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.mirage

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

Advertisements

How Not to Get Fired

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.

donald-trump-youre-fired

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

The Idea Myth

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

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.

bonus

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.

I jumped into a taxi on my way to JFK airport from Manhattan with only 90 minutes to my flight. It was the last flight out to Boston, and I was stressed about making it in time. The driver asked which way I’d like to go and suggested the Midtown Tunnel. I took out Waze on my iPhone and looked up routes. 55 minutes via Queens Blvd local roads and 75 minutes via the Midtown Tunnel. I opted for the local roads. The driver immediately protested that we really shouldn’t go that way, insisting that the Midtown Tunnel was better. I’m a zealot for Waze and told him to take the local roads.

623-02750895

He incessantly complained about my not trusting his experience until we arrived at JFK.  Every time we stopped at a light he decided to exclaim again that the local roads are a crazy way to go to JFK.  

My driver was wise, but blind. 

Perhaps nine out of ten times he was right that his route was better, but without real time on-the-ground data, he didn’t know which way to go.  As I became exasperated listening to his groans, I realized, he’s exactly the same as a bad Venture Capitalist.

Good investors understand their role. They know what they are good at and what they are bad at.  They know where to push and when to stay back. Good investors have some confidence that they have some wisdom to share, but also know that they are blind.

Wisdom comes as a result of experience and pattern recognition.  Good investors have years of experience and a range of current case studies informing what makes companies succeed and fail and learn they from and share these experiences.  In our view, the best investors also have operating experience and have lived through many similar pains that are facing their investments.  That helps investors see patterns that lead to good outcomes and bad outcomes and bring those learnings to the company as helpful data to influence decisions.  This is where the role of the good investor ends.

Bad investors think that based on that wisdom, they know definitively what the company should do. Unfortunately, like my taxi driver, they lack self-awareness of how blind they are.  They don’t acknowledge that they have a tiny fraction of the data that management has to make those decisions.  Management may lack the wisdom that their investors have, but at least they can see what’s happening in the business and the market. Good management teams digest the wisdom, factor it into their decision process, and then follow their own beliefs about what to do. Good investors know the importance of ground truth and are comfortable with management going against their wisdom.

We arrived at JFK in 55 minutes and I made my flight.  Best not to let the blind lead those who can see.

I had lunch recently with one of our portfolio CEOs, and he said something that really caught my attention.  I had just commented on how well they were executing and the quality of the team he put in place.  He thanked me and said that he was really proud of the team, the culture, and how hard everyone was working.  Then he said “but it really doesn’t matter, unless we win.”

 

I think that comment sums up the key tension between founders and their investors and is somewhat unusual to hear from a founder.  When I was a founder, I remember feeling extremely deflated when my investors would point out that we were behind our plan.  We were working so hard and making progress.  I always felt that the investors didn’t appreciate our blood, sweat, and tears; despite the speed not being as planned, the progress didn’t come without amazing effort.  I was right that the investors didn’t really appreciate it, but didn’t consider that maybe they shouldn’t.  The hard work is table stakes.

 

Winning in entrepreneurship is really hard.  The second a founder takes venture capital funding, they are signing up to deliver improbable outcomes and the definition of winning becomes way more ambitious.  The investors are betting on an outlier business and the founders shouldn’t take the money unless they believe they can and want to build that type of business.  By definition, there are very few outliers and the odds are against the company.

 

The investors spend their time thinking about whether the company is winning and what it takes to win.  Typically, the founder cares even more about winning than the investors, but founders also care about many other intangibles including passion, a great team, a great culture, hard work, engaged customers and lots of faith.  Investors care about all those things as enablers of winning, but not as ends themselves.   Seldom do investors put money in companies prioritizing passion over economic expectations.  If the company fails to meet expectations, the inputs ultimately provide little solace to anyone involved.

 

When things aren’t going as planned, the founder naturally takes pride in everything the team built and all the intangibles that have been created to pursue the outcome.  As tough feedback comes from investors, it is natural for founders to be defensive and emphasize how much has gone into the business.  I certainly felt that way during our more challenging moments.

 

From the investor viewpoint, none of it matters if the company doesn’t win.  Understanding this difference in perspective is the key to overcoming the natural tensions between investors and founders.  Some founders, like the one I was having lunch with, seem to innately understand this better than I did when I was in the same seat.

One of my favorite founders in Boston is Jason Jacobs of Runkeeper.  Every time I see Jason, I mention to him how impressed I am with what I’m hearing about the progress of Runkeeper.  Without fail, Jason graciously thanks me for the encouragement and then shares the many challenges they are facing how much work there is to do to achieve his vision.

 

When I was starting out as a first time venture-backed CEO, I was way more insecure than Jason.  I was afraid to talk about the challenges with my team or board, for fear of seeming incompetent or dampening enthusiasm for the company.  Instead I harbored the challenges internally and always talked about how well things were going, until someone would point out the inconsistency of how far behind plan we were.  In reality, overselling the progress is what made me look incompetent.  I really wasn’t effective as a leader until I started focusing with everyone around me on the problems, while using the vision to build enthusiasm for the company.

 

Now that I have a portfolio of terrific founders, I have consistently seen this as the operating mode of the very best ones and particularly of successful repeat entrepreneurs and great operational CEOs.  Ask the typical entrepreneur how things are going and they feign a smile and say “terrific.”  Most founders feel the need to constantly convince their investors and everyone in the ecosystem that the company is doing extremely well; that the operational plan is well within hand, and the company is consistently outpacing it’s own aspirations.  This is not a characteristic of great entrepreneurs.

 

My best portfolio founders spend their board meetings telling the investors what is wrong with the business and how they are trying to solve those problems.  They don’t feel that they need to oversell the progress, because the ambition of the vision is the reason that they are so passionate and the reason that all of their constituents are committed to the venture.  The good news is either in the numbers or it isn’t in the numbers.  Hand waiving undermines credibility.  By putting the challenges on the table great leaders demonstrate how on top of the issues they are.  Most board members hear the bad news and think that at least they have someone excellent who is completely on top of solving the problems.

 

I have way more confidence in those that spend their time unearthing and focusing on the problems than those who pretend they don’t exist.  Sharing the challenging realities doesn’t demonstrate incompetence; instead it demonstrates the exact opposite.  Keep everyone energized by the big vision, but don’t oversell the progress in achieving it.