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Here are 10 quality posts from the Founder's Library:

Friends, Family and Fools: the worst investors

"If you're struggling to raise investment from angel investors, the next fallback is FFF funding - Friends, Family and Fools. You can always raise a few tens of thousands of pounds from this source no matter how early you are."

The above is a fairly standard bit of startup wisdom, dished out to all and sundry. It seems pretty sensible on the surface. If your idea is any good, if you're a smart person who can convince others that you'll do well, it ought to be possible to convince someone, anyone, to invest a few tens of thousands of pounds to help get you started.

And since your idea is really good and you are a brilliant new entrepreneur, this may be the best investment decision that those people make in their life. It could be their chance to become rich, piggy-backing on your hard work - but you don't mind that, after all, they're friends and family. And fools, but we'll leave those to later.

Yonder dark clouds

Unfortunately, it's a huge understatement to say that when it comes to startups, things don't always go as planned. In fact, as a first-time entrepreneur, there's a very high chance that your business will go tits-up. Entrepreneurship is a career, you see, and you're just taking your first steps up that ladder. You have no idea what you're doing, even if you wake up every day filled with the confidence to take on the world.

There are ways to decrease that risk, of course. Seeking revenues right away… Keeping costs low… Getting advice from experienced mentors… All those things will help reduce the risk of your first business, but still, chances are against you.

That's alright, in a way, because as long as you don't do anything really stupid and, for example, triple-mortgage your family house to fund your first business, you'll survive the demise of your first venture, and be in a position to take another, better swing at the magical piñata of startup success.

This is where FFF funding screws you over, though.

When can I have that money back?

You see, if you take investment from professional investors, or even other entrepreneurs, they know that it's risky. They know that there's a fair chance you'll screw up and lose the money. Of course, they want to convince themselves that you're different, but professional investors only invest money they can afford to lose, so if they do lose it, they won't cry a river over it. They'll draw a line and move on to the next thing - perhaps even invest in your next venture, who knows. Investors are, largely, rational beings who understand risk.

Friends and Family? Not so much. Friends and Family will often get very upset when they find out you lost their money. You might find yourself highly embarrassed as the story of how you pissed away £20k of Uncle George's retirement funds makes the rounds over, and over, and over again for the next two decades. Not only that, but since they're your friends and your family, you may well feel somewhat obligated to repay the money somehow, sometime, once you've made some more money. It's like a lifelong debt that you can never truly shrug off, unless you're the sort of ungrateful git who probably wouldn't be invited to family reunions anyway.

Friends and Family investments are like the reverse of a convertible note. If everything goes well, they remain an expensive, low-valuation share investment. If things go badly, they turn into a loan securitised by that most valuable of assets: your personal relationships.

One would do well to stay away from such dangerously sharp-edged financial instruments.

Fools

Who's the greater fool? The fool who invests or the fool who takes the fool's money?

"Fool" investment basically means taking investment from people who are not friends or family, and who are also not professional investors or entrepreneurs of any sort. In short, they know nothing about startups, but they buy your sweet talk and decide to invest their hard-earned cash anyway.

The problem with this sort of investment is similar but different to the Friends and Family sort. Fools will not impose an eternal personal debt on you. However, experience shows that when the business turns south, they too will suddenly consider that the money invested should now be withdrawn from the business as soon as possible, and remain deaf and dumb to your declaration that the money has been spent and cannot be recovered.

Unfortunately, this sort of behaviour seems to be the rule rather than the exception. In the midst of a startup failure, which is a depressing enough event to begin with, Fools will drag you down and drag it all out endlessly, until you finally break all communications with them, under unpleasant circumstances.

Whilst a Friends & Family investment is likely to turn into a lifelong debt, a Fool investment will probably turn into a lifelong enemy, someone who will curse you under their breath every time they think of you and all the money you lost them.

Who should you take investment from, then?

There are only two categories of people that I'd consider taking investment from - and this is true at any stage of any business.

The first is professional investors, in which I include people who make regular angel investments, as well as wealthy people who have invested in things that lost them a big chunk of cash before, and who therefore will be fairly rational about the whole process.

The second category is other entrepreneurs, particularly those who have both failed and succeeded, as they know what it takes, they know it's very hard, and they know that if the business is going down the drain, the best thing to do is to let it.

Another key point about investments is you should only ever take money from someone who can afford to lose it. If my advice above falls on deaf ears, at least never take money from someone who simply can't afford the failure. Be very careful about that: you don't want someone's personal ruin on your conscience.

It's worth noting that with the recent advent of SEIS in the UK, investment by both professional investors and successful entrepreneurs is now much less risky than it used to be.

As I hope I've made the case above, taking investment from other types of investors, in particular FFF investors, will only result in trouble and pain further down the line, if the business doesn't succeed as easily as you might have expected.

If you can't raise the investment you need from proper investors, and you find yourself thinking of resorting to FFFs, I suggest you instead consider the idea to be out of your reach. It's better to work on another idea than to end up with the sort of nightmarish scenario that is all too common near the end of an FFF-funded startup.


Lean Startup Machine learnings  

Eric Ries, already mentioned earlier today, also posted this retrospective on Lean Startup Machine, a Boston-based "build an MVP in 48 hours" event.

He makes a few really important points:

For example, one team managed to put together a very decent looking minimum viable product, in the form of a landing page with a "click to signup button" that basically did nothing but collect data about who was clicking. And their MVP even had a reasonably high click rate. But is a 25% click rate validation of the idea? That depends on who's clicking and why. Do they understand the product? Are they eager to try it, or were they just enticed by the shiny button? Unfortunately, the team had no way of answering these questions. They weren't even collecting contact information from these first customers. They were just counting clicks.

(...)

This is a classic startup fallacy: "ship it and see what happens." Whenever you use this plan, you are guaranteed to succeed - at seeing what happens. Unfortunately, if you cannot fail, you cannot learn.

One way to organise the MVP-building process to ensure it does answer real questions is, of course, Hypothesis-Driven Development, covered here before.

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).

The zero-cost entrepreneur

If you try to sell things to businesses (as I do in the context of GrantTree), you'll notice a split in the mindset of people who run companies.

"Can I have it for free?"

Some people are unwilling to pay for anything. No matter how appealing the product might seem, how tangible the benefits it brings, how proven, safe, secure, universally lauded the product is, some people will try to get it for free, and not buy it if they can't.

Even if you're providing a service (which, as I've argued before, has immediate tangible value in most people's minds), they will ask if you can do it for free. Or at a 90+% discount. Or maybe you can get paid later.

In the worst incarnation of the zero-cost entrepreneur, you find people who will offer you shares in their business in exchange for your work. I call this one the worst, because I feel very strongly that founders should treasure their shares like the precious life-blood they are. Also, as previously pointed out, experienced entrepreneurs know the value of equity and preserve it. If someone offers you shares in exchange for your work, they obviously don't understand the value of their own equity - or perhaps they just think their equity is worthless. In either case, their equity is indeed mostly worthless.

This zero-cost entrepreneur mindset is more likely in young businesses by new entrepreneurs, than in later efforts. As a business grows or an entrepreneur acquires experience, a seemingly magical transition occurs. Most businesses come to a point where they decide that spending money for tangible benefits is fine. Before: "no way, we're not spending anything on recruitment, where can we advertise for free?"; after: "$350 for a Stackoverflow advert is fine if it will give us a selection of good candidates".

Even more dramatically, the mindset shifts from "we want everything for free" towards "stuff that's given away for free isn't really worth anything". This is somewhat similar to the App Store mindset that free apps are worse than paid apps, so don't even bother looking at the free apps, because your time is more valuable than the $2 you might save.

GrantTree charges a refundable setup fee to get started, and while we've had people tell us they didn't want to pay it (they didn't become our clients), we've also had others telling us that if we hadn't charged them a setup fee, they wouldn't have taken seriously (they did become our clients).

So, what's the deal here? Is one mindset better than the other? Are zero-cost entrepreneurs "bad"? Should they be lumped in with people who offer up equity for bits of work that really don't deserve it?

Credit cards and paying for things

Here's an interesting parallel with the domestic world. On a personal level, people often evolve through (at least) three phases of credit-worthiness.

First, people (at least in the UK and US) often get credit cards before they're ready for them. What happens then is sadly predictable: they overspend and get in debt. A lot of people never seem to get past this stage 0 of financial responsibility by themselves. They stay in debt, let their debt balloon, maybe declare personal bankruptcy, and at that point, they're forced by the system to go to stage 1: learning to be on top of their expenses (because they can't do anything else, since they have no credit).

In stage 1, the person learns to be financially responsible, to manage their expenses tightly enough to make sure they can always pay their rent and other essentials. Finally, once a level of confidence about personal cash flow management has been built, they can progress to stage 2: responsibly using advanced financial instruments like credit cards (which is possible!).

The evolution of business owners seems similar, with perhaps fewer people stuck on stage 0, at least in the parts of the world, outside the Valley, where money is scarce (I don't have enough direct experience of SV startups to comment here, although it does seem that they are quite willing to take on large fixed expenses without any way to sustain them other than raising further investment).

Stage 0 being a willingness to spend without control, stage 1 is the time when control is built, when founders learn how important it is to keep track of cash flow, reduce fixed expenses, etc. Since this new control is a reaction to a fear of stage 0, it is often an overreaction. "Since keeping on top of expenses is difficult, let's not spend anything".

Is it unhealthy? No, I don't think so. If you don't feel confident managing your cash flow, it's very reasonable that you should cut down your expenses as much as possible. This is why investment is dangerous to new founders: it enables them to let their expenses grow without learning the hard lessons of keeping on top of cash flow. Perhaps this also explains why so many Silicon Valley VCs feel compelled to bring in a "grown-up" to manage the business more closely, when they invest a large sum into a promising startup.

Evolving

At the same time, I think it's important not to think that stage 1 is the best place to be. Overreaction is not a healthy long-term lifestyle choice.

The healthy path is, as always, in the middle. You do need to be on top of your cash flow, but spending when it makes sense does, well, make sense.

If you can spend $100 and save yourself a day of work, you should not hesitate to do so. Even if your company is pre-revenue (perhaps especially so), being able to move quickly, when you know where you're going and how to get there without falling, is important and worth investing in. Learning to leverage your cash reserves to generate more income faster is as essential as learning to keep cash in the bank.

There are many things that need to happen in a business, and most of them are not critical for you to do personally. For those, you should bring in other people or products, and if you want good work out of them, you'll have to pay for them.

So, I guess the take-away from this article is:

  • being out of control of your spending is bad;
  • cutting down your spending to the minimum is a natural reaction to the fear of being out of control, and you should keep costs as close to zero as possible until you are in control;
  • the best situation is to be in control and have the willingness and judgement to spend money where it makes sense, rather than try to keep every cost to zero forever.

If you build it, they won't come  

Tom Buck:

If you build an application first, chances are you'll get pretty disappointed when the initial burst of announcement traffic dies down… and you're left with close to zero sales. Sure, there are success stories out there, where an app brought in megabucks from it's very first mention, but - and I'm Sorry to say it - unless your lottery numbers come up on a regular basis, this is not going to happen to you.

Indeed. It's a paradox and a fallacy: the inexperienced salesperson thinks it is much harder to sell something that doesn't exist, than something that does. Surely, if it exists, people are more likely to buy it, right?

Actually, selling something that exists only in your mind is far easier, because once you've sold something, so long as it's realistic and achievable, you can very likely create the thing that you sold.

On the other hand, when something exists already, it needs to match your customer's specific requirements in order to appeal to them. This is certainly possible - and all successful products do it - but it mostly arises when the work of building the product was preceded by an effort to discover the market.

And the best way to do that is to try and sell the product before you build it.

How to evaluate and implement startup ideas using Hypothesis Driven Development

So you've come up with an interesting idea. You think it might work. You've sketched it out using various tools like the Business model generation canvas, a business plan, an Excel financial model, etc. You're still positive on the idea and think it's probably worth giving it a shot.

What next?

One common approach is to visualise launch day and work back from there. Figure out what you need to launch some kind of initial product, and then start casting the spells and incantations required to get there (mostly in the form of code or application specifications).

A slightly better approach, which those who have tried the above method usually end up using next, after they built something that took them 6 months but was utterly useless to anyone, is to build the bare minimum that you need in order to get some users, any users, to use the system on a regular basis. This is better, and gets you feedback much more quickly than the previous method.

Even better is to aim not for something you can get people to use, but instead try to build something you can charge for immediately, even if the price is lower. This is often favoured by Lean Startup afficionados who haven't quite taken the lean methodology the whole way yet.

What do all these methods have in common? They present the unfolding startup as a series of tasks to be completed to get somewhere.

Here's a better approach.

Hypothesis-Driven Development

A startup idea is not a plan of action. A startup idea is a series of unchecked hypotheses. In essence, it is a series of questions that you haven't completely answered yet. The process of progressing a startup from idea to functioning business is the process of answering these questions, of validating these hypotheses.

Let's consider a theoretical startup to illustrate this. Let's say we're looking at building "Heroku for Django". The initial three questions for most web startups will be in the form:

  • Can I actually build it?
  • Can I get people to know about it?
  • Can I make money from it?

Often, this is the order in which they will arise, if you have some experience of web startups but are fundamentally a builder type. Making money is the last concern. "If I can get lots of passionate users who are willing to pay something, then it will probably be alright."

To apply Hypothesis-driven development properly, you will want to order your questions by priority before proceeding. This is especially essential once you break down the questions into sub-questions and end up with dozens upon dozens of questions.

The best way to prioritise the questions is by uncertainty. An initial order for these three questions might then be:

  1. Can I make money from it?
  2. Can I get people to know about it?
  3. Can I build it?

Your own prioritisation may vary, but if you're technical, "Can I build it?" will probably be last on the list. Of course you can build it. If you couldn't, you would probably have discarded the idea before even getting to this stage.

Before trying to answer the questions, you first break them down into sub-questions (please note this breakdown is nowhere near exhaustive enough, it's just an example):

  1. Can I make money from it?
    1. How much will it cost me to serve the smallest users?
      1. Which cloud platform is best for this?
      2. How many instances will I need at a minimum to run the platform?
      3. How many users will I need just to break even?
    2. How much will I be able to charge per user?
    3. What proportion of paid vs free users will I have?
    4. How well will users convert from free to paid?
  2. Can I get people to know about it?
    1. What channels are there to get the message out?
    2. How much will each of these channels cost me?
      1. How competitive are the Ad-words for this?
    3. Do I have enough contacts to get the initial, core users so the service will be useful to real users?
  3. Can I build it?
    1. What are the hardest bits of technology I'll need to put together?
    2. Can the scope be cut down so that I have a chance of building a version 1 with extremely limited resources?
    3. Which features can be put off until later?

You should keep expanding this list until you can start to see what the burning uncertainties are. These will be unique to your startup idea and to your skills and available resources. Two people evaluating the same idea will probably come up with different key questions. Once you've got those key questions (the ones which make you think "Hmm, I really don't know this and it's really important."), shift those to the top.

Then, start working through the questions, one by one or even in parallel. Most of the time, the answer will not be found in code, but in good old-fashioned research, planning, and the dreaded Excel spreadsheets. You don't need to answer all these questions with 100% certainty, but you should be clearly aware of the limits of your answers, and when the answer is really critical, you should make an effort to answer it as fully as possible. You can't know everything, but you gotta know what you don't know and how much it can hurt you.

At some point, if the idea has answered enough questions, the next most important question will require you to build something - be it a paper prototype, a landing page, or something else. When it's the most important question, do it, and do just enough to answer the question. Later, if your idea is really good, you will probably, at some point, start to do the really expensive stuff: building a real application.

At that point, with so many critical questions having been answered, the likelihood that you build something that nobody uses or pays for should be low.

Of course, you may succeed by shooting from the hip and just going for it without a second thought, but more experienced entrepreneurs will usually look before they leap.


Building a strong company trunk  

Here's an excellent article by Spencer Fry of of Carbonmade, about the importance of building out a very strong core capability before branching out into other domains.

Think Apple and Facebook — both launched with a single stripped down product — Apple's operating system (their hardware was just a delivery system) and Facebook's simple social networking: messaging and, more importantly, photo sharing. Both focused all their attention on building their trunk and then leveraged their core product to branch out.

Spencer also has some good advice for how to go about building this strong trunk: be patient, persistent, and focused.

Too many entrepreneurs think that they need to rush to become overnight successes or they'll never get there. They think it's a sprint and not a marathon. Carbonmade has been around for five years as of December, 2010. It took us three years to be able to work on it full-time, and then another year and a half before we were able to hire our first two employees. Carbonmade is only at 1% of what it'll be in five years. Patience, my friends.

Other than having patience, you need to build a stripped down, functional product that is focused on a special type of user, but at the same time something that can still be used by a more general audience. That way you aren't discouraging anyone from using it.

What's your company's trunk?

Get more out of your startup reading

How many startup-related articles do you read every day? If you're anything like me (i.e. addicted to Hacker News and other startup news sources), this ranges from 1 or 2 on slow days to more than half a dozen, maybe even a dozen.

How many can you remember reading? If you're like me a few months ago, not so many. There's the odd article that stands out, and, with some effort, sometimes you can recall what the point was. While you're reading it, it feels like you're learning useful stuff, but as soon as you close the article and move on to something else, it fades into the background noise and you forget any actionable information you had encountered.

Reading articles about startup advice should be good and productive for startup founders, but the reality is that most of the time people spend reading startup articles is much like productivity porn - something that you do to procrastinate instead of actually building your startup (or even, instead of even starting it).

There's a better way.

The benefit of taking notes

A couple of months ago, I started this site, swombat.com. Its purpose is to make use of all this time I spend reading startup articles, and turn it into something useful for others. There was a hidden benefit that I haven't realised until recently, though: I remember the good articles and their points much more clearly.

The reason for that is simple, and nothing new. When you quickly read an article (as you must if you're regularly perusing a source of news like HN), it doesn't leave much of an impression. You forget it quickly. On swombat.com, however, I try do several more things with the article:

  • I extract the key points;
  • I determine whether it's worth sharing with swombat.com readers;
  • I summarise the article so that readers will be able to decide whether they want to click through;
  • I try to relate it to previous articles that I've posted about;
  • I try to relate it to my own experiences and come up with an insightful comment where possible;
  • I write this down, make a post, and summarise it even more into a tweet.

Doing all these things forces me to really assimilate the article. Not only that, but I often glance over the articles I've previously posted to judge, a few days or weeks later, whether I posted the right kind of stuff. This reminds me of the key points from these articles and so I forget less of what I assimilated.

Involuntarily, I've created a note-taking system for startup advice articles, and the result is that I'm much better at remembering the points that were made in those articles.

You can do this too

Use whatever note-taking tool you're comfortable with. I prefer a simple notebook for this purpose, because a notebook allows you to look over your previous entries in a way that an electronic notes application does not. But the key point is this:

Whenever you read an article:

  • Extract the key points and write them in your notebook
  • Look over previous entries and try to relate it to previous articles you wrote about
  • Write down your opinion about this article
  • Try to summarise the most important point of article in one line
  • Do the above as if someone else was going to read your notes later

Doing this will force your brain to really assimilate the points of the article in a much more permanent manner. It should help you make much, much better use of all this startup wisdom out there.

An additional benefit of this is that when you will become much better at recognising empty, time-wasting articles. Those are the ones where you have nothing worth writing down by the time you get to the end. Avoid those, or at least treat them as what they are: pure entertainment.


Mocked and misunderstood  

Fred Wilson:

When your company and services gets mocked and is misunderstood by most everyone, particularly the mainstream press and media, just smile and keep doing what you are doing. You are on to something big.

Or, in Paul Graham's words:

Don't be discouraged if what you produce initially is something other people dismiss as a toy. In fact, that's a good sign. That's probably why everyone else has been overlooking the idea. The first microcomputers were dismissed as toys. And the first planes, and the first cars. At this point, when someone comes to us with something that users like but that we could envision forum trolls dismissing as a toy, it makes us especially likely to invest.

Of course, that's only true if you are actually seeing traction - although I suppose the mainstream press would not bother mocking you unless you've done something right to catch their attention.

The obligatory counter-example would be Color, which was mocked right off the bat, for good reasons, and now seems to be using its insanely high $41m pile of cash to pivot into something that perhaps will still be mocked, but will actually be used (and hopefully they'll achieve that before all the founders bail out).

Giving advice  

Advice is a funny thing. When people take your advice, they often feel like they're doing you a favour. And when it doesn't work out, you tend to get the blame.

Moreover, most people don't want advice. One of the most important things I learned in Accenture was that there's a time and place to offer advice. The right advice at the wrong time falls flat, or, even worse, causes irreparable damage to relationships. One should be even more careful dispensing advice than receiving it.

So, one should always be very careful when giving advice. That said, it's also possible to swing too far in the other direction, which I believe Jason Freedman does in this article, when he states:

Don't give bullshit advice. Don't tell an entrepreneur whether you think his idea will work. You don't know. You have absolutely no idea. Entrepreneurs have to see around several corners. They have visions for a future that doesn't currently exist. That vision currently doesn't exist because the product hasn't been made in just the right form and/or because the world is just not ready for it. Yet. And you can't predict how or when the world will change. You may have decent product intuition, but the great achievements in innovation are so massive precisely because everyone else got it wrong at the time. Don't be that guy.

Jason suggests that instead of answering the common "Do you think it's a good idea?" question, one should focus on clarifying hypotheses, advising on process (do they know their lean methods from their elbow?), making introductions to other entrepreneurs, potential customers, and investors, and providing support.

Those are all very good points, but going so far as to suggest you can't offer an opinion as to the validity of the idea is silly. Opinions are just that - opinions. No entrepreneur worth his salt will give up on the next Facebook because someone else (however important) said it was a bad idea. In fact, every entrepreneur working on anything important will be told over and over that their idea stinks and can't possibly work.

The reason you shouldn't declare assertively that such-and-such idea has no chance is really because you'll look like a complete idiot when it does turns out to be the next Facebook, after the other guy/gal ignores you (like the other 500 people who said it couldn't work) and goes ahead anyway. Save yourself the trouble, and instead, offer a tempered opinion: "Well, I can't say for sure, but I think you may have a lot of trouble with X, Y, and Z, but at the end of the day, that's just a high-level guess".

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