Startups and angels: Along the way to success

Long term thinking -- for entrepreneurs

While it isn't always top of mind for entrepreneurs caught up in the rush of running and growing their businesses, long term thinking, including thinking about relationships, is pretty important.

I attended a business presentation last week at Marquette University's College of Business.  The speaker was John Schlifske, CEO of Northwestern Mutual.  He spoke about the value of long term planning in his business and gave several examples.  

At first, most of us think that we should of course keep our promises and so forth.  John gave an example of a practice of theirs that rewards all of their current policyholders with upgrades as those are introduced to new policyholders.  In other words, they don't ever use an upgrade to sell a new policy without also providing that benefit to existing policy holders.  

Good idea.  Excellent marketing.  

His next example was of the young policyholder who'd died in a tragic accident and hadn't taken advantage of an available policy increase.  He felt that the logical conclusion was that if she'd seen the offer, she would've taken it - so they assumed she had taken it and paid the higher amount.

These are great stories, but they come from an admittedly very strong company with tremendous financial assets. 

Would they really apply to an entrepreneur with little or no assets faced with a similar situation?

I'm reminded of the first company I was involved with after I'd left GE.  It was called RTMS and among other things, it provided CRM services that in one product became mailing labels for retail promotions. 

The company prepared, as I recall, several million labels for their big customer (really their only customer) a major retailer based in the midwest.  The labels were delivered, and the promotional material for the biggest event of the year went in the mail.  

What RTMS missed was that instead of the boolean logic selecting the top 2MM customers, it had selected a random 2MM customers.  They failed to mail a substantial portion of the best customers for the biggest event of the year.  Again, as I recall, it was about 300,000 households.  

The retailer figured it out through an innocent question that was something like "why didnt the CEO's wife get a promotional flier?" This led to a quick list check, followed by a rerun of the logic, followed by the discovery of the error.

At this point, RTMS had one customer paying them what amounted to all of their annual revenue - plus or minus $500,000 I think.  And, now they come to discover that they'd created a problem that would cost their customer millions in lost sales. 

This all happened on a Thursday at about 4pm with the sale starting the following Wednesday.

If they reprinted and remailed the missing material, (at a cost of about $150,000) the fliers wouldn't reach the customers across two states in time for the event because ofthe way the post office delivers what was called bulk rate mail.

If they mailed the catalogs at each individual city location from southern Illinois no northern Wisconsin, they'd get there in time.  But they had to be at the post office within 18 hours or they'd be too late.

So RTMS chartered a DC3 and flew from city to city starting at 8am, calling ahead at each airport for taxis and hauling the material to each post office. They paid for the reprints, the mailing and the plane charter. The stuff got to where it was going and the sale went fine. 

This whole thing was funded with a home equity line of credit and resulted in a substantial loss for the year of 1989.

However, last time I checked, 23 years later, that same retailer still buys CRM services from that same entity - which has been sold twice in the intervening years.

Lots of people over the years have provided great service to the customer, of course.  It isn't as though this one event alone held their loyalty.  But it was a cultural stake in the ground for RTMS that demonstrated to everyone involved that doing the right thing for the long term was paramount.  It preserved their reputation.  (They fixed the boolean problem too.)

For entrepreneurs, thinking about delivering on what people were not only promised, but also expected, is really important, I think.  We all really know what promises mean and what people expect. 

 

 

 

 

Technology versus market risk in angel investments

Many of you have seen this great post at Tech Crunch by Andy Ratleff from a couple of days ago.  One of his points is that angels tend to lose money because they take on companies with high market risk and low technical risk.  I find this to be a compelling insight about the investing process that has a lot of implications for the way most angels think about their decision making process. 

You can think of this a couple of ways. 

Risk, of course, is what is at the center of the investment premise.  More risk, in theory, drives higher potential returns.  And risk comes in many varieties.  In growth stage companies, for instance, we talk of execution risk.  

However, execution risk really doesn't describe the type of risk.  That is, when we think a company primarily has "execution risk," do we mean that they're facing scientific and technical hurdles to achieve results, or do we mean that they are facing the risk of selling to their market, or of delivering a product to customers who've bought?

Andy's comment, that  " ... you want companies that are highly likely to succeed if they can really deliver what they say they will," is a comment about scientific and technical risk as a predominant factor, and perhaps production risk secondarily.  It implies that selling to the market is a task that needs to be accomplished, but that the business is focused on an existing market that has high demand for the product.

Think "Porter's Five Forces." 

And then, companies with scientific risk retire that risk primarily with the talent they have on the scientific or technical side.  When this risk retires, the rest works pretty well.

For those of you old enough to remember, think about Jimmy Treybig, the founder of Tandem, whose VC, Tom Perkins, said something like "when the Tandem computer system performed as expected, (i.e., the really hard technical risk of failsafe computing in the 70s had been retired), the market took off.  

This is much different than companies who have very low technical risk, i.e., they can write a really good "app,"  but who ultimately cannot sell enough to make the business perform.  This risk is out of their control.  

We often talk of this as "will the dog eat the dog food?"  

It's interesting to think about the typical selection process for angel investments.  Often the investments they prefer are the ones that they understand.  They believe they can see the market need, sometimes make a personal decision about whether they would buy or not, and get "bought in" by the prospective sales pitch to the market.  This tends to lead them down the path to market risk dominant companies, including a lot of consumer internet deals.  

I talked to a company recently that had market risk in the educational business but also had a distribution agreement with a big player.  My advice was to execute with the big player by bootstrapping and then, as the market risk retires, to think about deploying outside capital. 

Greg Gianforte at RightNow Technologies in Bozeman, Montana (recently sold to Oracle) is a famous proponent of bootstrapping for this exact reason.  He took market risk out of the RightNow product by finding a market and selling to it before he'd gotten down the road with outside money.  He also, of course, invented some very cool algortithms that make up a substantial intellectual property base.  

Another example that comes to mind is Yieldex and Doug Cosman, its Boulder-based founder.  Doug solved a very difficult technical problem that had been worked on for a decade.  And as the technical risk retired, he added Tom Shields to run the company and bring the product to market.  

It is true, of course, that there's sales execution risk in Tandem-style deals as well.  Customers  ask for demonstrations, evidence of performance, price concessions, proof of financial stability -- all of that stuff. But those are manageable risks to retire with talent and money.  

This all leads to asking how angels could invest in high technical risk startup opportunities about which they have little domain expertise.  For us, when we have taken steps in that direction, it almost always involves both a long process of following a technical trail, finding experts, and often helping to put those experts in place to be company managers.

And, I suppose, it's critical to make sure angels understand the lack of control they have when they take market risk and trying to find ways to invest only at stages at which there is evidence of market acceptance.  This is Andy's comment also about VCs "outsourcing" these risks to angels.  If angels are going to invest at the idea or seed stage, they are taking this risk which is largely outside of the entreprenur's control.  If they wait to invest until there is evidence of early acceptance, especially in non-California markets, they may be able to achieve better returns.