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Investment as a cushion or a springboard

I believe new entrepreneurs should not take investment. Here's why.

There are two primary types of investment that I've observed being taken: investment as a cushion, to protect the company from having to focus on short-term revenue generation right away, and investment as a springboard, to help the company grow faster or enable a cash-intensive business model. These can be loosely matched with the Seed and Series A stages of funding, though some Series A are cushion funding, and some Seed funding is used as a springboard.

One might expect me to launch into a tirade about how one is better than the other, but that's not really the case. Both uses are valid. However, cushion funding is dangerous for inexperienced founders.

A cushion from reality

Starting a business with zero revenues and zero funds, you have to do what's called "bootstrapping". As UK entrepreneur Iqbal Gandham (who contributed this swombat.com article) argued on TechCrunch, bootstrapping from zero funds is impossible:

The harsh reality for startups is that you need someone somewhere to pick up a tab for around £50k, which of course could be split over two people, i.e £25k a piece, but still that is just £300 or so pounds less than the average salary in the UK.

However, many people commonly raise this initial £50k (though it's often much less) from their own savings (saving £50k is hard, but hardly impossible, when you're an IT contractor earning £50-100k/year). Bootstrapping, then, is creating a business without taking external investment. When it's your own savings dripping through the hourglass, when every expense matters, you end up, hopefully, being very focused on reaching revenues as soon as possible. Lack of funds creates an extreme awareness of the need for more funds.

However, if you have a nice £100-200k cushion provided by someone else, you don't feel the bite quite so much. Sure, you still have a runway, and it is diminishing, and it is something you need to "think about", but it is far more theoretical than seeing the biggest number in your bank account steadily approaching zero.

One of the biggest things that new entrepreneurs (at least in most of the world outside of Silicon Valley) need to learn is not how to build a product or deliver technical work, but how to run a business profitably. It's all these ancillary tasks, from sales to accounting, finance, legal, marketing, and general business management, that take three years to learn (give or take). That learning is one of the most important forms of progress for the new entrepreneur.

In that context, any cushion which slows down the learning, which delays it, makes it more distant and theoretical, is potentially harmful. Most successful entrepreneurs are the kind of people who thrive in sink-or-swim situations, and investment-as-a-cushion can turn this into a delayed sink-or-swim, and even set things up for a sink: having funds makes you more likely to take on fixed expenses start relying on your ability to spend, which you shouldn't - not until you have a functioning business and/or know what you're doing.

So, my advice to new entrepreneurs is: don't take funding, and if you do, take a minimal amount and spend as little of it as humanly possible.

A cushion from short-term focus

The proposition is considerably different for experienced entrepreneurs. Managing your cash flow, your runway, your fixed expenses, etc, is a very hard lesson to forget. Once you learn how to sell a product that doesn't exist based on a reputation that's only in your head, that's a skill acquired for life.

Many experienced entrepreneurs who could fund themselves take seed funding anyway. However, they don't take it "because they couldn't afford to do a startup otherwise", they take the seed funding because it enables them to put aside the short-term revenue focus for a little while and aim for something bigger and riskier. Once you've learned how much the short-term focus matters to your survival, it's very hard to ignore it. The cushion of external investment enables an experienced entrepreneur to temporarily ignore that pressure.

In this situation, I think it makes a lot of sense to take external investment as a cushion.

A springboard to greatness

Finally, the third case almost exclusively applies to experienced entrepreneurs, since, at least in the sane world outside of the Valley, VCs will pretty much never invest in a business that doesn't have either a proven founder or proven revenues (both of which add up to an experienced entrepreneur).

In this case, funding is required to enable the business to grow much faster than by organic growth alone. This is particularly important in winner-takes-all and first-mover-advantage types of markets. Paypal and eBay are great examples of the first: most people will have only one online payment account, and they'll pick whoever has the most popular platform. This winner-takes-all advantage paradigm is so strong that even with all their misbehaviours, both of those players are still firmly lodged at the top of their respective markets. Worth taking investment to get there first? You bet.

For the second case, looking in the enterprise market, many pieces of software like SAP have huge installation costs. A large SAP installation might cost $200m: $20m in software licences, and $180m in consulting fees to set it up. In a market like this, being the first to make the sale is pretty important, because customers are very rarely going to change platform if it costs that much.

In these contexts, taking growth investment makes sense, because otherwise a competitor who does take that investment will beat you to the post. This type of investment is not at all a cushion - in fact, it makes the fall much harder if you miss, turning a moderate success into a complete failure - it is a springboard, an amplifier of your efforts.

If you know what you're doing and are willing to take the risk, springboard investment does of course make sense.

Conclusion

So, in summary, taking investment can be seen as either a cushion from reality (often the case with new entrepreneurs), a cushion from short-term focus, or a springboard to greatness.

Only the latter two are good uses for investment. If you don't yet know what you're doing, if you feel you need the cushion just to survive, then you probably should not take it.

To conclude, it's worth noting that these arguments apply mostly to the 99% of the world outside of Silicon Valley, where spending tens of millions to build a company with zero revenues for years is not an option.


Startup gung-ho

Businesses, investors and consumers alike are gregarious. They want to go where everyone else is going. They want to buy success, from successful companies.

This leads to a perversion that affects the startup world as well as the rest of the business world: the need to appear more successful than you are, in order to get business, investment, customers.

This is not entirely artificial. Building a successful business is also about being able to project the right image to appeal to customer, and an appearance of success is part of that. Fake it till you make it, as they say. People don't want to buy from or invest in a dying company, so you've got to look like you're doing great, even if you're an invoice away from technical bankruptcy.

But there's a reverse side to that, which I believe is harmful to some startups: this projection of fake success extends to meetings with other startups and potential mentors at networking events, and because of that, founders who could really use a good dose of advice from a more experienced entrepreneur end up flying blind and making all the same mistakes again.

Startup networking events

When I turned up to my first startup networking event, I didn't know what to expect, so naturally, I turned on the "we're doing great" façade (which, I quickly observed, everyone else did too). Isn't it amazing how, in a high-risk industry where most companies are expected to fizzle out in the next few months or years, everyone is doing great, growing fast, acquiring more users, etc? How often do you meet a new founder and hear "Yeah, well, I've been at this for 9 months and our revenues are still way too small, so I think I'll be throwing in the towel and trying something else soon, because this isn't working."

Another aspect of this problem is that once you start putting up the appearance of success, it becomes very tempting to do so consistently, with everyone. Anyone could refer you to some business, after all, so you have to be on your toes all the time. Otherwise, you might miss out on some great opportunity that would have come your way if only people thought you were doing well. At least, that's how it often feels.

To make matters worse, if you introduce yourself by presenting what's wrong with your business, people will peg you as a negative type, and that's not the kind of founder people think of as being headed for success. No, you have to be an outgoing, friendly, open extrovert with a strong dose of self-confidence and a very slight touch of arrogance.

I'm very lucky that I can genuinely say that at this point, the two businesses that I am involved in are doing very well. But this wasn't always the case.

Missed opportunities

In the times when my companies were not successful, did I get any amazing opportunities by claiming to be successful to my startup peers? I don't think so. Founders have a pretty finely tuned bullshit detector. I doubt anyone was all that fooled. What about investors? With them, faking success is even less useful. VCs will not invest without doing a fair amount of due diligence. Claims that you're doing great when you're going bust will never lead to investment, unless you're a consummate con man.

What opportunities did I really miss, then?

How about opportunities for advice? Entrepreneurs are a helpful lot, but if you don't present your problems clearly, your peers won't be able to help you. Even non-entrepreneurs seem more likely to offer advice and connections if they think you're struggling and they could make a difference. Perhaps the only set of people to whom you might want to project the "appearance of success" are clients, during a pitch. Even that is unclear, though. It really depends on your industry. In some industries, a fledgling startup is more likely to get a foot in the door than a mature, successful company, and expectations will be lower, and therefore easier to beat.

In summary

  1. Appearing more successful than you really are will destroy more opportunities than it will create.
  2. Instead, be honest with fellow entrepreneurs. Don't be negative about it, but don't claim to be doing great when you're not.
  3. VCs will not invest based on an appearance of success, so bullshitting them won't work either.
  4. Appearances of success may work with some types of customers in some industries, but think about it for a few minutes instead of simply defaulting to the startup gung-ho attitude.

Don't ask customers what they'll pay: tell them  

Ash Maurya with an excerpt from his book, Running Lean:

Suppose I place two bottles of water in front of you and tell you that one is $0.50 and the other $2.00. Despite the fact, that you wouldn’t be able to tell them apart in a blind taste test (same enough product), you might be inclined to believe (or at least wonder) whether the more expensive water is of higher quality.

Here, the price can change your perception of the product. Not just that, but there can be viable markets at both prices and the bottle you end up picking defines the customer segment you fall in.

Great point. The book seems well worth buying, if it's filled with these sorts of insights.

One classic mistake is to send a survey to potential customers suggesting several price points. In such a situation, customers will almost always pick a lower price than what they're actually willing to pay, thus making the output of that survey garbage. More importantly, you'll fail to extract the key insight from pricing research, which is the segmentation of the market and relative sizes of each segments. How many of your potential customers are willing to pay $2 for a bottle of water? Are there enough for you to have a market worth addressing?

Think small, be specific  

Sahil Lavingia, serial app maker, on being specific:

Instead of a one-size-fits-all product, you often end up with a one-size-fits-none product. It leads to over-generalized products — and messaging! — that lacks any focus and emotion, two things you need when acquiring your initial user base. You can’t build everything for everyone, at least not at the start.

Indeed. I made exactly that mistake on my first startup: we built it for "small businesses online", without any specific customer in mind. As a result, when we finally launched, no one found it all that useful.

Unfortunately, if your product is built for no one in particular, it will be useful for no one in particular. On the other hand, if you can focus on a niche and dominate it in terms of usefulness, chances are people outside that niche will find it useful too.

Another big problem with designing a product for "everyone" is it makes it impossible to focus your marketing efforts. Marketing effectively to "everyone" is much more difficult than marketing effectively to "programmers", which in turn is much more difficult than marketing to "ruby programmers", which in turn is more difficult than marketing to "ruby programmers who use Rails 3 and above". The more you expand the market, the more expensive it is to reach. A tight product focus enables a tight marketing focus.

There's a time and place for "thinking big". Sometimes, thinking big is the right thing to do (as always, context is everything). However, if it's your first startup, chances are you can't really execute a "huge idea" effectively anyway, so building something directly useful to a specific group of people is most likely a better approach at first.

Signup page conversions 101  

This article by Brett Cooper might seem a little basic for those who have been following the startup world for a while, but for newcomers, it outlines a number of mistakes that are all too common, such as over-complex freemium models, too much text, complex incentives, etc. The fundamental principle, as always, is to keep things simple and clear.

Worth a read if signup page conversions are a new topic you want to learn about.

Three modern organisational structures  

I found this gem by Aaron Dignan linked via this previous article. While the general theme is around "what to do with a 10,000 person stagnant organisation" (and it offers some concrete advice towards that), the really interesting part is the overview of three modern ways to structure a business, namely:

  • Holacracy (Medium, Zappos): "authority should be distributed, everyone should be able to sense and process (solve) the tensions (ideas/problems) they perceive, roles and employees are not one-to-one, and that the organization can and should evolve toward its “requisite structure” (the ultimate structure for its current environment)"
  • Agile squads (Spotify): "Instead of an engineering department, a design department, and a marketing department that each collaborate on products with dubious ownership, they organize vertically around products (or more specifically pieces of products) and traditional disciplines are loosely held horizontally."
  • Self-organising (Valve, Github): "Unlike the examples above, they accomplish this by essentially having no structure. Employees are encouraged to work on whatever they want — to find the projects that engage them and do the best work of their lives."

GrantTree is somewhere in between Holacracy and Self-organising - but I'd never heard those terms before today, so perhaps that's the case for many people who will read this article.

Agile Squads is the only one that doesn't seem all that new - cross-functional teams are hardly ground-breaking - but perhaps the meat of the newness is somewhere else than in the cross-functional element.

Key quote:

The defining characteristics of these models are fairly straightforward. They aim to distribute authority and autonomy to individuals and teams. They let the changing nature of the work (expansion/contraction/shifting) impact the structure of roles and teams in a fluid way.

I firmly believe that if you're starting a business in today's ever-changing environment and not making any effort to make the business more adaptable to rapid change ("anti-fragile", as the article calls it), you're setting up your business for failure a few years down the line. Getting big won't protect you, either. See Blackberry as a warning.

Product scope: where to draw the line  

Des Traynor:

The most important thing a product manager does is decide where their product stops and someone else’s product takes over. If the product doesn’t do enough, it won’t be worth the cost of installation, registration, maintenance, let alone purchase. If it does do too much, it’ll clash with some pre-existing software or workflow that is already well defined.

Des provides some great guidelines for where to stop.

You should usually stop your product when the next step…

  • has well defined market leaders looking after it (e.g. PayPal, IMDB, Expedia), and you don’t intend to compete.
  • is done in lots of different ways by lots of different types of users (e.g. trying to process salaries in a time tracking app would be tricky)
  • involves different end-users than the previous steps (e.g. managers, accountants etc.)
  • is an area you can’t deliver any value.

Can you think of examples which overstepped this boundary and failed because of it? What about the opposite? Products which broke the rules and yet took the market?

Only work on single-miracle startups  

Elad Gil:

If your startup needs multiple miracles to succeed, you need to go back to the drawing board and come up with an idea or product that has only one miracle. Otherwise you are multiplying out multiple low probability events and are extremely likely to fail.

Many people delude themselves on whether they are a one-miracle, or multi-miracle startup. They way to tell is to ask yourself what your product or business end goal is. Is your approach directly focused on achieving that end goal? If not, you may have a multi-miracle plan without realizing it.

Yep. Although I disagree with Elad's assertion that:

If your startup needs zero miracles to work, it probably isn't a defensible startup.

That is true only in a winner-takes-all market. Some markets are naturally fragmented. You don't need a miracle to build a successful web development company, you just need competence, hard work, skill, luck, good business relationships, and a dozen other tricky but achievable ingredients. And, depending on your definition, those can be startups too.

7 startup post-mortems  

You can learn a lot from reading about startups that didn't work out. Kudos for the founders of these startups for sharing the experiences. Each story also includes a link to a longer version.

How not to recruit cofounders  

Like many other technical people with startup experience, Tristan Kromer gets approached by non-technical founders and is tired of people making basic mistakes in their pitch to him. Here's his list of don't's when approaching a technical cofounder:

  • Don't bullshit. If you don't know, say so.
  • Have more than an idea to offer.
  • Don't ask for an NDA.
  • Be clear. If you can't be clear even this early in the relationship, working with you will be a hassle.
  • Show that you can do it by yourself.
  • Know your metrics.
  • Don't make up words to describe your way of working.
  • Don't negotiate about share percentages.

The last point is interesting:

If you offer me 1% of the equity, I’ll do 1% of the work. If you offer me 25% percent, I’ll do 25%. If you offer me 60%, I’ll insist on only taking 25% and I’ll work 24/7 for you.

It's a bit tongue-in-cheek, but makes the point that if you're arguing about percentage points already this early in the startup, chances are the relationship will struggle. If you want to encourage loyalty, err towards generosity (but only with committed cofounders).

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