Startups and angels: Along the way to success

Thoughts for New Angels

I was in Italy a couple of weeks ago at the request of the US State Department to discuss angel investing with IBAN, the Italian Business Angels Network.  Here's a list of angel practices I discussed at the end of the first day's presentation:

When beginning as an angel investor, think about these things:

1.    The most important person in the business is the customer.  Everything starts with solving a problem the customer has, and solving it in a way that is valuable - in other words, that the customer will pay for.

2.  The inventor is critical to the business, whether he works in the business or not.  Without his commitment to helping the business succeed, chances for success are much smaller.

3.    Spend lots of time making sure that the people in the company are the right people.  Know what critical experience and skills will be needed and make sure it is there.  All successes and all failures can be attributed to people. 

4.    We must always remember that there is plenty of money to be invested but too few really good ideas.  As soon as we have made an investment we become members of this team and our sole focus is on helping them succeed so that we may be worthy of their effort and their respect.  Over communicating our expectations, hopes and goals will build a more trusting and more successful company.

5.    There is no substitute for experience in the process of assessing and investing in companies.  We seek to cooperate with other investors so that we may have access to as much experience as we can get.

6.    We tell entrepreneurs that who they take money from is much more important than the relative price they pay for it.  We are very careful about our investment partners for this reason.  It would be a terrible idea for an entrepreneur to take what we call “dumb money” – from unsophisticated investors who may have restrictions or controls about what the company can and cannot do, for instance.

7.    It is more important to prove that a market exists and that a product works than it is to build infrastructure.  We actively discourage companies from hiring when they can use contractors, from thinking about developing their own manufacturing, or in any way building too many fixed costs.  Fixed costs can be a real burden in a situation of cost overruns.

8.    When companies do hire, hire slowly and accurately.  The cost of hiring quickly and making mistakes is very costly in many ways.

9.    A simple business model is always better than a complex business model.  It should be embodied in a business plan that is robust and is the constant guide for the daily implementation of the business.

10.    Before you write the first check, have an agreed upon exit plan and strategy.

11.     Always remember that entrepreneurship is at the opposite end of the spectrum from administrative or bureaucratic behavior.  It is a never ending process of innovation, Identification of opportunity; marshalling resources; action/exploitation; and, harvesting. 

A New old Idea: Direct Marketing Revisited

Or that's what it used to be called. 

I am struck by how many of the businesses I see can really use tried and true techniques that were pioneered by the direct marketing industry a hundred years ago. 

If your business acquires customers, for instance, whether they are businesses or consumers, and you care about how long it takes and what it costs, then customer acquisition testing is more than important -- it is a business requirement.

If your customers buy more than once, then you care about retention rates and lifetime value.

Now, no amount of good marketing can repeatedly sell vinegar in wine bottles.  So this is not a discussion about the quality of the service, etc.  But, when all is said and done, there are only two ways for businesses to thrive in a competitive environment.  They have to get a higher revenue per unit than their competitors, based on sustainably adding value, or they have to have a lower total cost per unit sold. 

I believe that, given an excellent, value added product, direct marketing helps you do both. 

Here's a report [Download PostfutureIndexH1-2006.pdf] from Harte-Hanks (they used to be named Harte-Hanks Direct Marketing) about enhanced clickthrough and open rates using personalized at-home printing based on variability.  This is just one small example of an old technique - customized variable image printing - being used very effectively today. 

I don't think many companies that have needs in customer acquisition or increasing customer transaction size or frequency understand well enough how to effectively use techniques like this.

We built  promotions with that technique (this was in the {gasp} 1980s) that sent 1MM customers a postcard announcing an annual retail sales event at a department store.  The secret was that the message included a "passing reference" to three items that were on sale among the "hundreds featured" in the annual event.  Of course the three items were the output of an algorithm based on each customer's buying history.  Customers loved it.  It had very high response rates and great customer comments.

We also used this kind of mass individualization for thank you notes, business to business lead generation activities - a whole host of things. 

It worked then and it works now.

Another whole example is source code matching, where the marketer traces sales all the way back to the original source to determine ultimate performance as a function of the cost of the original source.  It can make the difference between great future results and not so good ones.  It helps not only select media but also to tune offers, incentives, and sales activities to the desires of the individual customer, and in an affordable way. 

I've gone on too long already.  But, the closing thought is that if you or your business have any of these needs, be sure you understand - in detail - how this all works.  Get the knowledge inside your company one way or the other.  It's critical to success.

What's the Best Use of Your Borrowing Power?

I just talked to a business owner the other day who has grown her startup nicely - 15% a year or so - up to revenue of a bit over $2.5MM.  Now, (in the service business,) the venture is at the point where she could accelerate its growth.   Through managing expenses and getting paid for  added value, the business has some positive cash flow.  This "borrowing power" can be used to generate cash - once.  But that cash has to be used to grow cash flow faster - much faster - than the payments due to the bank. 

Obviously.

New equipment?  Expanded service force?  New salespeople?  Nope.

She wants to triple her current occupancy costs and build a new building.  There may be some efficiencies to be gained, but at a huge cost.  If the company is 15% EBIT, Every $1 in new debt obligations has to be supported by $6.60 in new revenue.  If occupancy costs, as an example, go from $45,000 to $135,000, that's almost $600,000 in new sales - just to stay even with the business as it is today.  (On revenue of $2.5MM, that's a 24% increase just to pay the bank.)

Is this really the best use of the business's borrowing power? 

When is the time?

Here's a great comment from Ryan that I just posted:

"My fellow angel network managers say that they usually won't talk to inventors because the company anticipated is usually not ready for angel investment."  I'm sure that most inventors pitch their idea with a powerpoint presentation and/or prototype, but at what point does an innovative idea or product become worthy of an investment?

Well, for an entrepreneurial company to be ready for investment - that is, to wisely use money to grow and increase the value of the Enterprise beyond the value of the money invested - it seems to me that there are four basic requirements.

1.  The idea must be focused on the market.  That is, the entrepreneur must be able to articulate what problem the company and its product is solving, why that solution is of value to the marketplace, and how the market will value it (and pay for it.)

2.  The entrepreneur must have financial foresight, either themselves or in some way that brings the foresight to the company in a daily basis.  That means, to me, understanding cash flow, minimizing expenses appropriately, investing in projects, processes and people well, and planning for cash flow and capital needs.

3.  The company must have a plan for a great team that fills all of the gaps required for success.  (I talked to someone today who clearly needs a particular kind of expert, but, as "CEO" is fearful of hiring someone in an area in which he is not an expert.  His company is going to struggle because of it.)

4.  The founding entrepreneur must be clear about their capabilities and their desired future role in the company.  He or she must articulate this upfront.