Startups and angels: Along the way to success

Plan B Strikes Again - The Value of Angel Groups

It's axiomatic that no matter how well planned, almost every startup needs a "plan B" because what it started out to do isn't what the opportunity turns out to be.  The software company I was involved in - RTMS - started as a consulting and services business, for example.

Well it happened last week at our angel group meeting.  I think this story highlights the value of angel groups.  A presenter of a medical device, well prepared, and well qualified, thought that the opportunity for the medical device was, well, in medicine.

It was a small market but interesting from an investment perspective.  Late into the meeting a member, who is in the manufacturing business, asked a question about capabilities of the product - and things got exciting.

Turns out our member is an industry expert on this kind of non-medical use and saw an enormous industrial opportunity.  It's a chance to be a first mover -- and faster to market since there is no need for regulatory approval.

If the entrepreneur hadn't met these folks, he may never have found "Plan B" - or at least not nearly as quickly and at a time when success here changes everything for the growth of the enterprise. 

He only got this opportunity to present because he was really well prepared, knew his science, and had a ton of credibility.  And without the group, he might've taken investment money from an uninformed source and spent a long time not seeing Plan B.

More About Testing

Here are Greg Gianforte's answers - and comments - to his test for bootstrap ability:

1-B; 2-D; 3-B; 4-B; 5-B or C; 6-B; 7-B; 8-A; 9-D (involved includes spouse, accountant, printer, lawyer, insurance agent and yourself) 10-C (and enjoy it!)

Score yourself:

0 - Bureaucrat.  Run for public office.

1-3  Junior bureaucrat.  Go to work for a government entity.

4-6  Find a big company and call it home.

7-9 You can work in a startup.

10 - Bootstrapper.

Test Your Bootstrap Ability

This quiz was written by Greg Gianforte, founder of RightNow Technologies.  It's a great way to think about your innate startup skills. 

1.  What should you do first?

    a.  Write a business plan and then try to raise money
    b.  Call lots of people to understand the issues in your market;
    c.  Develop a prototype of your product idea;
    d.  Hire a marketing consultant

2.  You have an idea.  What next?

    a.  Implement the business plan;
    b.  Rent office space and buy used furniture;
    c.  File for a patent;
    d.  Fax or email your idea to 300 people and then call them.

3.  You have a good product.  Next?

    a.  Find a good lawyer to protect your idea.
    b.  Build a prototype and you personally start selling.
    c.  Try to raise money.
    d.  Hire a salesperson to sell your product.

4.  You find a prospect.  Next?

    a.  Explain that you would like to have them join your beta test program.
    b.  Try to get them to place an order;
    c.  Tell them you don't have the product available yet;
    d.  Tell them about all of the features you are going to add to the product.

5.  Your product does not do everything a prospect wants.  You should?

    a.  Tell them it won't do those things;
    b.  Get them to pay for the enhancements;
    c. Take the order and tell them it will ship in four weeks;
    d.  Explain why those things are difficult to do and convince them to buy the     current product.

6.  A major publication calls, saying they are writing a big article about your product and they want you to buy an ad in the same issue of their magazine.  You have enough money for the ad, but not much more.  You should:

    a.  Buy the ad;
    b.  Tell them your advertising budget is already committed;
    c.  Tell them you don't have enough money;
    d.  Tell them to get lost.

7.  You are still getting started and Dun & Bradstreet is asking for company info and detailed financial data.  You should:

    a.  Give them the information;
    b.  Politely decline;
    c.  Refer them to your accountant;
    d.  Don't return their call.

8.  A major prospect says they want to fly out and visit you, but you are still working out of your house.  You should:

    a.  Tell them you are just getting started and don't have an office that will         accommodate a visit;
    b.  Rent office space prior to the visit and get your family and friends to             occupy all the desks;
    c.  Tell them you will be traveling the same week they want to visit;
    d.  Borrow your accountant's office and hang your shingle over theirs the day     of the visit.

9  You are the only person working fulltime in the business and you are asked how many employees you have.  Tell them:

    a.  50
    b.  20
    c.  just me
    d.  We have five people involved in the business.

10.  You have just made your first sale and generated your first monthly profit.  You should:

    a.  Give yourself a raise;
    b.  Get a bigger office;
    c.  Throw a party;
    d.  Hire a consultant.

The challenge of these kinds of things is to really try and work out answers - so I will wait until later in the week to post Greg's.

Our View of Deal Flow

...on video from the series on "due diligence" by the Kauffman foundation.  Deal Flow Video.

Dealing with Attorneys and Legal Advice

In the process of starting and growing ventures, everyone deals with attorneys across a wide spectrum of issues.  Depending the business, these range from incorporations to investment documents, operating agreements, intellectual property issues, and many others. 

The whole concept of the rule of law goes back at least to the Roman Republic.  In many ways it is the foundation of civil society, and much older than relatively new ideas like organized business entities. 

I point this out only to underline the fact that the idea of legal advice and structuring is centrally important to what we do as entrepreneurs.

The lawyer's job is to protect his client first and foremost.  It is not to enhance the business prospects, unless this happens as a byproduct of protecting the client's interest.  This is an excellent point of view for your attorney to have. 

What's critical, though, is for the entrepreneur to understand the process and to manage and direct it as the person in charge.  In lots of ways this is not a doctor-patient relationship in which the patient is in a subordinate position.  If you feel that way about your legal advisers, it is time to have a candid conversation with them.

Attorneys are only as good as the people that employ them.  Here are a couple of thoughts:

1.  Be certain to drill down on advice that seems to be the conclusion of a train of thought, but where you have not heard or understood "how we got from here to there."  I've sen an IP case recently where the advice to the client was largely to miss substantial market opportunities while waiting for a patent process.  When the entrepreneur drilled down, he found there were alternatives that accomplished much the same protection without losing the opportunity.  Yes, the alternatives carried some risk - but not much - and missing the market is an unattractive idea.

2.  When structuring, be certain you - the entrepreneur - understand the tax implications and future limitations you place on yourself in the choices around how you set up your company.  If you start a venture with five parts, and later plan to divide them into separate companies, for instance, make sure you have a clear view of the future hurdles you'll face.

3.  Ask about size.  Some structures fit companies until they grow to a certain size and then have less value.  Others are the opposite.  Understand which is which and where you might fit.

4.  Get the facts and weigh the alternatives yourself.  I saw a deal the other day that I, frankly, didn't think was fundable.  The solo entrepreneur told me, however, that he had received a termsheet from an angel I knew but that his lawyer had advised him to walk away because the lawyer thought "they could get a lot better terms" elsewhere.  I urged him to understand what that meant, (He didn't know) and sit down and talk to the angel directly about what might be negotiable.  It isn't the lawyer's place to be making those kinds of recommendations, unless the lawyer is going to invest himself.

5.  NEVER let lawyers negotiate on your behalf with potential partners or the other side's lawyers.  Do all of that yourself with your business advisers, draft the terms in plain English, and ask the lawyers to prepare the documents.  There's nothing wrong with asking lawyers for their advice to you as you negotiate a deal, but don't let them do it.  Their role is only to protect you, not to reach an agreement.

6.  Make your lawyer walk you through a draft before you give it to someone else.  Again, you have to make sure that a new term, concept, or subtlety has not been inserted that you didn't expect, understand, or agree to. 

The whole idea here is that your lawyers will be happier with you if you always seek to understand the underlying thoughts, ideas and principles.  In addition, if you creatively explore alternatives and "what if" scenarios from your unique entrepreneurial perspective, you will add a lot of value to their work.

You'll be well protected - and successful.  A nice combination.

The Sound of One Hand Clapping

The sound of one hand clapping:

1.  Telling a customer you are busy--when you aren't
2.  Telling a VC you have another term sheet -- when you don't
3.  Telling an investor the round is 80% subscribed -- when it isn't
4.  Telling a potential business partner you are close to signing with his competitor -- when you aren't
5.  Telling an acquirer you have another offer -- when you don't.

Real Applause ("Bualadh Bos" in Irish, in case you wanted to know) sounds like this:

1.  Being busy and prioritizing work based on customer criteria -- and raising prices
2.  Having two termsheets and politely discussing the situation with each VC to seek not only the best terms but also the best relationship.
3.  Having a round oversubscribed and allocating fairly to all participants.
4.  Having a choice between two partner opportunities and working with each to understand the mutual benefits in each deal.
5.  Having a choice between two acquirers and working to keep each party fully informed.

The difference is not just integrity.  The sound of one hand clapping always carries with it the potential for disasterous results, based on the lack of a real alternative in a critical situation.  It is possible, I suppose, to cross a freeway blindfolded, but even if you've done it, it's a bad habit.

But, if you have worked hard to generate alternatives, then you are doing a great job leading your venture.  And, in most cases, everyone will applaud your diligence and integrity in each of these situations.    This is obviously a lot better than trying a shortcut based on illusion. 

And, if you cannot generate appropriate interest from two - or more - parties, perhaps it might be time to ask why.

Increasing the Probability of Success

I frequently surprise myself about how enthusiastic I can get when looking at a startup or a strong business idea.  While I won't admit in public to thinking "can't miss," I suppose I've come close.

And it's always a mistake to think that way - even when things go well. 

An idea is just the beginning of a venture.  Successful prototypes are just one more step along the way. 

Here's a practical way to think about "reducing risk" in a startup in a bit more detail.

Consider the major areas of what has to work (after a successful prototype) for the business to be profitable.  These are the "killers" that if for whatever reason they do not work, the business dies.  For example:

Pricing (P)
Manufacturing (M)
Distribution (D)
Success in beating competition (C)
Ongoing next generation research (Re)
Retaining key employees (Ke)

...and so forth.

Now,  assign a probability to your team's ability to make each area work - getting it right.  For simplicity here, say they are each 90% probable.  Multiply all of those probabilities to get to the overall probability.

Do the math.   (.9P) x (.9M) x (.9D) x (.9C) x (.9Re) x (.9Ke) = .53

So the "can't miss" in reality is closer to 50-50.

Every success or failure can be checked against this kind of matrix. 

Consider what happens if an otherwise workable model can't be easily distributed and, in our example, distribution success is only 50%.  Overall success probability drops to 29%, but, aside from that, it becomes evident that anything we can do early on to reduce the risk in distribution is early money very well spent. 

This makes it evident that the work spent in planning to avoid the "Death Star" scenario in each area is required to assure success.  Another way to think about this process is to get the right team in place whose experience can move through this process rapidly.   Read Bill Sahlman's "How To Write A Great Business Plan" in the July 1997 edition of Harvard Business Review .

(If you don't think that experience is so important, next time you need a surgeon, ask if there's an intern available for a cheaper rate.)

Said another way, if the probability of distribution success changes to 100% because of your planning (a signed partnership agreement might be an example), the probability of overall success rises to 60-40. 

I am making a case both for planning and for experience in the venture as a way of raising the probability of success.   Give it a try.

Reducing Startup Risk: A Video Comment

This video is only a couple of minutes long.  It's a brief comment I made during an interview about reducing risk.  Download reducing_risk_small.wmv I'd like to tell you that you'll see the entire program on 60 Minutes soon, but I can't.  And, yes, the forehead glare is real, unfortunately.

Startup Success in Silicon Valley

I've found a couple of links to "Startup Success 2006," a video of a Silicon Valley panel discussing what it takes to be a successful startup today.   Panelists include:

• Lauren Elliott, Founder, Personal News Network

• Reid Hoffman, Co-Founder and CEO, LinkedIn

• Joe Kraus, Co-Founder and CEO, JotSpot

• Daniel Mattes, Co-Founder and CTO, Jajah

• Alex Welch, Co-Founder and CEO, Photobucket

It's worth the 90 minutes it takes to watch.  Here's the link: Startup Success 2006

For those of us who are time-deprived, Dharmesh Shah, (whose blog I really like: onstartups.com) has done a great summary:  Dharmesh Shah.

When All Else Fails...Manipulate The Data

I saw that on a t-shirt worn by a bartender at the Milwaukee Irish Fest last night.  I have no idea why.  But I liked it and it got me thinking about entrepreneurs and investors.  Who is responsible when investors encourage entrepreneurs to "manage" the data? 

If my process of reviewing a business plan helps the entrepreneur to align the performance plan with my growth expectations and then to base the plan on a "reasonable" set of assumptions that subsequently prove to be optimistic, who is to blame?  Said another way, how do we both avoid doing this again?

Can you think of the whole process of due diligence not primarily as a verification of high growth process but perhaps as a joint learning activity?  Do we as investors owe an entrepreneur not only our courtesy and respect but also our active participation in the mutual discovery process about assumptions, markets, and so forth?

As the venture progresses from financing to revenue (whether financed by an investor or the entrepreneur) that first big, critical issue has to be the first miss on projections.  Will it happen? Yes. 

If the venture leaders keep rolling forward on the projection, without really determining what is going on, they have begun a process of convincingly telling themselves and their constituents that the projection and forecasting process is unimportant.  Risk at this point increases - a lot.   

So, I believe that the diligence process is really about learning together and developing not only projections that are reasonable, but also a way to stress test every one of our assumptions, paying real attention to the ones that, if wrong, will kill us. 

The inevitably of rolling forward on projections is a given.  What the entrepreneur needs to do is be able to be testing the underlying assumptions and reducing risk.  This starts with the process of understanding and explaining the business plan.

If, at the end of this process, it is clear to the entrepreneur and the potential investor that the business will not support high risk capital and its expectation of high returns, both parties win.  The entrepreneur has a better understanding of the business model and whether it really can be high growth.  She may also find better ways to finance the venture to better meet her own goals.