Anything's Possible

Back in 2005 at Brontes, I was working hard with our VP Engineering, Ed Tekeian, to convince a talented engineer to stay at the company and not take another job offer.  I was struck when the engineer said to us, “guys, I respect you, but I really don’t know why you’re making such a fuss out of my leaving.  I did a fine job here, but really only did what I was asked.  In truth, I’m very replaceable.”  Ed responded, “The more that you manage people in your career, the more you’ll find that it is very hard to find people who can execute well on what they are asked to do.  Don’t underestimate how valuable you are and how hard it will be to find a replacement.”  It was a very candid moment of talent assessment in which the bar of performance wasn’t innovation, but simply competently executing the expected job.  Ed was right, finding people who can do the job that is asked of them is quite hard.

When it comes to assessing talent, I’m not a believer in grade inflation.  Most people are C performers. C performers struggle to competently fill their role, but are somewhat productive with sufficient coaching. Hard to admit, but most people in the business world don’t have a particularly clear idea on how to do their job well.  It’s not just a question of experience.  I’ve seen very inexperienced people have a very clear idea of their objectives and find ways to deliver way above those objectives.  I’ve also seen extremely experienced people, who have been previously considered successful in a number of roles, but really don’t have a clear idea of how to deliver on their objectives within their function and be successful.  In many of these circumstances, when failing, these folks hide behind their experience to suggest that the objectives were unreasonable.  This problem isn’t limited to any particular type of job.  I believe this problem is true whether talking about senior executives or junior engineers.

The large company corporate world is filled with C players.  The term “Peter Principle” was coined to describe this phenomenon in which people in large companies are promoted exactly one pay grade beyond what they can competently do and then stay in that role for the rest of their careers.  Large companies thrive on inertia and the core job description of a large company employee is to keep that inertia going and do nothing to screw it up.  If last year’s top line grew 8%, the job is to grow it 8% again, not to figure out how to make a step function change and grow it 20%. In attempting to achieve that 20% step function change, there is high risk of a misstep that could lead to a decline in sales.  That’s simply unacceptable. 

Large companies fire those who get F grades, because they are not at all productive.  They accept C players, because they are somewhat productive with guidance and B players are hard to find. It is very easy for a C player to seem moderately successful when progress is largely based on inertia.   Large corporations celebrate B players who can competently complete their job with minimum coaching and maintain inertia.  These are the heroes of large corporations. Innovation within a function is risky and can threaten inertia.  

Large companies have very few A players.  A players don’t want to be at large companies because, more often than not, corporate bureaucracy and process not only fail to reward, but actually punish A players.  By putting the objectives ahead of process and politics, A players step on bureaucratic toes and don’t retreat based on false territorial claims.  Though there are exceptions, few large corporations create cultures that give A players room to win.  It’s not fun trying to innovate at a large company when co-workers feel that you’re threatening the core inertia on which the business is based.  They’ll say things like “that’s just not the way things work around here.” 

By contrast, startups have no inertia and need to create momentum from nothing.  This is a very different job. Startups don’t succeed with people who deliver at a minimum acceptable level.  There really is little room for C players in a startup.  Employees who are somewhat productive, with lots of coaching, take a spot away from potential A players that can make a major impact on the success of a startup.  Startups generally don’t even succeed with a team of only folks who understand their objectives well and deliver them competently – the B players.  Competence across a team is simply not enough to build momentum from a standing start and learn quickly to iterate on strategy and tactics.  To succeed, most startups need some core team of A players; folks who can “write the book and not just read it.” These are an incredibly rare breed of people who not only have a clear idea how to competently accomplish their functional objectives, but actually lead the organization to innovate and be world class within their functional area.  They raise the bar on the entire organization.

Those who suggest that startups should only hire A players are grade inflators.  They’re calling B players A players.  The actual A players are too rare for this to be a practical hiring plan.  I advise my portfolio companies to be cautious when hiring candidates from large companies and focus on people who have already proven they can be successful in startup environments.  Another successful strategy is to hire less experienced candidates who show enormous upside in their ability to innovate.  When managing talent, startups need to help C players transition out of the organization and coach B players on the need to not just competently deliver their function, but drive toward innovation within that function.  Most of all, celebrate the A players and give them the room to explore hypotheses and make mistakes.  When interviewing, seek hires that not only understand how to competently deliver functional objectives, but also want to innovate within their function to build momentum from nothing.  One way these candidates can be identified during an interview is when they actually teach the interviewer something about how the company can win.  The best hires are those who have time and again proven they can innovate in a startup environment.  That’s startup gold. When you find those folks, don’t let them out of the building. 

The currency of the startup and venture capital community is conviction.  Startups are born out of the conviction to leave a job and start a company that most people think will never get a customer.  They are built on the conviction of talent to join a startup, that has little or no traction, purely based on the promise of the future.  In our case at Founder Collective, our conviction is challenged every day as we decide when to take the leap and put our capital and energy behind the vision of an entrepreneur, that wants to change the world, but is at the starting gate.  Given this daily challenge, I spend lots of time thinking about where conviction comes from and how founders can convince others to share their level of conviction.

Founder Collective is a seed fund, and some of our investments are made based on little more than a founding team and an idea.  At the other extreme, I’ve tracked some of our portfolio companies for over a year, until they had early customer traction, before I had the conviction to write a check.  We invest when we have conviction about a company.  That can come pre-product, but sometimes it requires not just product, but early customer data to get us to the finish line.  Unfortunately, conviction is not a trivial thing to achieve.

No doubt this is really frustrating to some of the entrepreneurs that meet with us and don’t get funded.  I find myself in some meetings saying to the entrepreneur that I like where they are going with the company, but don’t have enough instinctual conviction to invest at this stage.  I frequently need to see some early traction before investing.  Inevitably I get a frustrated look from across the table, which often leads to the very blunt response from the entrepreneur, “but I thought Founder Collective is a seed fund.  I won’t be looking for seed funding when I have traction.”

This is one of my least favorite conversations, and I try to reconcile my feedback with the fact that we do many of our investments with little to no customer traction.  It is true that the more data we need, the less likely it is that the company will still be at a phase in which a seed fund like ours is a fit.  On the other hand, I’d say that more often than not, our seed funding is in companies that have some minimally viable product and early customer data upon which we can get an idea whether customers are engaging and buzzing about the product.

I don’t think the investor process to get to conviction is that different than the entrepreneur process to get to conviction; the challenge is at the pitch stage, when VC and founder are at vastly different points in the conviction process.  I advise entrepreneurs to take investors through their own process of getting to conviction.  What made them want to drop everything to build this business?  Hopefully that process was a good combination of instincts and various forms of customer validation of those instincts.  Entrepreneurs driven completely by instincts will typically struggle to find an investor who equally shares conviction purely based on the same instincts, unless they share similar experiences that shape how they think about the opportunity.  It’s way more effective to frame instincts as hypotheses and then show interesting early customer development data that helps validate the hypotheses.

Struggling to communicate the combination of instincts and data leading to conviction, I created the chart below to make it a bit more concrete.  Insert your own MBA 2×2 joke here…

The idea here is that some things are so instinctual for me that I need virtually no data to get excited.  That doesn’t excuse the need to start validating hypotheses, as instincts can often be misleading, but I can invest in those companies pre-product.  Other concepts don’t resonate so deeply that I can make a bet without some early customer data.  There are some startups on which I was extremely skeptical at first meeting, but data has clearly convinced me otherwise, and I could easily invest later despite my early skepticism.  Perhaps, as a seed investor, I’m too late at that stage.  In many cases, I’ve had the opportunity to back those entrepreneurs after they’ve gotten early traction.   More often than not, when I don’t invest, it isn’t because I believe that the startup is fatally flawed and won’t be a success; it’s because I don’t yet have equal conviction to the founder.  Ultimately, I can only bet based on my own convictions, and I think that’s also a good thing for founders.  I don’t think founders should want money from investors that don’t yet share their conviction. 

I was on a panel last year titled “The Future of Venture Capital” with four other panelists who had way more experience in venture capital.  In fact, I’m not sure what my credentials were to be on the panel, given my six months’ experience in the industry.  My credibility with the audience fell further based on what I think most people perceived as my naive and wacky comments.  All of my co-panelists agreed that venture capital was broken and that we’d likely see half the number of funds in five years.  All agreed that this would be a bad thing for entrepreneurs.

When it was my turn to speak on the subject, I predicted that we’d see double the number of funds in five years.  No doubt this further diminished my credibility, but I tried to explain my view that the venture industry was rationalizing and that it made no sense to have hundreds of funds managing hundreds of millions of dollars each.  Instead, we think what we were doing at Founder Collective and what our peers are doing at First Round, Floodgate, Harrison Metal, Baseline, IA Ventures, Betaworks etc. fills a big gap in the venture industry and that there is room for many sub $100MM funds.  I view this as a very good thing for entrepreneurs, but I also see this as a very good thing for larger venture funds.  In the last year, with the advent of what some are questionably calling the super-angel bubble, I believe the industry has shifted as I hoped with a much more active super-angel community and a more than tripling of the number of micro-cap funds raised.  In my view, this is a big win for everyone in the ecosystem.

There have been many blog posts lately commenting on the criticism of mainstream venture capitalists and the tension with angel/micro-VCs.  This has hit the ultimate peak with Sarah Lacy’s Super Angel/VC Smackdown with David Hornik and Dave McClure screaming at each other.  Some of this tension is only natural as we all get comfortable working together and competitive juices start to flow.  Brad Feld wrote a thought-provoking post on the topic last week.  My personal view is that this tension needs to die quickly.  Let’s all agree that most VCs don’t “suck” and nearly all seeded startups will need VC funding to become important companies.  It’s hard for me to think of a single company in our portfolio at Founder Collective that doesn’t intend to raise money at some point from a larger VC. The tension needs to die quickly because we all are creating value for each other and are largely non-competitive.  I’m going to try to articulate the role seed investors play in the VC industry, but first I’d like put seed investment in the context of the last decade of venture capital.

Looking back, as venture funds got bigger during the dotcom bubble, they became and marketed themselves as “life cycle investment partners.”  VCs were sized to invest in every round of a startup, though not always lead, and maintain 20% or greater ownership in every portfolio company.  In theory VCs told their Limited Partners that they would “lean into their winners,” but in practice they knew it was very hard to stop investing in the underperforming companies for a variety of reasons – Rob Go wrote a great blog post on this.  The biggest challenge is that VC backed startups are rarely good or bad companies for future investment.  The world isn’t so black and white.  Lots of companies have merit at inflection points, but hold tremendous risk.  Given the intention of being a life cycle funder, a VC walking away from a follow-on round of a portfolio company is typically catastrophic to that company.  If the initial investor wasn’t willing to write a check and that investor had the best information, why should anyone else be willing to do so?  In other words, any deal that a VC didn’t want to continue supporting would find no other venture capital support and die.  VCs didn’t really want to be in the business of killing companies and turn out to be much better at company creation and support than company termination.

The implication of large funds doing life cycle investing is an implicit huge commitment to any portfolio company regardless of the size of the initial investment.  There are recent exceptions to this rule as some larger funds are making lower commitment seed investments to many startups, which can be highly problematic for founders, but historically any investment was a long term commitment unless it was performing very badly.  This was generally a good thing for entrepreneurs, because through good and bad times VCs kept writing checks (not always at desirable terms), but it created a huge burden to clear the hurdle of getting an initial check.  VCs had to be very careful in their diligence and their conviction needed to be extremely deep, as even a Series A $2MM check could be an implicit $10-$20MM commitment to a company.  Unfortunately, deep diligence and high conviction is not fully correlated to investment success, as it only analyzes a snapshot, not a movie, about the merit of a startup.  These companies need time to show their worth and truly justify the large commitment.  Historically angels have provided some capital for this purpose, but the angel community was greatly damaged in the dotcom bust and further injured by the great recession. 

This life cycle investment approach also lent itself to investing in repeat entrepreneurs and avoiding first time entrepreneurs, as VCs really had to decide out of the gate if an investment was worthy of “taking a slot” among a handful of deals in a fund and an implicit commitment to a big chunk of capital long term.  In essence, this market structure led to very few at bats, but lots of swinging for the fences right out of the gate.  If considered as a funnel, the structure of venture, post the dotcom bubble, looked like a thin and minor taper round after round.  Few entrepreneurs were getting at bats, but the ones who got to the plate had the benefit of an over commitment from funds that needed to put lots of capital to work in a limited number of deals and were really bad at killing the companies that did not deserve so much capital.  To be fair, this had some pretty big pitfalls for the entrepreneurs too, but that’s not the focus of this post.

The common refrain of VC funds is that too much capital is chasing too few deals.  For me, this hits a major philosophical question as to whether great companies are born or are made.  If you believe they are born, i.e. they can be identified from day one and it isn’t the execution that matters, probably the increased birth rate has little benefit for creating more great companies.  If, like me, you believe great companies are made, i.e., by getting more at bats, more entrepreneurs will get a chance to prove they can build great businesses and more great businesses will be created, then the increased birth rate is a really good answer to the issue of too much money chasing too few deals.

My belief is that the shape of the investment funnel is changing for the better.  Angels and micro-vcs should be focused on the seed round, creating opportunities for entrepreneurs to build validation that justifies larger commitments from larger funds.  Seed investors must also avoid signaling by keeping funds small and showing restraint when it comes to follow on financings. That way many more founders will get at bats and less capital will be overcommitted to experiments that don’t merit the investment. 

The failure rate will be much higher, but I’m not sure that’s a bad thing. Fred Wilson wrote a great post on “The Expanding Birthrate of Web Startups” in which he fears that angels and small funds won’t be positioned to support the growing population of funded companies.  Fred asks “who is going to house, feed, school and send all these kids to college?”  I agree with Fred that this is an issue, but I also think this is the creative destruction of a major improvement in the startup industry.  The market should be in a position to decide the merit of a startup without the challenges of sunk costs of a large venture fund or the signaling of a single fund determining the future of a company.  This is particularly true if the implication is that many more founders get a chance to create something of value.  Most founders would rather be funded to try and fail, than never to try at all.  After all, an implicit commitment of $10MM being allocated to a very early stage startup going sideways can be used to fund 10 similarly staged startups at $1MM and perhaps create a few companies that become rocket ships.  Nearly all of them will require more capital from larger funds at some point to be successful.  Larger funds get the benefit of seeing more validation early of a greater number of startups without the obligation to over invest round after round, which should yield higher investment returns for everyone.

Not only will this broader funnel create more companies with capital to prove value, but it will also attract more people to entrepreneurship, as founders won’t be deterred by the notion that getting funding is impossible unless they’ve run a company before.  I believe we’re already seeing this benefit.  This is a positive spiral that will further create more interesting opportunities for the venture capital industry.

On a macro industry level, venture capital might have the same amount or even less capital infused into startups in the coming years, but I believe that capital will be more productive as it is redirected from overfunding underperforming companies to funding the creation of more companies that have a shot of proving their worth.  I believe this is a big improvement for founders, seed investors and large funds.  

I’ve been thinking lately about how founders should decide when it is time to sell their startups and how to put aside the different incentives that often drive these decisions.  Large VC funds have a strong appetite to fund entrepreneurs that want to swing for the fences.  This was evident in Sand Hill Road criticisms of Aaron Patzer for deciding to sell Mint for only $170MM and the coining of the term “The Patzer Problem;” describing entrepreneurs that are viewed as selling too early, where the return looks great for the Founders and perhaps smaller investors, but is disappointing for larger funds.

This post was also influenced by criticism I’ve heard of the East Coast, where entrepreneurs and investors are viewed as having less appetite for risk, selling startups early at the first good offer.  Bill Warner has shared some interesting thoughts on this topic and calls for Boston to strive toward more home runs in the interest of building a healthier entrepreneurial ecosystem. 

Contrasted to the Patzer Problem and the calls for East Coast entrepreneurs to aim for grand slams, is the story of Zappos, where Tony Hsieh ultimately conceded that he was pressured to sell the company to Amazon due to his investor’s desire for liquidity.  Finally my thoughts were advanced by the much covered decision of FourSquare to take capital rather than sell to Facebook or Yahoo.  The debate was fraught with value judgments of whether they would be selling it too early on the one hand or irrational not to sell on the other.

Understandably, investor and management self interest and incentives are very much at play in the discussion of when to sell. All of this talk of differing incentives has caused me to revisit our sale of Brontes to 3M in 2006.  We did sell early, but I’m convinced that we did not only act on our own incentives.  I genuinely think that as a board we considered an objective view of when was the right time to sell the company.  That is the duty of loyalty which board members have to the company’s shareholders.  A board member should be explicit about his own incentives, but put them aside to attempt to objectively measure whether accepting an offer to sell the company is the right outcome for all shareholders.  But how does a board member figure out whether it is in the interests of the shareholders to sell?  Ambitious startups have so much potential, yet are typically backed with expectation of eventual liquidity.

We did this by thinking hard about the risk that we had in front of us versus the amount we were being offered for the company.  Personally, I also considered the offer in the context of the dilution we would face as we attempted to build revenue and move to cash flow breakeven.  We had lots of clarity on that dilution, as we had a $25MM Series B financing in escrow when we sold.  With a refresh of the option pool that amounted to 40% dilution, which meant that to our existing shareholders the $95MM offer was the dilution adjusted equivalent to $160MM offer after our next round.  In other words, existing shareholders would have the same return after the financing only if we could clear that hurdle. 

Now measure the progress of the company.  We felt we had game changing technology, which was deep and defendable.  We had the potential to completely shift the way a market functioned.  We had evidence the technology worked and the system was in full beta in a form that was pretty much finalized for go to market.  Clinical results might take a while and have some rough patches, but experts would agree from in-vitro quantitative measures that the system would work clinically.  In other words, we were at a peak of hope.  We were not going to be paid anything extra for early revenues.  Such a revenue ramp was already assumed into the price.  The question was how long it would take the economic reality to catch up with hope and help us surpass the dilution adjusted offer of $160MM? 

Our best guess was three years.  Our first year plan was $3MM in revenue and our second was roughly $8MM.  It would only be in our third year of sales that we’d cross the $15MM in revenue we expected was necessary for reality to fully catch up with hope to believe someone would possibly pay more than $160MM for the company.  In other words, if we hit our plan for the next three years, our company would be worth roughly what we were being paid per share today.  With all the inherent risk in our plan for the next three years, I still think that’s a no brainer scenario for selling.

Value creation at a startup is non-linear.  Startups have inflection points where value increases significantly and meaningful future progress is assumed into the price of the company.  These are peaks of hope.  Startups don’t typically appreciate in value against these peaks simply by meeting a plan.  Reality needs time to catch up to the hope.  Another major inflection point needs to take place to surpass that peak in order to get a meaningfully higher price. The right question is how far away is that next peak and how much dilution will be endured in that time.

Based on this thought process, I think a rough and somewhat objective rubric can be established for when to sell: based on your plan, how long will reality take to catch up with the hope? Time is an important measure of risk in that startup visibility rarely stretches beyond 12 months. When an offer, based on reasonable multiples, is compensating a company for the past year’s performance, selling is about liquidating the asset.  When a company is being paid a standard multiple against a high confidence next year plan, selling is still largely about liquidity but does offset a year of risk in the plan.  When that multiple is applied to the next two years of risk, the board should be giving very strong consideration to selling.  At three years, I think it really is a no brainer. 

Hard to know, but I’d guess that the Patzer Problem was more about VC interests than whether it was a no brainer for shareholders, on a dilution adjusted basis, to sell Mint for $170 million.  I wonder how many years of Mint’s plan they were being compensated ahead of.  Probably they were at a peak of hope.  If so, it was a good time to sell.

Note: Obviously, this is a rough rubric and it is difficult to determine fair multiples for any early stage company.  Also, it can be argued that most of the shareholders are usually represented at the board level and therefore board members are justified in largely acting in their own best interests.  I’m not as big a fan of that argument, because most companies are started with some friends and family capital, which is not represented on the board.  Also, employees must be considered.  Of course, price is only one consideration when it comes to selling a company, particularly for the employees.  These issues are highly complex and the post is a simplification, but I belive the key point is to get beyond the discussion of individual interests and get an objective view of the offer measured against the risk.

Micah Rosenbloom and I had an endless debate at Brontes about whether Blink or Moneyball was more relevant to the founder’s skill set.  Blink argues that instincts are incredibly powerful and would suggest a more gut driven entrepreneurial style.  Moneyball chronicles how Billy Beane outflanked all other major league General Managers by largely ignoring instinctual decision-making (scouting), instead using data to make decisions.  We thought of this as a spectrum where Micah leaned toward the Blink side and I leaned in the Moneyball direction – probably a good combination.  I’d argue that I’d “Blink” to form a hypothesis, but use Moneyball analytics to decide whether to execute that hypothesis and how much to invest in testing the hypothesis.

As a seed stage investor, I think about this debate frequently.  I think there are early stage startups that are designed as more “Blink” style startups that are hugely successful.  I don’t know the true story of the founding of Facebook, but my guess is that Mark Zuckerberg didn’t start by getting his thoughts into a PowerPoint, doing market research or creating a financial model.  It almost seems laughable to suggest such a thing.  He was coding in his dorm room, had conviction about something users might want and built a minimum viable product to see how they reacted.  This was the furthest thing from a designed business.  100% on the Blink side of the spectrum.

Not to put the companies even in the same stratosphere, but at Brontes we were largely a designed business.  We used our instincts to figure out where to look and then did a ton of market research and put together a detailed plan in mid 2003.  If you look at that plan today, the business greatly resembles the plan. We made pivots along the way, based on customer data, and became much more sophisticated in our assumptions and implementation, but fundamentally we’re still in the business we set out to build in 2003.  Certainly some businesses lend themselves to more instinctual management than others, as iteration cycles can vary.

Which is better? I really can’t say.  If you compare these two companies, I’d rather be Mark Zuckerberg and the valuation math is about 1 to 250 in Facebook’s favor thus far.  However, I think it is dangerous to look at extreme outliers to draw conclusions, and despite not being Facebook, I’m not sure I’d change my approach the next time.

My feeling as an investor hasn’t changed much from my time as an entrepreneur.  I’m a big fan of the “designed” startup Moneyball approach.  While I value instincts, I think our instincts can greatly bias us and that the fly-by-the-seat-of-your-pants approach to entrepreneurship statistically results in failure at an overwhelming rate over the Moneyball approach.  It suggests to me that the founder may not listen to user data and pivot quickly based on facts, but solely on instinct.  Even in a highly iterative lean startup methodology (which I deeply support), I view the analysis of the data to make quick iteration decisions as a Moneyball skill.

I’ve invested in businesses that are examples of both of these approaches, but find the Moneyball model a much easier bet.  The Blink model requires me to either absolutely share the instinctual conviction of the founder, which is rare, or ask the founder to create evidence not in market analysis, but in actual user traction metrics. Imagine investing in Mark Zuckerberg when he had the first prototype for TheFacebook.com and no user traction, it would have been very improbable as an investor to share his instincts about what would work in social networking.  Peter Thiel was a genius for making the first investment in Facebook, but consider that the investment was made after Zuckerberg amassed evidence of hundreds of thoustands users with a astoundingly viral trend line.   It was still a big and early bet, but it wasn’t made solely on shared instincts.  Arguably, at that point, an investor could take a Moneyball approach to analyzing whether the user traction would continue.

 Thanks to several local leaders in the New England startup community, June is being celebrated as Innovation Month in New England.  Rather than being abstract about the many unique ways that our ecosystem nurtures startups, I thought I’d give a direct example of my previous company, which I’m not sure could have been born and raised anywhere else.

Brontes Technologies was based on research led by Dr. Janos Rohaly and Professor Douglas Hart out of the Department of Mechanical Engineering at MIT.  The investigators were among the first research teams to be funded by the Deshpande Center at MIT, which was created by local entrepreneurial guru Desh Deshpande out of a desire to fill the gap between academic research and commercialization. 

The company was born when two repeat entrepreneurs (Micah Rosenbloom and Eric Paley), both of whom came to Massachusetts to go to business school at Harvard, met the principal investigators at a MIT 50K Competition team-building mixer.  After initial tension resulting from speaking different languages (engineering and business), the team began to collaborate well due to the clear benefits of everyone bringing different disciplines to our preparation for two business plan competitions.  The team further gained confidence in each other after being named runner up at the MIT 50K and HBS Business Plan Competitions.  The team also received help from the Venture Mentoring Service at MIT and Professors Bill Sahlman, Joe Lassiter, Rebecca Henderson and Felda Hardymon at HBS.  Additionally Brontes got exposure and candid feedback by twice participating in the MIT Enterprise Forum (Concept and Startup Clinics). 

The company was originally financed by a true angel investor who based his decision completely on trust.  That angel was David Frankel, a business school classmate of mine and Micah’s and now our partner at Founder Collective.  Without David’s trust in us, Brontes would never have existed.  Angel financing was critical as it took the venture industry a bit of time to appreciate our quirky market.  That appreciation came first from Jeff Bussgang at Flybridge Capital Partners, whom I initially met in Professor Bill Sahlman’s Entrepreneurial Finance Class at HBS.  Jeff and I built a one year relationship in which he gave us feedback and coaching and got to know our team and mission well enough to make a bet on us.  Together we rallied two other local and outstanding venture capitalists, Ted Dintersmith of Charles River Ventures and James Nahirny of Bain Capital to help fund the company.  We also added two local independent board members, Kelsey Wirth the Founder of Align Technologies and Gerard Moufflet an investor with deep ties in our industry, who both provided enormous value to the company. 

We built a team of 32 extraordinary engineers, executives, and clinical specialists with deep experience in hardware, software, optics, computer vision, medical devices, dentistry and rapid manufacturing.  We relied on local vendors for additional optics design (Innovations In Optics) and industrial design (Manta) capabilities.  Early endorsements, industry insights and market validation came from Dean Bruce Donoff of Harvard School of Dental Medicine and Doctor Gerard Kugel of Tufts University School of Dental Medicine. 

It takes a great ecosystem to build a company.  There are few places in the world that Brontes Technologies could have been born and built. Thank you Massachusetts.  

*This blog has 27 links; all of which are to Massachusetts-based individuals and institutions that contributed to making Brontes Technologies a success.  

“I thought getting funded would be as simple as pitching my idea to a smart VC and getting a check based on the magnitude of the idea.” 

Two different first time entrepreneurs in their early twenties both made some version of this comment to me in the last month.  I like and respect both entrepreneurs and they were confiding in me that the fundraising process has been very disappointing and were seeking advice on how to close on some capital.

The fact is that raising money is really hard unless you’ve built a successful business before.  Of course, that actually makes some sense given that building a company is really hard and most venture-backed companies don’t return capital to investors.  The likelihood that an investor will fund a first time entrepreneur simply based on an interesting idea is exceptionally small.  Consider that the entrepreneur has an tremendous amount of conviction about the concept.  However, the investor has never heard the concept before and is likely hearing it (or at least this version of a theme) for the first time and is quite unlikely to share the depth of conviction that the entrepreneur holds.  In fact, a typical investor is regularly hearing credible ideas and cannot possibly fund them all.  Even if the investor is enthusiastic about the concept, she is likely meeting the entrepreneur for the first time and hasn’t yet established the trust and confidence needed to believe the entrepreneur has what it takes to execute the idea and be one of the few to succeed.

So what can a first time entrepreneur do to overcome the odds and get funding?  Here are a few tricks that I’ve seen work well:

Figure out who in the world you know that can afford to put some money into the company and believes in you without caring much about the idea.  Even if it is a small amount of money, this can be used to create more evidence that you’re building a fundable business.  The value of such trust networks is actually way more effective for raising money than the idea itself.  If the people you know that have the means to bet on you aren’t willing to fund you, why should you expect someone that you don’t know to fund you?

Find experts related to your business, preferably ones who have built a successful company in the same space, and sell them on your idea.  The more you can sell that person, and the more credible that person is, the better.  If that person signs up as an advisor, that’s helpful, but a director is better; signing up as an investor is much better and taking a leadership position on the team is the best.

The most important thing an entrepreneur can do prior to raising money is to keep building the business regardless of the funding situation.  Continue to validate the market opportunity and try to prove out that the founder’s convictions are right.  Build the team with people who will work for sweat equity.  Create some early product and show market traction. It is very hard to know when you will have enough evidence to convince investors, but an entrepreneur that can continuously show progress has a good shot of convincing investors that he is scrappy and capable.  When an investor is trying to figure out if an entrepreneur has what it takes, that ability to keep building the business is great evidence.  Certainly the entrepreneur should not sit around and wait for a check in order to really start building the business.  At some point if the company is showing meaningful signs of living up to the founder’s beliefs, it becomes very hard for investors to ignore.

At what point does an entrepreneur hit the wall and cannot live on ramen noodles alone? This is a very personal decision and the reason that most successful entrepreneurs have inspiring stories of perseverance.  It’s a question of objectively assessing the depth of the entrepreneur’s conviction, how much struggle he can endure, and how much progress he can make without capital.  First time entrepreneurs rarely get a benefit of the doubt from investors and getting funded is rarely easy.  

I love my iPad.  I have discovered some great use cases for why I “need” it.

Now that I have that disclaimer out of the way, let’s talk about why the iPad is a terrible example for startup founders.  Apple has violated all of my deeply held beliefs about innovative product development and marketing.  It may work for Apple – time will tell – but it won’t work for the entrepreneurs that I know.

The challenge is that the iPad was not designed or marketed with a clear use case.  I think this has been the cause of much of the negativity about the iPad that I’ve seen in blogs,  and on Twitter.  Because Apple failed to present a clear use case, we have been left to imagine the use case for ourselves.  This has led way too many users to think of the iPad as a laptop replacement.  Unless a customer only previously used a laptop for consumption, and not productivity, the iPad falls way short of that use case.  Given that many people have now realized this, potential customers are wondering whether they need a computing device that sits between their smart phone and laptop or is the iPad just a cool extravagance.  Moreover, without a clearly articulated use case, marketing to find the right customers is expensive and inefficient. Without that focus, the company is pretty much marketing to everyone hoping that users figure out what to do with it. 

This can work for Apple, but I don’t believe it will work for my fellow startup founders.  Apple has an unmatched brand and loyalists (me included) are buying the iPad and figuring out their own use cases.  Apple also has an incredible marketing engine that not only inspires people, but also spends way more money than any startup can afford.  Apple has an unmatched developer community trying to create killer apps for the iPad.  Finally, Apple has terrific distribution that no startup can match.  For all these strengths, the iPad may succeed despite lacking a clear use case.

Let’s rewrite this story with a hypothetical startup.  Imagine that a product equivalent to the iPad was created by a startup called Pear and no one has ever seen such a device before.  Pear has no proven distribution and a very limited marketing budget.  Let’s assume that Pear had the extraordinary hardware design, software UX and supply chain expertise to create something as beautiful, low cost and multipurpose as the iPad and was the first in the world to market such a product.  Let’s call it the PearPad.  Let’s even assume that Pear is reasonably well financed for their launch with $15MM in fresh venture capital.  Would anyone buy the PearPad?  Besides a small group of fringe early adopters, I think the answer is no.  I think PearPad would be lucky to sell 1000 devices in its first month; far from Apple’s 1MM.  It would be a stretch to imagine how PearPad would ever recover its enormous R&D investment to create such a high quality product. Put another way, an innovative device marketed at everyone is likely to fail because it doesn’t solve a clear problem for anyone.

What would PearPad have to do to be a success?  Pear would need to design the system around a clear use case and market to customers that had the strongest need for that use case.  Over time that use case can broaden to target more customer segments.  However, at the beginning, a lack of focus makes it unclear what one does with the device, who should buy it, and how to market to the right customers.

The following are some pretty half baked examples of use cases, but hopefully the point is clear: the PearPad could be the world’s best mobile multimedia device, and will effectively replace the market for portable DVD players; then Pear could target family travel.  Or perhaps it is the world’s best lightweight road warrior device and will disrupt the netbook market; then Pear could target business people taking commuter flights and the product specification would emphasize productivity tools instead of entertainment tools, as in the last example.  Maybe it is the best home web surfing device; then Pear could target stay-at-home parents and focus the software on the browser – it may even need Flash. Pear might be the best portable gaming device; the specification would maximize graphics and marketing should be tilted at gamers and likely a younger demographic. Obviously any of these focused use cases would require a different product specification to maximize value and prove out the benefits.

Entrepreneurs beware.  You are not Apple and won’t be successful following its example.  Figure out who your customer is.  Focus the design of the product at a use case that creates clear value for this customer and utilize your very limited marketing dollars to gain the attention and admiration of that customer.  Otherwise, you’ll end up having the sad outcome I imagine for Pear; raising obscene amounts of money and never finding a market for your extraordinary but ill-defined product.

After we sold Brontes in 2006, every venture capitalist I bumped into would ask me how soon I would be free to do something else.  From their perspective, the only reason that I would stay at the acquirer was financial, and we had already cashed out.  Therefore, it was obviously time to go start another company and chase another pot of gold.

I had little monetary incentive to stay after the acquisition. Yet two years later, I was still at the company and so were 29 of the 32 employees who were with us at the acquisition.  We actually had less attrition in the two years after the acquisition than in the two years before.

I know many VCs who scratch their heads at the fact that we gave up so much opportunity for so little upside as part of a Fortune 500 company.  For the venture capitalists involved in the Brontes, the day of the acquisition was their last day at the company.  As investors, their motivation was solely monetary.  While, for the team, the monetary benefits of a win were very exciting, they were far from the only motivation for spending day and night building the company.  We loved the creative process of imagining a product and the future of an industry and trying to make our fantasy a reality.  We envisioned our product in tens of thousands of doctor’s offices benefiting millions of patients.

Had financial rewards been our only motivation, we would have given up before the company ever started.  The founding team began working together in October 2002, and we were first financed in January of 2004.  We had near death experiences during that time and more in the years after financing.  If any of us were just pursuing the pot of gold, we would have quickly concluded that there are easier and certainly higher probability ways to make money.

Strong companies are not built by people who hope to get rich quick, but by people who are motivated by creating something of value and executing an exciting vision for the future that makes some meaningful difference to customers.  Founders motivated by money alone are almost sure to fail, as they are unlikely to endure the trials of building a company.  I believe deeply that the mission of the startup needs to be the primary motivation, with the assumption that meeting the mission will have many rewards.  Our mission wasn’t over the day of the acquisition. 

A few years back, I was chatting with one of my investors at a social event and he was describing one way of looking at startups and VC.  He said that until startups are funded, they are basically just fantasies.  I responded that startups with VC funding are also fantasies – they’re just fantasies with money.

When I started Brontes I was very confident in our market opportunity and product concept.  That confidence helped us convince people to join our team and investors to put money into our company.  However, I confess that I had many sleepless nights over whether I was simply wrong about the premise of the business.  My recurring nightmare was that I was leading everyone off a cliff based on a narrative that had come from my imagination.  Perhaps this is the courage it takes to be a startup founder.  On the other hand, it was impossible to deny that everyone was betting on my business plan which might never amount to more than a fantasy.  Raising money didn’t change this.  It only made the nightmare worse.  It was still my fantasy, just now with money.  Had I misled everyone?  Was there really a business here?  No doubt my investors frequently wondered the same thing.

The challenge is that it typically takes years to transform a startup from a fantasy into a real business.  Sure there are small milestones along the way that help make the startup more real, but the road to reality is long.  At the start there are questions about building the team; then about the product’s market fit.  Once a product is launched and adoption begins, there are questions about achieving early sales.  Once early sales are achieved there are questions about whether the company will become profitable.  Once profitable, there are questions about whether the startup scales and how fast.  These fears pretty much prevail until the company is large and profitable or achieves liquidity. In my case, I had some reassurance that the company was not a fantasy when we received the first acquisition offer four years after we started the company.  However, once we sold Brontes, the nightmares came back, as I was operating the company for 3M and realized that we were still a pre-revenue fantasy. 

The only thing that made me feel better the morning after each of these nightmares was to get into the office and ask myself – What can I do today to make my company a little less of a fantasy? What can I do to make the company a little more real?  These are the key questions for any founder at any stage of a startup.  It is often unclear what milestones will make a company more real.  A successful founder must discover the right milestones and spend every day chiseling away at the fantasy and finding reality.