November 12, 2013
Nearly every week, I receive an email from one of our portfolio founders that reads something like: “Hey, Eric, great news! We just got out of a meeting with Dave from AwesomeVC and he loves what we’re doing. I have a good feeling he’s going to lead our Series A round.”
Not long after, a few more superenthusiastic emails follow about the high probability that other VCs are also very interested and how the founder expects to wrap up the round quickly and painlessly.
Then the balloon deflates. One by one, the VCs pass on the round, and the founder has to break the news to the co-founders, employees, and existing investors. He’s completely dejected, his team is now concerned about running out of money, and his initial investors fear they may have funded a dud. How could he have been so wrong about the interest level of the VCs? They seemed genuinely excited; what went wrong?
The problem is that venture capitalists often give off signals that are inconsistent with the real probabilities of their actually making an investment. Venture capitalists are not just buyers of companies; they’re also sellers of capital–meaning that because the best deals are competitive, investors use enthusiasm to increase their chances of winning (should they ultimately decide to invest). That’s not to say their enthusiasm isn’t genuine; it just doesn’t necessarily reflect their likelihood of investing.
Every VC is different, but here’s a breakdown of a few steps in the investment process to illustrate how a founder’s expectation of closing a deal differs from that of a VC’s. This is far from a scientific analysis, just a general sense of the numbers from my experience.
The VC Invites You to Pitch
Likelihood You’ll Get Funded:
In your mind-10% In reality-<1%
Most VCs take a few hundred meetings a year and fund one to three investments a year. Founders typically get in the door with a strong personal introduction from a mutual contact, which can lead to the assumption of real interest from the VC. Don’t get excited about getting a meeting; VCs are paid to listen to you pitch.
The VC Invites You to a Second Meeting
Likelihood You’ll Get Funded:
In your mind-50% In reality-10%
Being invited back happens right away, and
it can make you feel that momentum is building. Unfortunately, I’d estimate that the
typical VC quickly invites back 20 to 40 companies a year after a great first meeting.
The VC Invites You to a Partner Meeting
Likelihood You’ll Get Funded:
In your mind-90% In reality-50%
After multiple meetings and due diligence, a VC will often invite you to pitch the partnership. Although some firms really do rubber stamp investments at partner meetings, I’d estimate that about half of these investment discussions vaporize at this point. Frequently, the partner leading the deal loses enthusiasm after facing the crucible of his colleagues.
The VC Offers You a Term Sheet
Likelihood You’ll Get Funded:
In your mind-100% In reality-90%
This is often the most painful disconnect between founders and investors. Most founders consider a term sheet to be a 100 percent guarantee of financing. Unfortunately, my experience is that 1 in 10 term sheets self-destructs. When the term sheet comes, you shouldn’t take closing for granted.
Why does any of this matter? Raising money is like any other sales process, only the
consequences of failure are usually much more significant. Qualify your prospects accurately, make contingency plans, and don’t appear naive by overestimating the odds of a close. Once the deal is done, then you can celebrate.
A version of this post was originally published on Inc.com http://www.inc.com/eric-paley/what-to-expect-when-expecting-funding.html
November 5, 2013
Most of the business advice you’ll receive as a start-up CEO seems obvious. In fact, it’s rare that an investor or adviser makes a suggestion that you have never considered. More often than not, the suggestion is, in fact, probably already being implemented at some level.
Your company isn’t scaling as quickly as planned, and a board member says you need to boost sales. “No kidding? Thanks for letting us know,” you sarcastically think to yourself. Even the more concrete suggestions from experienced advisers or team members often seem either painfully obvious or just a regurgitation of things the company is already doing or has tried before. From your viewpoint, it can feel demeaning, because it suggests that your job is so easy that people think they can do it by giving generic advice while sitting in the cheap seats.
At times, real life can resemble that TV commercial in which a bunch of businessmen in suits sit around a conference room making insanely obvious statements and the tag line is something like, “If business were this easy, you wouldn’t need us.”
No matter how obvious these suggestions may seem, take a minute to really consider the magnitude of your efforts. When it comes to operational issues, your start-up often succeeds or fails in accordance with the degree to which your company embraces these seemingly obvious ideas or suggestions. The advice may not seem earth shattering, but very often it is the successful companies that embrace that advice and put forward a serious effort in following it.
Take, for example, an exchange between you, the founder, and an investor. The investor is concerned about the quality of your customer development and advises you to get your hands dirty spending time with customers. That’s completely obvious to you, and you respond that you’ve done so and will continue to do so.
Box checked and issue resolved, right? Not at all.
Yes, technically you are talking to customers, but are you doing enough of it? Because you are already talking to customers, it’s very easy to shrug off the advice and move on. However, that advice typically reflects the investor’s concern about the scale of your efforts. In this instance, the investor is trying to tell you that whatever amount of customer development you’re doing, you need to do much more.
When I read Delivering Happiness, by Zappos CEO Tony Hsieh, I found the book both incredibly insightful and incredibly obvious. The book explains Zappos’s formula for success–putting the customer first and offering delightful customer service. Most of what Hsieh writes about probably seems familiar to any founder. What business doesn’t want to put the customer first and offer delightful service? The difference between Zappos and most other companies is one of magnitude. Zappos manages to do so at a completely different level than almost everyone else.
As a CEO, you should never blindly follow the advice of anyone–be it a team member, a board member, or an adviser. After all, whatever the outcome, it ultimately belongs to you. But you do need to seek out the best advice to figure out the right answer. Sometimes, the right answer comes from someone in a way that initially seems painfully obvious.
A version of this blog was originally published in the November issue of Inc. Magazine http://www.inc.com/magazine/201311/eric-paley/why-you-should-listen-to-obvious-advice.html.
September 25, 2013
I read a good number of blogs. I still like magazines. I love books, and I wish I could find time every day to read the newspaper from front to back. I also have great respect for academic writing.
Formal prose, however, has no place in a start-up. While I was working on Brontes Technologies during my second year in business school, our team entered both the Harvard and MIT business-plan competitions. Both contests required the submission of a written business plan. Our plan was 42 pages. It was obsolete before it was even completed.
The judges seemed to have skimmed it, as did our academic adviser, but I don’t think they really read it. Even if they didn’t read it closely, they read more of it than anyone else ever did. We shared it with some investors, but it was clear they never read it. We never referenced it again ourselves. We never gave it to new staff members to help them understand our business. We never edited it as our business changed. We never really used it in any way. It was little more than academic.
No matter how gifted a writer you are, slide presentations, or decks, are a better way to get your message across. Quick to read and easy to edit collaboratively, slide decks are a much more concise way to express an idea for discussion and decision making. Prose is great for one-way conversations, but it
falls short for any type of engagement in a group. Ultimately, prose is not agile enough for start-ups.
Start-ups need to move fast, organize their goals succinctly, and edit on the fly. I’ve never seen a start-up go back to rewrite the marketing section of its business plan after rethinking its marketing strategy. I have, however, seen many start-ups in the same situation rip up the marketing slides in their slide deck and insert the updated ones.
This concern doesn’t apply just to business plans, either. Prose should be used sparingly in all types of business communications–annual plans, formal specifications, etc. As an investor, I’ve noticed that I have a very strong bias against teams that send me executive summaries. I rarely read them when they are one page long, and, unfortunately, most are four pages. This is your opportunity to make your company’s narrative inspiring and compelling–don’t waste it by submitting the equivalent of War and Peace. When I get an executive summary, I immediately ask for a deck, which I find much more energizing (when well executed) and digestible.
I think the formal business plan is a relic of the start-up business-plan competitions that originated at academic institutions. If you apply the academic mindset to a start-up, then it probably does make sense to start with a written thesis on the opportunity. Unfortunately, it took me a full year to write my undergraduate thesis, and I don’t remember anyone ever reading it outside of the professors responsible for grading it. I would encourage academic institutions to replace the traditional business-plan competitions in favor of pitch-deck competitions.
As for entrepreneurs, my advice is to discourage your team from writing prose whenever possible. If you want to tell a story, tell it in a compelling and concise narrative slide deck. If you have an argument to make, do it live in a team meeting. If you want to codify what has been agreed to on any aspect of the business, build concise slides that are easily digested, shared, debated, and edited as a group. If you want to slow your business down, stifle real-time discussion, and prioritize the argument over the outcome, write prose.
A version of this blog was originally published in Inc. Magazine http://www.inc.com/magazine/201310/eric-paley/writing-advice-for-start-ups-and-entrepreneurs.html-
August 29, 2013
I’m a big believer in the key tenets of Steve Blank’s The Four Steps to the Epiphany and Eric Ries’s The Lean Startup. Particularly, I like to see start-ups follow the authors’ approach to finding what both call product/market fit.
One of the key concepts of product/market fit is that you should not start to invest in building your company until there is evidence that the product fits a need in the market. Blank and Ries encourage start-ups to get their first product in front of customers quickly, get feedback, then tweak their product accordingly. That’s great advice–scaling a sales force and infrastructure to sell a product that the market does not want can be catastrophic to a start-up.
Unfortunately, the pendulum rarely swings halfway, and I’ve recently noticed a worrisome trend among many start-ups. Entrepreneurs are building good products, putting them in front of customers, getting solid feedback, and then iterating into infinity in search of something they will probably never find. In most cases, the product is viable, but it isn’t magically obvious that it is extraordinary.
Many entrepreneurs seem to be waiting for their product to go viral before they actually build out their businesses. Although it’s fantastic to see companies grow without paid marketing, many outstanding companies have been built on products that have never gone viral. Some products just require a more meaningful marketing investment to educate and acquire customers before they achieve success.
Look to other metrics besides how fast your company is acquiring users to determine whether you are ready to scale up. User engagement metrics like net promoter score are very powerful in determining whether your product has satisfied users and you are ready to invest in growth. Even those numbers will never be perfect, but they should give you confidence to take a leap and believe your product will work for a large enough group of users.
Scale tends to breed scale. Start-ups often need to get some type of critical mass of users before their products start to be fully appreciated and begin to spread more organically. Malcolm Gladwell explores this phenomenon in The Tipping Point. Without making some efforts toward scale, you typically won’t have the possibility of the market tipping in your direction.
Furthermore, when you begin to intelligently scale up, you can then start to focus on the challenges of marketing and selling the product. Those areas are also critical to long-term success and will require just as much hypothesis testing and iteration. As the company gets good at overcoming these challenges, you then have the opportunity to show some pretty impressive evidence of product success that might not have been possible with a smaller user base.
When scaling up, do it rationally and sustainably. When a seed-funded company goes to investors for the next round of funding, the first question typically is, how much traction with users does the company have? Some churn is to be expected, as are some product problems.
Investors don’t expect a perfect product, but we do relish analyzing a business’s customer growth and engagement. If your company has a product that looks solid but hasn’t demonstrated the ability to scale up, you are going to find yourself meeting with lots of VCs and falling victim to the Series A crunch.
Of course, you should continue to improve your product, but don’t wait for some magical moment to start building the rest of the business. Sometimes product is the reason a company isn’t ready to scale, but often the culprit is the insecurity of the entrepreneur.
Originally published in Inc. Magazine http://www.inc.com/magazine/201309/eric-paley/no-product-can-be-perfect.html
July 2, 2013
Getting fired from the company you created is probably the last thing you can imagine. Unfortunately, it’s a fairly regular occurrence that can have devastating effects on both you and the company.
Dismissing a founder is never an easy decision for a board to make. In general, investors have good reasons to want to see you lead the business to long-term success. You are the person who got the investors excited about the company and sold them the vision, and you are the person they bet on to lead the company. Start-ups have lots of luck hiring managers but generally little luck hiring visionaries. Not to mention the fact that hired CEOs are quite expensive.
But boards have an obligation to investors to do what is in the best interests of the company, and if you give them no better option, they will get rid of you.
I have found that there are a few failure modes–fireable offenses, so to speak–that ultimately persuade a board to replace a founder. Here are the three most common.
Fireable Offense no. 1: Failing to Address Real Problems
In my experience, the most frequent failure occurs when founder CEOs don’t confront the hard facts. You get so invested in selling the grand vision of the company that you fail to deal with the challenges that the company is facing every day.
Moreover, fear of appearing incompetent can cause you to downplay any problems in the business. By failing to address those challenges, however, you start to lose all credibility with the board of directors. I’ve seen CEOs who insist that things are going well, even though the company is demonstrably far behind plan. It is nearly impossible to take meaningful corrective action as a company when a CEO is insisting that everything is rosy.
Fireable Offense no. 2: Neglecting Functions Outside Your Comfort Zone
Most founders have expertise in a single area–be it engineering, product, or marketing. Staying within your core experience and neglecting other areas is a common problem. For example, I see lots of founders who come from product backgrounds (my bias as the best background for a start-up CEO) and fail to recruit and manage a great sales and marketing organization.
Too often, they undervalue the importance of less-familiar functions to the company’s success. When a product-experienced CEO is struggling in all areas but product, that person should probably consider stepping down as CEO and simply running product.
Fireable Offense no. 3: Not Recruiting an Awesome Senior Team
Founders are frequently threatened by leaders with more experience. Perhaps you worry that the board regards senior managers as your potential replacements. In my view, however, the best evidence that you should stay in the CEO seat is if you demonstrate the ability to recruit and lead a team of experienced functional leaders. If outstanding talent is willing to work for a less-experienced but inspiring CEO, that’s evidence enough that you are doing a terrific job as a leader.
To be sure, I have seen numerous underperforming start-ups whose board members are so impressed with the founder that they find it simply unthinkable that anyone else would lead the company. If you can manage to avoid the mistakes above, you’ll earn the support of your board, and you’ll stay in the CEO seat long enough to get the business back on track.
Originally published in Inc. Magazine http://www.inc.com/magazine/201307/eric-paley/how-not-to-get-fired.html
June 4, 2013
Back in 1995, I purchased a used Mac laptop via auction on the Internet. The company that enabled that transaction doesn’t exist today. That same year, eBay was founded and today is worth $68 billion.
Amazon wasn’t the first company to sell goods online. Google didn’t invent search, and Dropbox wasn’t the first server-based storage offering. Pick a successful company, and you can almost always point to the sad story of a failed predecessor that had the same core idea.
When the movie The Social Network became a commercial success, many of my friends outside of the technology industry asked me what I thought of Mark Zuckerberg stealing the idea for Facebook from the Winklevoss twins. I told them that the technology community thought the Winklevoss claim was laughable and opportunistic.
Facebook is far from an original idea. Social networks had been around for nearly a decade, in companies such as SixDegrees, Friendster, and Myspace. Facebook’s success didn’t come from the idea but instead from countless ideas and iterations around product implementation, go-to-market approach, and customer engagement.
In October 2002, my co-founders and I started Brontes Technologies, a company based on an invention created at MIT that used 3-D imaging to enable mass customization in the dental industry. Numerous venture capitalists passed on Brontes after their technology advisers told them that the idea behind the technology was highly risky and probably wouldn’t work.
They were right.
By late 2004, we had abandoned the initial technical idea on which our business was created. But although those VCs were right that our idea probably wouldn’t work, they were wrong not to invest. We made the necessary changes and eventually were acquired by 3M–which provided a healthy return for our investors. Our doubters incorrectly assumed that the company was built simply on our initial idea, rather than the problem we were trying to solve and the people working to solve that problem.
I believe this is why the technology community has so much disdain for our patent system, where nonpracticing entities–otherwise known as patent trolls–that have never faced the challenges of building a product or a business can make claims solely on the basis of simplistic ideas. The system vastly overvalues ideas and undervalues execution. (And it’s still a pain to use; see “Patents: The Race Now Goes to the Swiftest.”)
Great entrepreneurship is in the execution. Rarely does the initial idea dictate the outcome-;perhaps never. Success is about the thousands of ideas and decisions that are made along the way and the speed at which those insights are implemented according to customer needs and feedback.
So are ideas worthless? I wouldn’t go that far.
Every company needs a starting point. I encourage entrepreneurs to focus more on falling in love with the problems they want to solve rather than their initial ideas. As founders dig deeply into that original hypothesis, they will learn, adapt, hit walls, adapt again, and build critical expertise that they never considered when starting out.
In fact, in many cases the original idea later seems humorous or at least incredibly naive compared with the lengths to which the start-up needs to go to become successful. Like scientists, entrepreneurs solve problems through a tremendous amount of work validating and invalidating early ideas-;not from a single spark of inspiration. Great entrepreneurs build their success over time, not in a single moment. Ideas are static. Entrepreneurship is dynamic.
Originally published in Inc. Magazine http://www.inc.com/magazine/201306/eric-paley/a-great-idea-is-never-enough.html
May 6, 2013
Venture backed startups are incredibly ambitious. A startup team comes together to try to create something highly improbable and well beyond what can reasonably be expected given the scarce resources at hand. Once financed, everyone at the startup should have a reasonable salary, but the real compensation for achieving the improbable is the equity that is typically shared between all employees proportional to the expected contribution of each person.
Inevitably, I get into a discussion with my companies about bonus packages. The idea being that startups are cash constrained and should limit the guaranteed salary costs, but that if the company is achieving goals, it should reward its employees with non-guaranteed compensation for a job well done.
The logic is compelling, but faulty. Bonuses are toxic at startups.
Outside of sales rep commissions, I don’t think startups should be giving employee or management bonuses in the early years and not until the company has very well understood financial performance. The problem is that bonuses don’t match well with the audacious ambition of the startup and aren’t fair to the company or the employees.
Inevitably, startups don’t quite live up to their goals. Using revenue metric.s because they are simple, consider the startup that has $3MM in previous year revenue and is hoping to 4X that this coming year to $12MM. Instead they do $9MM in sales. The team bonus is based on hitting or exceeding the goals. The team has worked really hard and, by all means, has done strong work growing the business. Yet they’ve fallen short of the goal. Unfortunately, somewhere over the course of the year, the team members start to assume that they will get the bonus. After all, the team tripled the business and worked really hard to do it. Yet the bonus was clearly for meeting or exceeding the goals. What should the company do now? Disappoint their hard working team by not giving a bonus or give the bonus and suggest that the goals are soft goals and the team will get paid as long as there is general progress and the team works hard. Add to the scenario that at $12MM in revenue the company would be positive cash flow for the first time and have cash to pay a bonus and at $9MM the company loses $1MM and will need to raise more capital and suffer additional dilution to cover the loss and potentially the bonus. It’s easy to imagine employees leaving the company and saying that the goals are crazy – “we tripled the business and didn’t even get our bonuses.”
Most companies just pay out the bonus anyway. Did that make the employees happy? Not really. They expected it. Did the bonus help set the ambitious goals for the next year? Not really. Paying the bonus below the goal suggested that the goals don’t really matter, which undermines the idea that the bonus is a form of motivation that leads to retention.
Worse yet, bonuses are not effective at recruiting employees. Most people that I know are a bit skeptical of bonuses before they join a company. They have no idea how ambitious the goals are or how likely they are to achieve the target bonus. On top of that, there is an ego element tied to salary that is absent in bonuses. All other things being equal, most people would rather join a company offering $100K a year in salary than make $90K a year with a potential target bonus of $20K. That isn’t so much an issue of risk aversion, but more of self assurance that they are worth $100K salary combined with the unknown of how likely they are to get any bonus at all.
Bonuses also create a culture of sandbagging and therefore are a bad motivation tool. Instead of wanting to achieve incredibly ambitious goals, employees start to consider whether the goal is likely and whether they will achieve their bonuses if they accept an ambitious goal. By arguing for lower goals, employees are optimizing for getting a bonus while actually working counter to the interests of the company.
Why are large companies different? At large companies goals are not as ambitious (10% growth vs. 200% growth) and employees typically don’t have the equity potential that they have at startups. Most importantly, financial goals are much better understood and typically achievable. Startups forecast based on what’s possible. Large companies forecast based on what’s probable. It’s esier to bonus employees on the later than the former.
So bonuses aren’t a good recruiting tool. Or a good retention tool. Or a good motivation tool. For these reasons, bonuses damage culture and focus the team on the wrong objectives.
What compensation tool is effective for recruiting, retaining, and motivating employees at a startup? Equity. Pay employees a fair salary for the stage of the company and keep everyone aligned to the extraordinary equity potential of huge growth. If the company achieves a 4X plan, the company’s equity has appreciated more than if it achieves a 3X plan. When employees don’t quite achieve plan, they understand that the equity hasn’t appreciated as much, but they are still rewarded for the forward progress with assumed appreciation of their stock. Employees have no financial incentive to sandbag because trying to achieve ambitious goals is how they maximize the equity reward. Best of all, equity has the potential of paying out orders of magnitude higher than any potential bonus.