough and experienced enough to know when a lucky break comes their way and to take advantage of it.  Surely luck can play a significant role in the magnitude of an outcome, but whether or not they have built the necessary foundation for success is based more on 3-yards in a cloud of dust than on throwing a Hail Mary.  Forest Gump type successes happen from time to time, but again, that's buying a lottery ticket which I can do at any local service station.

So while I'd rather be lucky than smart any day, I prefer to rely on smarts and hard-work over luck.  I know I can count on the former and I love it when I have the opportunity to take advantage of the latter.

Focus, Focus, Focus!

One of the biggest advantages startups have over larger, more established companies, is that their inherent lack of resources forces them to do fewer things - to focus.  Focus is important for all companies, but while a lack of focus in an established company can slow growth and lower returns, inability to focus in a small company will kill it.  I've seen more companies die from indigestion than starvation.

Being focused isn't just the best way to maximize your chances for success, it also happens to be critical when you're pitching venture capitalists.  It's difficult for a venture capitalist to connect the dots when they are scattered all over the place.

I've had some variant of the focus conversation, usually more than once, with every company I've been involved with, whether as an angel investor, an advisor, or a venture investor.  It's not necessarily a bad thing to have to remind an entrepreneur to focus - in my experience, one of the hallmarks of a really good idea is that you always have more directions you can take it than you have time and resources to pursue.  The key is figuring out what of your available options you are going to do, and more importantly what you are NOT going to do and then run like hell.

Focus permeates every function of a company, but it starts with product-market fit and determining the minimum viable product.  Much has been written about these concepts, and while they are related, they are not the same thing.  Product/market fit implies something about the customer you are targeting.  It's easy to understand that the needs of a Global 2000 customer, and therefore, the minimum viable product you'd have to deliver to service them, are going to be different from the needs of an SMB customer - although I have had companies argue they can do both.  Where it gets tricky is when you have what seems like the same type of customer, Global 2000 for instance, asking for the same solution delivered in a different way.  One wants it delivered as a service and another wants to license it and run it themselves.  While your solution may have found a product-market fit, the minimum viable product for those customers is different - pick one.  A seemingly innocuous decision to "take the money" and serve both today has a compounding impact on every aspect of your product development, delivery, and go to market.  You'll pay dearly for it later in your inability to innovate as quickly as necessary to stay competitive. 

But what if the option I choose isn't the optimal among my choices?  I need to keep several options open just in case I chose wrong or one of the alternate paths "pops."  Typical.  Keeping multiple options open is self defeating.  While you think you're hedging, you're actually not doing justice to either alternative thereby dooming both.  If you do come to the very difficult conclusion that you need to pivot, you need to do so with conviction and run like hell down your newly chosen path.  Straddling two camps is a surefire way to rip your company apart.

Focus, focus, focus.  Repetition doesn't spoil the prayer.