At some point after crossing into my 30’s, I gained a genuine, deep appreciation of the insights of the people around me. It’s a common phenomenon; as you gain more experience, you realize how little you know. Then you realize you can tap the people around you to fill in the gaps.
Another thing that happens as you age is that you see the same patterns over and over again. See a pattern enough times, and it becomes a “truth”. When the pattern becomes a truth, no mere mortal is going be able to dislodge it with his unique perspective.
When building your team, I think it’s imperative to know your truths, and to make sure they are not at odds with your team. I agree with the conventional wisdom that diverse perspectives improve a team…99% of the time. But where team members disagree on the fundamentals, the result is often toxic.
Here are my truths for startups:
- Winning takes a lot of hard work, usually in the form of long hours and unrelenting pressure to move forward as quickly as possible.
- Focus hard. That’s not to say startups shouldn’t experiment, but there is a distinction between an experiment and a direction. Startups should only have one direction at a time.
- Frequent small iterations trump infrequent total overhauls
- The world is small and dishonesty will bite you. Don’t play games with peoples’ trust.
- Brace for battle. There are people who are just as smart as you who want to see your company dead. If you’re not attracting this caliber of competition, your market isn’t very attractive.
"People don’t want to buy a quarter-inch drill, they want a quarter-inch hole."
— Theodore Levitt, Economist
I’m currently raising capital for an early-stage company. I’ve been getting a lot of questions about how the business plans to defend itself, which has brought to light thoughts on barriers in general. Here are some categories of barriers and how well I think they work in the Internet software space:
Technology. I have yet to see technology in the space that couldn’t be replicated with the right hires and the right amount of capital. Technology, in a static state, is more of a speed bump than a barrier.
Rate of Innovation. Some companies start with a differentiated technology and build a culture that relentlessly keeps pushing to evolve. As opposed to companies that rest on their existing technology, companies that develop quickly and continuously are very hard to catch.
Network. Networks of partners, suppliers, channels are difficult to build. Unlike technology, which can be expedited with capital, the time to build a network is constrained by the pace of 3rd parties. It takes time to catch companies with scale on a network.
For all the attention we pay to barriers, I think in the Internet software space, it’s mostly about who can run fastest and make good decisions while running quickly.
I was helping someone flesh-out a business idea the other day, making very rough cuts to cull complexity, and I realized how much I like the number three. If I stay within three, I’m streamlined, if I go beyond, I’m a mess.
I try to keep it to no more than three:
- Key selling points
- Competitive frontiers / attributes that I want to own
- Entities before mine in the value chain
- High level steps in a process
I once read that the number seven is significant to the human brain; (something like) we can retain and recall seven items in our short-term memory, and beyond that, we start to forget. For whatever reason, I find that when I go beyond the number three, eyes glaze over, my audience loses interest, and I open the idea to logistical issues. More than three is my queue to dig harder to find a better way.
By the time most startups raise capital, they have formed a well-defined self image. In fact, the raising process itself almost requires that you have one; most investors like to see entrepreneurs with “conviction” and “passion” around their idea. The unfortunate result of conviction is that startups come to market artificially anchored to a positioning. The reality is, the market will lead you to the right positioning if you focus on listening to your customers to understand what they want on a fundamental level, and how the rest of the market is falling short. Conviction gets in the way if it’s too specific.
Another way in which startups are unduly influenced is the appeal of a “hot” area. As an entrepreneur, you’ll get more attention from peers, potential employees, and investors if you associate yourself with a big growth area like mobile or social. Everyone wants to catch a big wave. This inclination can distort an accurate view of the market and cause you to miss an even bigger wave.
As an example, I know a startup that has an elegantly simple service for small businesses. The founders have tech backgrounds and always envisioned their service as being cutting edge. They have focused their promotional strategy on the web and social media. The problem is, the most exciting thing about their service is that it has market appeal way beyond the cutting edge. It solves a very basic problem shared generally by small businesses, the bulk of which are laundromats, convenience stores, vending machine operators, independent sales reps for industrial fasteners and the like. The odds of these customers caring what the company has to say on Twitter are slim. A self image distorted by hot areas caused this company to miss the bulk of their potential market, the scale of which is mind-boggling.
Market positionings that truly resonate are formed by listening to the customer. Don’t expect customers to be able to articulate exactly what they want, but expect them to give you an understanding of fundamental problems that are not addressed by the market. If you are attentive, and insightful, you can innovate in a way that’s useful.
Picture a graph where you have time on the x-axis and confidence on the y- axis. The line in the graph has shifted, getting steeper as we better understand the nature of the Internet industry. We know more about using data to make better short-term predictions, like whether a given site visitor will buy, but we have no idea what our businesses will look like in a year.
I have been working in the Internet industry since 1999, and I remember having to put together 5-year forecasts for new products. I once wrote a 29-page business plan for a company that was acquired six months later for something entirely different than what I had identified as its core asset. Through the boom and the bust that followed, it became clear that we had no clue what was going to happen in a year, let alone 5 years.
The real shift happened with the proliferation of development skills, particularly overseas, and frameworks that gave us code shortcuts. The question became, why sit here gazing into my crystal ball when I can spend a weekend (or a few hundred dollars) creating a live test that will tell me for sure whether I’m onto something?
I recently read that in the most recent application cycle at one of the nation’s most celebrated accelerators, a full 14% of applications were “no-idea” applications. That means the applicants didn’t even bother to conceive of a business, they just assembled a team and said, “Here we are, invest in us, we’ll figure out the rest.”
My current thinking is that the recipe for startup success can be distilled into 3 steps:
- Identify a big problem
- Assemble brilliant people
- Create an organization that pushes code frequently and judges hypotheses quantitatively
But that may change, too. Hard to predict.
I’ve decided to eliminate the “complete overhaul” from my array of options. It’s such a tempting proposition — redesign exactly the way we want it and everything becomes more efficient. The problem is, I’ve never been part of a complete overhaul that worked out that way.
My previous company made its living acquiring and streamlining e-commerce properties. In a few cases, the properties were up for sale as a result of a disastrous complete overhaul. Overhauling a shopping cart consumes development resources, can destroy search engine rankings, breaks external integrations, forces everyone to retrain on a new system, and causes other wrinkles that can take years to sort out.
Even though I had witnessed the follies of complete overhauls second hand, that did not stop me from pursuing them on my own. In a few acquisitions, burdened with unfamiliar legacy code, I decided to just rebuild from scratch. The outcome was invariably less amazing than the vision. I never had a disaster, but I doubt I ever reached a positive ROI on the efforts.
The point of positive ROI brings me to why I think complete overhauls are wasteful. For Internet companies, there is too much uncertainty and change to forecast returns on big efforts now, for years into the future. Chances are that by the time you’ve sorted out the kinks in one overhaul, you’ll be finding reasons for yet another overhaul. Changes in small increments, made as frequently and quickly as possible, seem to be a much better route.
"Make no little plans: they have no magic to stir men’s blood."
— Daniel Burnham, the Chicago architect whose vision recreated the city after the great fire of 1871
I’ve found that my flow of business ideas turn on and off like a spigot. If I’m engaged in something that’s growing, the spigot turns to the right. If I’m engaged in something that’s slowing, the spigot turns to the left. If I’m engaged in something uninteresting or not engaged at all, the spigot turns all the way to the left. That’s when the bad ideas really start flowing.
When I have a bad idea, it usually takes me somewhere between 1-3 days to get a whiff of its stench. I call these three days my “sobering-up period”, and I make sure to not put anything out in public about the idea during this time.
There are two recurring themes to the bad ideas. 1) Treachery. The bad ideas can be really complex. I find myself coming up with complicated schemes to overcome hurdles, then I realize that the strategy is so convoluted that it would take an aligning of the stars to pull it off. 2) Futility. The bad ideas often address tiny markets.
When the ideas are flowing, a few good ones pop out as well. In these periods, I’m more in tune with daily challenges and I’m more open to thinking about possible solutions.
When an idea is good, I’m reminded of it every time I hit the same challenge that spawned it in the first place. And I never seem to forget the good ones, because they solve problems that occur frequently. I’ve been clinging to a few ideas for decades, just waiting to meet someone with the right capabilities and bandwidth to take them on.
I was talking with a VC and he stated a valuation in terms of a multiple of gross profit. Admittedly, I don’t have a ton of experience with VCs and the way they ply their trade, but I have been a part of quite a few small business valuations and I have never seen one that drives directly off of gross profit.
What I’m used to seeing is a valuation that drives off of EBITA and a rate of sales growth. When I think about it, however, in my own valuations, I quickly dismantled expenses to see how a company would look when folded into a different operation with a different expense structure. Which means previous EBITDA was rendered almost irrelevant.
Further, I always assumed whatever was happening with sales growth would be disrupted (either positively or negatively) with the acquisition. So sales growth followed EBITDA right out the window.
Which leaves, sitting right smack dab in the middle, gross profit. In my experience, gross margin stayed relatively steady following acquisitions, so maybe gross profit was the right valuation metric all along.