Growth Times

ReadWriteStart, the entrepreneur’s channel of ReadWriteWeb, nicely published an article I wrote for them called 10 Principles For Not Killing Your Startup.

With the new wave of entrepreneurs brought about by the financial crisis, I suspect the mortality rate of startups is at an all-time high. I didn’t find robust data to back my observation yet, but I did come across a page that points out that, before the financial crisis:

• the chances were six in a million that an idea for a high-tech business eventually would become a successful company that goes public;
• a venture capitalist financed only six out of every 1,000 business plans received each year;
• and bankruptcies occured for 60% of the high-tech startup companies that succeeded in getting venture capital.

Wow. Persistence is paramount.

As you know if you have visited my “corporate” blog, my mission in life is to change that. Start-ups shouldn’t die. They should live, prosper, and grow into healthy businesses that make people happy.

So I tried to identify the most frequent root causes of death, and for each, I created a principle. You will find the result here: http://www.readwriteweb.com/start/2010/03/10-principles-not-killing-startup.php#comment-195260

Please help make the list stronger by commenting and offering additional principles.

Develop, Fund, Lead, Market commercialization, Entrepreneur, entrepreneurship, managing a startup, new business, product management, Start Up, start up mortality, start-ups, starting a business, tech ventures, venture

Karen Mazurkewich, Financial Post, in an interesting article on Monday entitled “The new uber-angels” comparing the VC-fund approaches of Ontario and Quebec, declares on the Ontario Venture Capital Fund that “What Ontario didn’t — or couldn’t — predict was the lack of potential co-investors for these funds.”

Karen, I would invite you and Ontario’s decision-makers to step up your due diligence and review Growth Times’s August 4th, 2009 blog post entitled “Who Will Match Ontario’s $250M Emerging Technologies Matching Fund?”……………..

Really, was it that hard to anticipate? Ontario could have predicted this, but there were political and financial forces at play and incompetence at the top. Let me guess that the persons in charge will actually get rewarded with more assignments and rewards for their mistakes, while the rest of us in the private sector get to work harder to actually make innovation happen.

[Addition to the post following subsequent inputs I received: the setup of the Ontario Venture Capital Fund remains such that Business Angels can barely play. The restrictions pretty much rule it out ($1MM min investment, full net worth disclosure, etc.). They should reduce the barriers for Angels to participate, given they are one of the few true sources of capital these days.]

As a rule, I am starting to realize that the public institutions in this province, and that includes a lot of the nonprofit hubs, are not quite designed to really encourage innovation. Except in rare cases, they are designed to grab taxpayer’s money and redistribute it to their supporters based on loyalty, not performance.

One thing Ontario and Canada really needs to get urgently, is that smart regulation has much more leverage than direct intervention. If Ontario really wants investments, it should work to repel section 116 to get American capital flowing here.

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Canadian entrepreneurs, Fund Due diligence, Financial Post, Financial Services, innovation, Investment, Karen Mazurkewich, Ontario, venture capital

Josh Kopelman, Managing Director of First Round Capital, wrote a great post today building on Fred Wilson’s VC math problem, and call Why VC Performance Has Fallen Off A Cliff.

I argued in a recent post that in parallel to the “moonshot” approach Josh rightly describes as the norm for VCs,  there must be a model that focuses on extracting revenues from a portfolio of tech companies with lesser risk.

Overall, it’s pretty clear to me that what we call VC companies should cover the entire risk-return frontier for any early-stage tech company, because that would allow large investors to place their bet as they like in this category. I’m not suggesting VCs turn into bankers or private equity investors, but there is a clear case for filling the early-stage funding gap towards tech ventures that hold less risk and more proven revenue models than moonshots.

For all the analytical firepower of VCs, it feels a lot like playing this field is still an art not a science. If really, VCs take a classic portfolio approach to early-stage returns, like I’d argue they should, then risk-return is a continuum and the industry ought to cover it entirely to offer interesting options to large-fund investors.

Which brings me to this: the expectation of a 20% return yearly is completely unrealistic, when the average growth rate for the world economy is 2-3%  (tidbits from my finance classes at Stanford – I don’t think our average growth rate has gone much above that since I finished my degree there…) If VCs as an industry grows faster than that rate, then by definition it will have to return to the mean (back from the moon) sooner or later, hence the cliff. Risk has nothing to do with this, since we are talking about a risk-return continuum in a vast portfolio managed by the entire VC industry – over time the failed companies bring you back to that 3% mean.

If you can do better than 2-3%, or say 5% to be a bit more optimistic about the growth capacity of our system, then you’ve nailed some distortion in the market and/or you’re taking more risks than you should. It’s hard but possible to do that as an investor, but impossible to do it sustainably as a large industry. Sooner or later, the industry will lose big, just like gamblers. Keep in mind again that I am talking about the VC industry as a whole, not individual players here – there is much variability there.

The problem with promoting those 20% rates is that it fuels hype and bubbles – the only viable mechanism to achieve those returns for the entire VC industry, if not a sustainable one. So I think it would be great if VC as an industry could stop pretending it can do much better than the mean, and focus instead on offering a decent continuum of risk-return options to their investors based on early-stage plays. From that angle, VCs are just expanding the range of investment options available and that, I think, would be good enough for everyone.

Unfortunately, the current system is set up to create monopolies of sorts by maintaining a complete imbalance between money pools and money needs. VCs are encouraged to bet on moonshots because that’s how, individually, they can make it and retire (with that feeling of intellectual superiority one gets for betting on the right horse at the tracks). They don’t lose much money on failed investments, but they make tons on successful ones, so of course they swing for the fences. The first thing VC firms should do is take a good look at their compensation system and rehaul that.

As things go well and returns grow, a few investors that actually beat the mean quite consistently (there will always be some – they are the right dots in the normal distribution of investors) make everyone hope over time that they can too – and thus the system as a whole progressively takes more risk without realizing it.

Meanwhile, companies with a lower risk-return ratio – but not low enough to warrant a bank loan – have a heck of a time finding money. Angels fill some of that gap, but while they’ve structured themselves greatly in the past few years, they don’t have the discipline a VC firm could bring, which only would attract the big money from the big funds.

Unlike what some observers think, I’m convinced the VC system is here to stay. But not without adjustments – either angels will structure themselves more and more to fill the void VCs left, or VCs will get back in there as they should. The overall lesson as a VC is that you can shoot for the moon if you wish, but keep your feet on the ground, because your industry will go back to the mean sooner or later.

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Fund Financial Services, First Round Capital, Fred Wilson, Fundraising links, Josh Kopelman, Private equity, start-ups, tech venture, venture capital

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To any current or would-be entrepreneur, I highly recommend the following video of a presentation this month by Aaron Patzer, CEO of Mint, which was recently sold to Intuit for $170 million.

At first I thought it was a bit long, at 22 minutes, and so I figured I’d only watch the first few minutes. 23 minutes later, I am writing this blog post. Aaron goes over the start-up creation and growth process in practical details, even presenting slides from his own original pitch.

One thing, I’m not a fan of the first advice he gives, about focusing entirely on the product and hiring only engineers when you start, which has some truth to it in a number of situations but can lead to complete trainwrecks in others. Someone on the team needs to tie your development to a market need and a winning revenue model – it may not have to be a business person, and a well-atuned engineer can do that as Aaron shows, but it’s got to be someone with a certain ability to think ”market”. Leaving that detail aside, his advice is a gem.

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Develop, Fund, Market, Scale Aaron Patzer, entrepreneurship, Fundraising links, growth stages, Mint.com, Start Up

Varun Mathur, the Techvibes Community Manager, who I just learnt is based in Toronto (I look forward to meeting you, Varun), made an excellent point yesterday in his Techvibes post on What Separates 37signals And Twitter ? 

For all the talk about “getting to revenue” as fast as possible, VCs are still valuing companies based on hype and unproven potential for exponential revenues. You can build valuations based on traffic, but if you can’t attach a realistic average $ amount to a visitor, and if you are going to hemorrhage your traffic as soon as you offer ads, then your valuation is built on shaky grounds – which in finance means you should likely be extremely conservative or discount it.

I don’t say there is never a case for giving high valuation to companies that have great brand awareness and usage even if they haven’t made a buck yet, but my thesis is that the risk of this revenue never materializing should lead to discounting valuations more heavily than they currently are. VCs should put their valuation through a simple risk-based, probabilistic tree analysis, contemplating the likelihood of 3 basic scenarios:

1. will never get to revenue and can’t sell or IPO company
2. can never get to revenue but can get company acquired
3. can get to revenue (and then look at the different types of revenue to differentiate linear from exponential in particular)

The problem, which ultimately has to do with the probability and payoff you attribute to each scenario, is especially with number 2. Even in this market, founders and VCs can rely on overpriced acquisitions to unload a company to an unsuspecting acquirer (hello eBay).  And so, with the right connections, the probability of scenario 2 is still implicitly weighted higher than it should likely be in VC valuation models.

My theory is that the Silicon Valley is an echo chamber for tech venture hype (just like Wall Street for blue chips), and a lot of founders and investors are masters at amplifying and riding this wave – rather than focusing on actually creating a revenue engine. In other words, ladies and gentlemen, yes, there are a lot of respectable-looking scammers in that business, and very successful ones too.  VCs won’t tell you this but lots of them love embracing irrational exuberance, because bubbles is how they get rich quick. 

Right now the real-time web is where this exuberance can be found. To Varun’s point questioning whether 37signals didn’t get Twitter-type valuation because of its Chicago location, I would add that perhaps the main reason why a valley-based Twitter will get a higher valuation than a Chicago-based or Canada-based twitter is that irrational exuberance dies off quickly when you have to take a 5h flight to close an acquisition -  reality-distortion fields don’t work well that far from the epicenter of the tech mecca. Locations that can turn perception into reality have a clear edge in businesses that rely on hypothesis for their valuation. So, yes, if 37signals want to reach astronomical values, it would do well to move to Mountain View or Palo Alto, drop any source of revenue, and change its name to reduce the likelihood their past revenue figures will constrain their future valuation.

However, that’s not all. In all fairness, one must point out that the potential for exponential revenues by 37signals as a platform developer targeting, well, application developers, is lower than a Twitter that can be used by potentially anyone. There is a lesson here for business models. Based on whether you target revenue or fundraising, your runway and product mix looks very different. In the first case (seeking revenues), you often need to diversify across a small range of products to test and create multiple sources of revenues – alpha, beta and subsequent market iterations are less dangerous because they don’t impact your long-term success as badly as a highly hyped flop from a VC-funded venture. You can fix things, there is less pressure to grow to $100M in 5 years, and quite often the decision to give you money is distributed across many potential users as opposed to concentrated on just a few VCs (who know and speak to each other).

In the second case (seeking capital), you often have only one chance to build buzz, and if it fails to support your story, it’s unlikely you’ll raise a round, and it’s likely you’ll die of capital thirst. So you want to bet the farm on one-single make-or-break application. It’s a different discipline. But still, the problem remains in the fundraising model, that it doesn’t encourage you to build your product with a revenue model in mind, until often too late in the game.

All in all, that’s a real problem for venture consultants like me as we generally encourage start-ups to get to revenue asap, and then a Twitter investment by VCs reactivates pipe dreams that all you need to do is a cool app and you’ll be a millionaire. If you are after VC money, it’s better not to make revenues if those are going to disprove the revenue potential of your model… Maybe that’s why new VCs need to emerge that don’t take a “winners take all” approach to investment, and instead focus on growing real revenues across their portfolio. Mmm, sounds like a hybrid of VC and management consultant… Did I just evolve my model? Thanks Varun!

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Develop, Fund 37signals, Capital Access - Financing, Initial public offering, monetization, revenue generation, Revenue model, Silicon Valley, tech venture, twitter, valuation, valuation model, venture capital

I have just added a reading list on Growthroute’s website, to help clients, prospects and would-be entrepreneurs quickly identify some key reference frameworks that drive our actions. If you exclude the all-time classic of Peter Drucker, Innovation and Entrepreneurship, which deserves its own section, this list is divided in 6 parts, inspired by the Develop/Market/Fund/Scale framework Growthroute uses to classify the type of actions and projects we work on with entrepreneurs:

• Broad guides on entrepreneurship: those books attempt to cover the whole entrepreneurial process, from generating ideas to building them to marketing them and financing them. Some of those books, such as Richard C. Dorf’s Technology Ventures: From Idea to Enterprise, are used at MBA and commerce programs, while others are established general references.
• Develop: books in this category primarily help readers figure out where to start, what market to target, what product to launch, and what go-to-market to pursue. This category includes thesis books such as Crossing the Chasm (my personal favorite), Blue Ocean Strategy, or the Innovator’s Solution, and other strategy pamphlets.
• Fund: this contains guides to raising money from VCs and Angels. There are generally less references in this category, I think primarily due to the more limited consumer appeal of the topic, and the general focus on learning by doing rather than by reading in that field. This said, I think the books listed here are excellent introductions to the topic.
• Market: it’s one thing to build a great product and another to get it spoken about. Or is it? In my opinion, an integrated promotional strategy using the product at its very engine and a select channel mix works best. Those books focus on that, i.e. making your product as “word-of-mouthable” as possible and effectively leveraging the right delivery mechanisms to amplify the buzz. If you read only one, then I recommend Chip Heath’s Made to Stick: Why Some Ideas Survive and Others Die. By all criteria, this is the bible of buzz.
• Scale: so you have a great product and some market traction? What next? These books help you structure the organization for exponential growth, keep the momentum going and reap the dividends. Blueprint to a Billion: 7 Essentials to Achieve Exponential Growth, by David G. Thomson, is probably the most straightforward and useful reference on this topic.
• Lead: this really is a sub-chapter of the “scaling” section, but the importance of good leadership cannot be underestimated once your organization starts to grow and founders have to rely on others to get stuff done. Those books make excellent points on management practices and are designed to make you think about your own approach and style. Chris Bradford was my professor at Stanford and his book Power Up: Transforming Organizations Through Shared Leadership, is the one that made me the most about leadership styles.

Lastly, I also listed a must-read for anyone planning to rely on business book theories to drive their companies: the Halo Effect, which argues that business book authors often confuse the causes and consequences of the business “best practices” they advocate. In our reading list, I have tried to avoid authors who do that, although even some of the books I listed fall for the halo effect at times. But one thing is certain, you won’t find Good to Great here!

Let us know what you think of those books and please do ping me if you feel like I missed any that should figure here.

Develop, Fund, Market, Scale business classics, business reading list, Entrepreneur, entrepreneurship books, Publications, start-up books, top business books, venture reading

It’s official, the Ontario’s Emerging Technologies Fund (ETF)  is now open for business. This $250-million fund will co-invest into companies in high-growth sectors such as clean technology, life sciences and advanced health technology and digital media and information and communications technology. Co-investments are made along with qualified venture capital funds and other private investors. For more information see http://www.ocgc.gov.on.ca/

I am generally not a fan of public sector intervention in the private sector, but this comes as a positive move in contrast, since the government has wisely decided to let VCs and angels screen investments for the fund money instead of trying to do it itself. And frankly, after distorting the economy through massive subsidies to under-performing foreign car manufacturers, any public money directed towards innovative ventures is welcome. It also comes as somewhat of a relief to the Venture Capital industry in Canada, which is doing much worse than in the U.S. (yes that’s possible, apparently!), and is down to almost nothing according to this report by their association. Not that there was much in the first place!

The main question is whether there will be dollars to match. In other words, this program unlike, say, SR&ED, doesn’t make investments more attractive. It just makes it possible to invest in more companies. Since the VC model is under attack for its supposedly poor returns (with arguments I am still quite skeptical about, but that’s another story), all eyes are turned towards them to see whether they make use of that fund, or it goes primarily to Angel investments. After all, as the book Fool’s Gold asserts (thanks to the National Angel Capital Organization for the link), Angels Finance 27 Times More Start-ups Than VCs, at least in the US.

To ventures who wish to apply for a slice of this pie, my recommendation is to work both on your frontend, i.e. ultra-targeted pitches, b-plans, networking with VCs and Angels, influential advisory board, and your backend: management team, sales process, go-to-market and scaling strategy, monetization, exit. Those are both sides of the same coin, and unfortunately one of them often get neglected. Needless to say, we can help.

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Canadian entrepreneurs, Fund Angel investor, canada, Canadian innovation, emerging technologies fund, Ontario, venture capital

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Fund, Market business case, customers, Revenue model, technology commercialization, venture capital

My friend Fred Sweeney of VG Partners pointed me to this interesting call for help by the biotech industry in Canada, whose start-ups are finding it difficult to raise money to survive, let alone thrive. In these times of hardships, the ventures with the least obvious path to commercialization and revenue are the ones who suffer first and most. Given the lengthy development cycles and uncertain payout, biotech ventures evidently stand at the frontline of the crisis.

What all that shows is that a start-up should at all times be able to articulate the revenue model it is proposing to pursue. It should tie all its current efforts to this model, or “reverse-engineer revenue” as per the expression I coined at GrowthRoute. Doing just that provide three benefits: one, you stand in first row against competing start-ups when comes the time for VCs to hand out cash; two, keeping your eyes on the prize helps you identify where to focus your efforts today, and better allocate your current resources; three, spending some time thinking about how you will make money could point to nearer-term sources of revenue you may not have thought of.

Without a destination and a map to get there, you can have a tight ship and yet run it in circles. Better to never count on the government to get you back on track.

Develop, Fund biotech, biotech industry, business model, canada, commercialization, customers, eyes on the prize, Fred Sweeney, government programs, innovation, innovation entrepreneurship, Revenue model, Technology, technology commercialization, venture capital, vg partners