The published title of the talk was, “How to Create a $100M Business and Out Innovate your Competition.”  I read that and thought, “If I knew how to do that I would have been a VC.”  So instead I gave a talk I called, “Why Product Managers Need Sneakers.”

The gist of the talk was to observe that:

1. startups are not smaller versions of large companies
2. startups search for a business model, large companies execute an existing one
3. the skills that talented product managers bring to a large company are at best not transferable to a startup (and at worst destructive)
4. product managers in a startup can either be an asset or an albatross.
5. They’re an albatross if they perform as they do in a large company, and believe that they “own” customer interaction, feedback to engineering and authoring market requirements documents.
6. They’re an asset to a startup if they understand that their job is to get the founder outside the building and in front of customers.
7. They can be the scorekeepers in Customer Discovery and Validation as the company iterates and pivots the business model and refines the minimum feature set.

“Why Product Managers Wear Sneakers” was a reference to the amount of running around outside the building (with the founder) product managers will need to do in a startup. Except they won’t be called Product Managers. In a startup they will be part of the Customer Development team.

If you’ve seen my talks before you can skip forward to slide 19.

This post is not advice nor is it a recommendation of what you should do. It’s simply my interpretation of what I observed watching my daughters grow up. Our circumstances were unique, times have changed, and your conclusions and opinions will most certainly differ.

Gender Differences
Growing up in the 60’s and 70’s when women were struggling against inequality in jobs, pay, etc., my wife and I came into parenthood with an unconscious bias that gender differences were mostly cultural. So how we raised our kids was an unintended science experiment.

When our two girls were toddlers, my wife started dressing them in overalls, and consciously bought them trucks and “boy toys” to play with along with dolls. We were both surprised and bemused to see them ignore the trucks and cars and prefer to play house. A bit later, our biggest eye-opener was when our younger daughter started asking for the “pretty pink dresses” instead of the overalls. (Given they didn’t watch TV, we ruled that out as a major role in their choices.) We started to believe that perhaps there was some hard-wiring about gender.

Boys With Sticks
As our kids reached grade school, the next lesson was watching them at play. I remember hiking with my girls and two 8-year old boys. When we stopped for lunch, the boys found sticks and immediately began a sword fight. When they tired of that, the boys chased each other and wrestled until they were exhausted. The girls, finding their pile of sticks, began building something together and telling each other stories. The suggestion of “why don’t you guys try each others games?” was met with utter 8-year old disdain. I realized I was looking at something – competition versus collaboration – that also seemed hard-wired. (Competition versus collaboration is my shorthand for a much longer set of gender-linked behaviors.)

Boys Rules, Girls Lose
When I entered the business world, I quickly found that office politics was just an older version of boys with sticks. The testosterone level was higher, and the game was more like musical-chairs with winners and losers until there was a single person on top. As a guy I didn’t need a rulebook to understand the game; there was a hierarchy, it was competitive, I win you lose.

It took me awhile but I realized that implicitly that advancement in corporations was unconsciously constructed around how men interact with each other. And unless they consciously work at it, most companies are not set up for collaboration.

As I grew older I realized that women in the workplace around me were having a harder time than the guys. They’d all come from college equally ambitious, but only after a few years, something different was happening to their careers.

Over time, I observed women who succeeded in the business world (as defined by their interest in moving up the hierarchy) headed in one of four career directions:

1. They chose departments within corporations where collaboration was an asset like Public Relations, HR, customer service, etc.
2. They set up their own companies to provide services and ran their own companies collaboratively.
3. They opted out of the workplace and raised a family, returning later.
4. They figured out the “boys rules” and followed them (having to work harder and smarter to prove that they were.)

Understand There Are Rules – And They’re Not Yours
When my girls started to play soccer, I used to remind them, “Make sure the people on the field aren’t carrying sticks because if they’re playing field hockey while you’re playing soccer, you’re going to get hurt.” As they got older, they understood I wasn’t only talking about sports but that I was trying to teach them how to figure out the rules of any game they were about to play.  And that included the workplace.

My advice to our daughters about women in the workplace has been pretty simple:

• The language of business is about winners and losers. Bosses who read Sun Tzu’s “The Art of War” as a guide to business strategy or “Leadership Secrets of Attila the Hun” are unlikely to create a culture of collaboration.
• There are implicit rules of competition and collaboration in companies.  It’s not that anyone is hiding a secret rulebook; it’s just that no one has articulated the rules.
• In most companies men set these rules. Again, nothing secret here, but men don’t realize that they behave and think differently. They don’t have to explain the rules to other men so it never occurs to them to explain the rules to women.
• As women, they will be expected to perform to boys rules as defined in their workplace: This means they need to spend the time understanding what the rules are in their company and industry. If they don’t, they will find others less competent but more adept at playing the game getting promoted instead of them.
• Women can be equally competitive if they desire. It’s not a question of competency. Or a skill only boys have. If they want to succeed by competing they can. They just have to learn the rules and practice them.
• Find mentors then become one. In every organization or industry there’s someone who’s figured out the rules. Seek them out and know what they know. By the time you do, it’s your turn to mentor someone else.
• Collaboration can make you a stronger competitor. The irony is that organizations which collaborate are more effective competitors. When they reach a position of authority, use their instincts to build a fearsome organization/company.
• If they prefer to collaborate and don’t want to play by boy’s rules, they need to understand what their career choices are. There are plenty of other ways to be a productive member of society other than a position on a corporate org chart.
• Understanding the rules and career options doesn’t mean the rules are right or they have to accept them as the only career choices.  They can make change happen if they so desire. But they need to understand the personal costs of doing so.
• Some find the idea of gender differences uncomfortable. Having fought to have men and women be treated equally, discovering that there may be gender specific hard-wiring for behavior sets up cognitive dissonance. Some simply won’t accept that there are workplace gender differences.
• I may be wrong. Perhaps I misunderstood what I’ve seen or that time has changed the workplace significantly. Take this advice as a working hypothesis and see if it matches your experience.

Time will tell whether we gave our daughters good advice.

Enter Brant Cooper and Patrick Vlaskovits who looked at my text as the equivalent of War and Peace. They decided that what the world needed was a simple explanation of the key concepts of Customer Discovery – the first of the four steps of Customer Development. Their book The Entrepreneur’s Guide to Customer Development: A cheat sheet to the Four Steps to the Epiphany does just that. If you are interested in Customer Development, there’s now a quick and simple way to get up to speed.

This is a book you should have on your shelf.

My last session was with a passionate, smart, entrepreneurial team from a Fortune 100 company. (And if I told you who they were I’d have to kill you.) Their copies of the Four Steps were dog-eared and marked with sticky notes. We spent two days of analyzing and exploring their customer discovery visits just completed across South America, Africa and Asia. Learning which hypotheses survived these visits were eye-openers for all of us. We used what they learned to plan their next steps for additional Discovery, and ultimately Customer Validation.

It reminded me of the differences in Customer Discovery between a scalable startup and a big company. Here’s what we observed:

It’s Easier for Big Companies to Get Meetings – But It’s Not Always a Blessing
When a big company calls prospective customers to set up Discovery meetings, their datebook fills up fast. Execs at higher levels than you’d expect join the meeting eager to hear what the big company has to say about their industry. That’s the good news. The bad news is that the meetings become far more formal and more crowded, than one that a startup would have. This crowd actually dampens the opportunity for learning. Since the meetings attract senior execs everyone around the table waits for the big boss to speak and follows his or her lead. This stifles or shuts down the important “outlier” conversations that drive pivots and iterations in the discovery process.

Solution: try to get a blend of one-on-one meetings along with the group session. And be sure to set expectations for the meeting before it happens.

We’re Not Here for a Sales Call
If someone from a large company is flying halfway around the world to visit your company, your presumption is they have something to sell you. Crucial in the Customer Discovery process is not selling…it’s listening. The exploring, probing, gaining reactions is why you’re there. (Of course, if someone forces a purchase order on you and you reject it, you’ve just failed miserably at entrepreneurship.)  Disabusing the audience of the notion that the visit is a sales call is vital to the customer discovery mission. Followers of the Customer Development process know that you can’t start selling until you have transformed product, customer and other hypotheses into a validated business model and sales roadmap. (Short-circuiting that process is a major “foul” that often leads to premature business models and suboptimal sales results.)

To potential customers who’ve never been asked for their opinion before, the purpose of a Discovery meeting can be confusing. There are business cultures where the vendor/customer interactions are limited to “here’s what I have to sell, do you want to buy it.”

Solution: spend more time on the “setup” for the meeting. Tell potential customers before you meet, “We’re working on an interesting product and we’d be happy to share where we are in exchange for some feedback. But we are not here for a sales call.”

Getting the Customer to Talk is Even More Challenging
There’s no more important skill in Customer Discovery than “good listening.” When a big company shows up, everyone expects an important formal presentation, which is hardly your Discovery mission at all.  Structuring the conversation in a way that elicits feedback before you reveal the product hypothesis is essential to getting honest reactions, good or bad. Yet just reading your questions from a list is a real-turnoff. Insert them casually into a conversation and don’t try too hard to get every one of them answered in every meeting.

Solution: One of our favorite hints, from a great post by ash maurya, is to pose problems to the group in a randomized list. “We see these three problems in your industry.  Do you agree?  Could you rank them in order of importance to you?”  This literally forces a discussion and prioritization and is repeatable again and again. “We believe the most important features you need in a supersonic transporter are….” or “Our research tells us that female consumers most want a, b, and c.”

Big Companies are Bred for Large Scale Success
When you’re doing disruptive innovation in a multi-billion dollar company, a $10Million dollar/year new product line doesn’t even move the needle. So to get new divisions launched large optimistic forecasts are the norm. Ironically, one of the greatest risks in large companies is high pressure expectations to make these first pass forecasts that subvert an honest Customer Development process. The temptation is to transform the vision of a large market into a solid corporate revenue forecast – before Customer Development even begins.

Solution: Upper management needs to understand that a new division pursuing disruptive innovation is not the same as a division adding a new version of an established product. Rather, it is a organization searching for a business model (inside a company that’s executing an existing one.) That means you may find that revenue appears later than the plan called for, or that there are no customers or fewer than the plan suggests.

Customer Development Without Agile Engineering Is A Plan For Failure
Beleving in Customer Development but still retaining waterfall development for engineering and manufacturing is a setup for problems if not outright failure. Even in a large company you can’t do Customer Development without aligning some part of engineering to respond to unexpected customer needs and findings.

Solution: Get engineering buy-in by. Make sure the engineering and manufacturing plans “before” Customer Development don’t look the same as “after” Customer Development.

Spend your Way to Success Usually Results in the Opposite
Ironically large revenue goals may lead to largesse in overfunding the new division, with the implicit assumption that dollars can “buy your way to success.” All the money in the world doesn’t negate the painful search for a business model, or the lack of a scalable/profitable one. And new divisions in large companies operate just like startups who get overfunded – somehow their expense budgets always equal at least their funding.

Solution: Eight and nine digit funding before Customer Discovery is a curse not a blessing. Take the money in tranches (equivalent to VC “rounds”) predicated on milestones in finding a repeatable and scalable business model.

There’s an Overhead Cost to Being an Entrepreneur in a big, established corporation
Large companies are just plain organized – with rules, HR, finance and more importantly, are built around process and procedures for execution. It’s why so few big companies succeed at true entrepreneurship.

Solution: Assume as a given that as a new division head at least 15% of your time will be spent managing up and protecting down. Few in your own company will understand what you’re up to.

Lessons Learned

• Customer Development in large companies has it’s own unique challenges
• Some parts of being a big company make it easier, others make being a startup even riskier

Here’s his story of when Customer Development failed.

——–

Hi, we’re Lottay!  We’ve been a startup for the past two years or so and we’ve come to a critical point on this crazy roller coaster ride.  Here’s our story:

We started like most entrepreneurs — an idea, an opportunity, and very little money. Our vision was to radically change the gift card industry. We were lucky to learn about Customer Development early on in the life of our startup.  It made more sense than our 60 page business plan predicated on a B-school class and a supernatural ability to predict the future. More importantly, we’d witnessed Customer Development’s massive success at another local startup.

We bought Steve’s book, started product development and began reaching out to customers ins search of our first earlyvangelists. Along the way we were fortunate to meet Steve, develop strategic partnerships, and raise a series A round of investment.  Confident we were Doing It Right, we pressed forward.  We even had some pretty monumental successes.  So how did Customer Development fail us?  Well, perhaps it’s more accurate to say that we failed customer development.

In retrospect, our mistakes fell mainly into one of two categories:

(1) Failure to follow the process

(2) Failure to be honest with ourselves

If we could travel back in time to that fateful meeting at the Coffee Cat and give ourselves a good talking to, what would we say?  Well, it just so happens that we’ve fitted Ross’s 2001 Subaru with a flux capacitor, gotten our hands on some plutonium and we’re about to hit eighty eight miles per hour!  Here’s what we plan to say:

Write it Down
This seems so obvious, yet it must be said: write down and track the evolution of your hypotheses. It’s something that’s almost too easy to gloss over — keeping track of your hypotheses and the results of your customer development work are vital. Failure to keep track of our hypotheses meant we were never quite clear on what was working and what was not.  This meant we had a hard time focusing our development.

It’s your vision damn it!
The customer does not define the product or vision for the company. The founders do. In Four Steps to the Epiphany Steve says you’re looking for a niche – he means that you’re going to hear a lot of “No’s” and that’s okay. What’s not okay is letting these non-customers define your vision daily.

Failure to maintain a coherent vision allowed us to pitch one thing, “It’s a virtual gift card you can spend on anything!” while selling something else, “It’s an ecard + money!”  After a while even we didn’t know which was our actual vision.

Make Money or Take Money?
Focus on revenue from day one.  It’s the only reliable metric for success. You may think you’ve found your earlyvangelists but you can only be sure when they start making you money.

Taking outside investment gives you options. But with this money comes temptation. Temptation to focus on growth and worry about revenue later.  Temptation to stay the course when your gut tells you it’s time to change.  Making revenue your first priority does so many good things for you as an entrepreneur – saves cash, validates customers, and tells you if you have a real business. It’s only a business if you make money.

Fail Fast and Move On
Being honest with yourself is perhaps the hardest part of being an entrepreneur. You’ve sold your friends, your investors, and yourself on your vision. You wouldn’t be putting yourself and your family through this if you didn’t believe in your idea. So who keeps you honest and tells you when you don’t have a business? Your customers and your hypotheses.

There may come a time you need to face the fact that the earlyvangelists you thought you had are actually just very polite users.  Face the fact that your product won’t be able to make money or scale.  Face the fact that your hypotheses are all wrong.  And ultimately, face that fact that it’s time to majorly rewrite your vision. The sooner you face these facts the more chances you’ll have to course-correct and win.

The Future?
Now that we’re back from the past, how are we moving forward?  Well, we’re back to customer discovery.  And this time we’re writing it down. In fact, we’re creating a simple software solution that guides us through documenting customer interactions and validating our hypotheses (let us know if you’re interested in testing it). We’re also charging customers and partners right off the bat for our services.  And we’re using that money to do more customer discovery and validation. Finally, we’re holding ourselves accountable to our vision and hypotheses.

Disclaimer
Keep in mind that our opinions are just that. We may have no idea what we’re talking about. After all we’re just some guys trying to make it in this crazy startup world.  We’d love to know what you think. Do these ring true to you?  How do you keep track of your vision and hypotheses?Leave a comment or email us at contact@lottay.com.

Lessons Learned

Customer Development is like being Agile.  It’s easy to say you’re doing it. Hard to actually do it.

Every time I see my graduate students try to teach for the first time, it’s usually so painful I bite my lip. Then I remember the first day I stood up in front of a classroom.

You Hired
My first job in Silicon Valley was at ESL (a supplier of intelligence and reconnaissance systems,) I had managed to talk myself into getting hired as a training instructor. (Long back-story here.) The company had a major military contract to deploy an intelligence gathering system to Korea, they needed to train the Army Security Agency on maintenance of the system, the 10 week training course (6-hours a day) hadn’t been written, and the class was supposed to start in 6 weeks.

I convinced them that I knew the type of training military maintenance people need, and I had done some informal teaching in the Air Force. Out of desperation and a warm body right in front of them, they realized I was probably better than nothing, so I got hired.

As I wrote the course, I was handed a couple of books on how to put together a training class for the military and given some advice on how to assemble lessons.  But besides my own experience as a student in military technical training classes, I had never taught more than one person at a time.

The Dry Run
About a week before the course was due to start, the manager of training said, “Steve, we’d like to see you do a dry run of a class tomorrow. Pick the material you feel most comfortable with teaching and give us a lecture for an hour.”

I didn’t sleep that night. While I had taught my peers in the military how to repair equipment, it had been informal side-by-side training on a lab bench. I had never been in front of a classroom. I was scared and nervous.

The next day I stood up in front of the classroom and in the audience was the rest of the training department, my manager and the manager of the entire intelligence system program.

I don’t remember exactly what class material I taught, but I do know I gripped the side of the podium so hard my fingers hurt as I read my notes and droned on. I was so nervous that I skipped an entire page of notes.  In the one or two times I managed to look up, I saw my boss wincing, the program manager putting his head in his hands, and then most everyone drift out of the room.  After about 20 minutes my manager said, “Thanks Steve, that’s enough.”  He quickly left and when I passed him in the hall, he was in deep conversation with the program manager, and I could hear snippets of my name and the word “terrible.”

Even I knew I had done horribly.  I was ashamed and disappointed, and when my manger called me into his office that afternoon, I thought I was going to be fired before the class started.

Teach Like You’re the Student
As I sat in his office, I wondered if they would pay me through the end of the month or would they just walk me out the door that day. The latter seemed likely when he said, “I’ve never seen my boss so depressed. He thinks the Army is not going to pay us for the training course if you teach it.”  I was waiting for the “you’re fired” words to come out his mouth. Instead, I was blown away when he offered,” Well the good news is that you can’t get any worse.”  And he was smiling. He continued, “You figured out 6-airplanes and 3-vans full of computer equipment in six weeks.  That’s better than anyone we have on staff could have done.  Your lessons are clear and well organized.  And most importantly you love this stuff, and it comes through when you talk about it.  But we thought you were going to have a heart attack up in front of the room.” I started to exhale.  Maybe he wasn’t going to fire me. He laughed as he said, “In the last 15 years I’ve hired lots of training instructors, and something tells me you’re going to be pretty good at it… if you get through the first two weeks.”  Then he gave me some advice about teaching that’s stuck with me for more than three decades: “Just pretend you’re teaching you.  How would you do that? What would you want to know? What did you dislike when you were taught? What stories would you tell to make it understandable? What would keep you interested and engaged?”

I Love This Job
The class started a week later, and the first two days were as painful for me as they were for my students.  At first I never left the podium and was afraid to stop reading my notes. But after the second night, the class and I all went out drinking in Sunnyvale, and I realized that my manager was right – my students were exactly like me.  What they wanted to know was what I would have wanted to know if I was in that classroom. Over the next weeks as I slowly relaxed, I started to connect with the class. I stopped reading my notes, got out from behind the podium and started telling stories about my own experience and all the things that could go wrong that weren’t in the manual.

I’ve never stopped.

Lessons Learned

Research says teaching excellence is associated with extraversion, agreeableness, conscientiousness, openness, and low neuroticism.

My experience says that all that may be true, but you need to teach like you’re the student.

Here’s why.

Electron-based Venture Capital
When I first came to Silicon Valley the world of Venture Capital looked pretty simple. VC’s invested in things that ran on electrons: hardware, software and silicon.  While individual VC’s inside venture firms specialized in particular domains (PC’s, peripherals, semiconductors, test equipment, operating systems, applications, etc.,) their investments had roughly the same time horizon and were focused around things that used electrons – primarily computing and computing infrastructure.

The VC business took off with the rapid growth of the semiconductor business. Fairchild Semiconductor became the progenitor of a flood of Silicon Valley chip companies and at the same time the adoption of the limited partnership as the model for Venture Firms gave VC’s their own profitable business model. The personal computer business was built on top of the semiconductor business about the same time that the last of the pieces of Venture Capital were falling into place – the 1979 change in the EISRA “prudent man” rule allowing pension funds to pour billions into Venture Funds.

Here’s what the start of Valley chip business looked like on a genealogy map, tracing most all of its DNA back to the first Silicon Valley chip company, Schockley Semiconductor.

Cell-based Venture Capital – The Birth of Biotech Venture Capital
In 1980 Genentech became the first IPO of a venture funded biotech company. The fact that serious money could be made in companies investing in life sciences wasn’t lost on the venture community.  But the knowledge that VC’s had built investing in electron-based companies didn’t translate to expertise in cell-based or cell-proximate companies.  The technologies were different, the time horizons were different, (2 to 5x longer to take a drug through FDA trials ~14 years,) and the regulatory environment was different (barely any in traditional VC investments compared to FDA trials for drugs and 510K approvals needed for medical devices.) Finally the amount of capital needed to take a drug to FDA trials could be enormously expensive, at least 10x more than startup costs at an electron-based company.

The two watershed events for biotech startups were the Bayh-Dole Act of 1980 and the Orphan Drug Act of 1983. Bayh-Dole allowed for private ownership of government funded intellectual property developed in universities while the Orphan Drug Act created incentives for developing drugs for disorders afflicting fewer than 200,000 Americans.

After a while, the only thing Biotech VC’s had in common with their compatriots who invested in electrons was that they both invest.  (In some Venture Capital firms they may share the same roof and overhead, but no one is confused, they’re in very different businesses.)

The Rise of the “Lean VC’s” – Consumer Internet Gets Funded
For a few reasons, I’ve been struggling to make sense of all the noise happening in what others have called the Super Angel arena. First, my students are confused about who to talk to and how to think about funding their consumer internet startups.  Second, and full disclosure, I’ve invested in a few of these funds; and third my teaching partner Ann Miura-Ko is a partner in one of these funds.

My take is that we are watching an entirely new category of Venture Capital firms emerge.  It is as an important a split as when the biotech guys hung out their shingles.

Consumer Internet startup investors are now their own category.  I call them “Lean VC’s” to emphasize why they’re different.

(In his indomitable way, Dave McClure describes this shift best, but I have to screen-scrape his posts, paste them into Word and clear the formatting to read them.)

One could argue that there’s nothing new here, as Internet distibution models started in 1995. But in reality they only became mainstream ~5-7 years ago. Most of the social and mobile channels (YouTube, Facebook, Twitter, iPhone, Android) have emerged in just the past 3-5 years. But these VC’s aren’t Lean because they fund startups with web-based distribution models. It’s because the startups are doing something very new that make them “Lean” :

• These startups embrace customer and agile development that Eric Ries has been evangelizing.
• They build a minimum feature set.
• Quickly iterate the product in front of customers.
• Drive for a repeatable and scalable business model (revenue in Dave McClure’s investment thesis, “network of scale” in Union Square’s.)
• Their capital needs are low at the front end. The advantage of commodity software stacks drops initial startup costs for Internet Commerce companies. (But scaling customer acquisition may take the same amount of dollars as a traditional software startup.)

Lean VC’s are Different
The skills needed to succeed as a “Lean VC” are different from those needed for traditional software investing. Previous experience of investing in software companies that hire direct sales organizations and take years to build the product using waterfall development doesn’t translate to expertise in Consumer Internet startups. The technologies are different, the speed of execution, iteration and pivots are different and the time horizons for exits are different, (2 to 5x shorter for a consumer Internet company.)

Finally, the “death of the IPO” and the emergence of the “small market M&A” changes Consumer Internet economics. One of the interesting characteristics of these new “Lean VC” funds is that they can be smaller than the traditional multi hundred million dollar VC fund. The small investments necessary to get a consumer internet startup going enables Lean VC’s to make lots of early bets and double-down when early results appear. (And the results do appear years earlier then in a traditional startup.)

(BTW, just like the Biotech VC’s who may share a building with Electron-based VC’s, you may find a Lean Venture Capitalist sitting under the same roof as a traditional VC. Just make sure they get and embrace the Lean VC principles. The test is, ask them how they differ in their investing philosophy from the rest of their firm.)

Lean Angels
Along with Lean VC’s a new class of angel investors has emerged. YCombinator, Techstars, et al, have been described as incubators but in reality they are the new “Lean Angels.”  These angels “get” the sea change happening in Internet Commerce. The difference is that unlike Lean VC’s, these angels help their startups rapidly develop the product, but typically don’t add much help in developing the market/customers. And while they provide the initial investment they rarely follow-on with the Series A dollars needed for scale. They’re a great feeder system for the new class of Lean VC’s.

Lessons Learned

Entrepreneurs in the consumer Internet space should look for funding from Lean Angels or Lean VC’s

Lean VC’s are expert in on-line distribution, Agile and Customer Development

They drive for early results inexpensively, and invest heavily when they see results

Their strategies for their startups differ – some focus on revenue, others build large networks of users

Keeping Score
One of the key concepts of Customer Development is writing down your initial hypotheses (guesses) of all the parts of your business model, then updating them with the facts you find outside the building.

Since I first wrote the book Four Steps to the Epiphany I’ve realized that an even better way to keep score is by diagramming each of your  business model hypotheses on a whiteboard and updating them as your iterate and pivot. I’ve been experimenting with how to best teach this idea to students in classroom and with startups. My favorite book of how to diagram your business is Business Model Generation written by Alexander Osterwalder.  It has the notion that any business model can be drawn with just 9 separate boxes.  It’s a great idea.

The Real World
My teaching partner Ann Miura-Ko and I both love the concept of Business Model Generation. However we find using the book to teach and in early stage venture problematic. It makes assumptions about the depth of knowledge about business models that we find that students and startups lack. For example, we find that the distinction between who’s a user and who’s a customer may be obvious to sophisticated strategists in large companies but is often overlooked in a startup. The same issues arise between understanding the difference between a distribution channel and the specific demand creation activities needed to drive customers into that channel. Being able to get these concepts is the difference between startup success and failure.  So while we love the book, Ann has been drawing her own business model diagrams you’ll see in the presentation below.

Given Ann and I are such big fans of the Business Model Generation book we were happy to have coffee with Alexander Osterwalder and share our thoughts about what we thought was missing. In hindsight I think we were asking for the business model generation book for dummies (kind of like someone asking me for six steps to Customer Development rather than four,) but Alexander was not only was generous with his time but posted a thoughtful response to our comments.

Business Plans Versus Business Models
Given what I think of Business Plan competitions, it was ironic that I spoke last week at the Clean Tech Open business plan competition conference. I did appreciate the venue and shared my thoughts of how a startup goes from an idea to a business plan to business model to customer development and finally to a venture pitch, all in the presentation below.

Lessons Learned

Gather all your hypotheses in Customer Discovery

Diagram all your hypotheses of your business model

Update the diagram as you gather facts outside the building

Minor iterations will make minor changes to the diagram

Pivots will have you changing major pieces

Great Suit
My wife and I had dinner last night with a friend of hers from high school. Tom, her husband whom I had never met before joined us as well. I took one look at his suit and guessed “high-powered lawyer. “ (I was right, the suit probably added another $250 per billable hour.)

Over dinner we got chatting, and I found out that besides the great suit, Tom was actually a pretty remarkable guy. He was a trial litigator, one of the guys that slug it out in court in front of a judge and jury. And Tom wasn’t just any trial lawyer. He was the hired gun that Fortune 100 companies and hedge funds bring in when billions are at stake.  Listening to some of his stories over dinner was entertaining enough, but after awhile I realized I was hearing something else – this guy played strategy while his opponents were using tactics.

Chess and Military History
It turns out that Tom was a student of military history and a chess player. He described preparing for cases like war. “Most trial lawyers play defense. I’m on the offense from day one. In depositions and filing motions I’ll use misdirection to get the opposing counsel thinking I’m heading in one direction, and I’m heading in the other. When I file for a Summary Judgment, it’s usually from a direction my opponents never expected.” He then went on to give me a tour of 30 years of trial lawyer experience.

So I asked, “Did you learn any of this in law school?”  He laughed. “I went to Harvard. They didn’t teach war there.” “Do any of your junior partners in your firm know how to do what you do?”  “Well they watch me, and I guess they learn by osmosis.”

Then I asked my favorite question.

“When you retire, what happens to all the knowledge and experience you’ve acquired?”

You Can’t Take It With You
I think the question caught him a bit by surprise. I explained, “You have a record in winning trials that’s based on a strategy and methodology you developed and you’ve likely have moved the state of the art in your profession – and it’s all going into the trash bin of history – unless you pass it on.

Teach It or Lose It
I asked Tom to think about writing down a longer version of the stories he told me over dinner, almost like an autobiography but focused on his career.  And for each big trial or milestone summarize it with a “Lessons Learned” section.  I observed that at the end of this exercise, he’ll come to one of three conclusions: 1) he has a great collection of war stories to tell while he’s skiing or playing golf or 2) he can make a book out of those stories or 3) buried in the stories and lessons learned was a strategy that was new, unique and worth teaching to future generations of lawyers.

I suggested that he volunteer to guest teach in someone else’ class at a local law school (and where he lived there were plenty) to see if he enjoyed it.  His war stories would certainly keep students on the edge of their seats. (If you were a law school student having him come in to your class and say, “The first time you run into me, I’d make you wet your pants” might get your attention.)

But more importantly this would help him decide if he wanted to teach as an Adjunct Professor after he retired. If as I surmised, he actually did push the state of the art in his field forward and his teaching went beyond war stories to a theoretical framework, most schools would be happy for him to develop and teach a class.

Why Do It?
I suggested that there were four reasons he ought to take teaching seriously. First, his accumulated knowledge will disappear when he does. Second, it’s incumbent on all of us to make those who come after us smarter than we were.  Third, having students question your assumptions makes you smarter (and at our age growing new neurons are helpful,) and finally fourth, for those of us whose career was on a stage, teaching is just another stage with an appreciative audience.

Not Just For Lawyers
Driving home for dinner, I realized that the same advice for Tom and lawyers would work for professionals in any domain; doctors, engineers, venture capitalists, CEO’s or even entrepreneurs. Don’t let your knowledge and experience die with you.

Lessons Learned

• If you don’t teach it or write it down, the accumulated knowledge of your career is gone.
• War stories about your career can be entertainment, or even better if you want to teach, make them the basis of a strategy and methodology worth passing on.
• Retirement doesn’t have to be only about golf and skiing.

Here’s an example in a direct sales channel.

Customer Development Diagnostics over Lunch
A VC asked me to have lunch with the CEO of  a startup building cloud-based enterprise software. (Boy did I feel like Rip Van Winkle.) The board was getting nervous as the company was missing its revenue plan.

These lunches always start with the CEO looking like they had much better things to do. Before lunch even came the CEO ticked off the names of forty or so customers he talked to during the company’s first nine months and gave me a great dissertation on the day-in-the-life of his target customers and what their problems were. He went through his product feature by feature and matched them to the customer problems. He talked about how his business model would make money and how the prospects he talked to seem to agree with his assumptions.

It certainly sounded like he had done a great job of Customer Discovery.

Sales Process
Next, he took me through his sales process. They had five salespeople supported by two in marketing. (They had beta customers, using but not paying for the product.)

Over lunch the CEO told me he had stopped talking to customers since he had been tied up helping get the product out the door and his VP of Sales (a successful sales executive from a large company) had managed the sales process for the last six months. In fact, the few times he had asked to go out in the field the VP of Sales said, “Not yet, I don’t want to waste your time.”

Too Good to Be True
For the first time I started squirming in my seat. He said, “I insist on getting weekly status reports with forecasted deal size and probability of close. We have a great sales pipeline.” When I asked how close any of the deals on the forecast were to getting closed, he assured me the company’s two beta customers—well-known companies that would be marquee accounts if they closed—were imminent orders.

“How do you know this?” I asked. “Have you heard it personally from the customers?”

Now it was his turn to squirm a bit. “No, not exactly,” he replied, “but our VP of Sales assures me we will have a purchase order in the next few weeks or so.”

I put my fork down. Very few large companies write big checks to unknown startups without at least meeting the CEO. When I asked if he could draw the sales road map for these two accounts that were about to close, he admitted he didn’t know any of the details, given it was all in the VP of Sales’ head. Since we were running out of time, I said, “Your sales pipeline sounds great. In fact, it sounds too good to be true. If you really do close any of these accounts, my hat is off to you and your sales team. If, as I suspect they don’t close, do me a favor.”

“What’s that?” He asked, looking irritated.

“You need to pick up the phone and call the top five accounts on your sales pipeline. Ask them this question: if you gave them your product today for free, are they prepared to install and use it across their department and company? If the answer is no, you have absolutely no customers on your forecast who will be prepared to buy from you in the next six months.”

He smiled and stuck me with the tab for lunch. I didn’t expect to hear from him ever again.

What If the Price Were Zero?
Less than two weeks later, I got a call and was surprised to hear the agitated voice of the CEO. “Steve, our brand-name account, the one we have been working on for the last eight months, told us they weren’t going to buy the product this year. They just didn’t see the urgency.” Listening, I got the rest of the story.

“When my VP of Sales told me that,” he said, “I got on the phone and spoke to the account personally. I asked them your question—would they deploy the product in their department or company if the price were zero? I’m still stunned by the answer. They said the product wasn’t mission critical enough for their company to justify the disruption.”

“Wow, that’s not good,” I said, trying to sound sympathetic.

“It only gets worse,” he said. “Since I was hearing this from one of the accounts my VP of Sales thought was going to close, I insisted we jointly call our other ‘imminent’ account. It’s the same story as the first. Then I called the next three down the list and got essentially the same story. They all think our product is ‘interesting,’ but no one is ready to put serious money down now. I’m beginning to suspect our entire forecast is not real. What am I going to tell my board?”

My not-so-difficult advice was that he was going to have to tell his board exactly what was going on. But before he did, he needed to understand the sales situation in its entirety, and then come up with a plan for fixing it. Then he was going to present both the problem and suggested fix to his board. (You never want a board to have to tell you how to run your company. When that happens, it’s time to update your resume.)

The Phantom Sales Forecast
The implications of a phantom sales forecast meant something fundamental was broken. In talking to each of his salespeople, he discovered the sales team had no standardized sales process. Each was calling on different levels of an account and trying whatever seemed to work best. This was just a symptom of something deeper –  while they thought they understood the target customer their initial hypotheses from Customer Discovery were wrong. But no one had told the CEO.

He realized the company was going to have to start from scratch, Pivot back to Customer Discovery and find out how to develop a sales road map. He presented his plan to the board, fired the VP of Sales and kept his best salesperson and the marketing VP. Then he went home, kissed his family goodbye, and went out to the field to discover what would make a customer buy. His board wished him luck and started the clock ticking on his remaining tenure. He had six months to get and close customers.

Customer Validation
The CEO had discovered what happens when you do a good job on Customer Discovery but get too “busy” for to personally get involved in Customer Validation. It wasn’t that he didn’t need a VP of Sales, but he had entirely outsourced the Validation step to him. Until a scalable and repeatable business model is found the CEO needs to be intimately involved in the sales process.

Lessons Learned

• Ownership of Customer Validation belongs to the CEO.
• A VP of Sales can assist but the CEO needs to answer:
• Do I understand the sales process in detail?
• Is the sales process repeatable?
• Can I prove it’s repeatable? (Proof are multiple full-price orders in sufficient quantity.)
• Can we get these orders with the current product and release spec?
• Do we have a workable sales and distribution channel?
• Am I confident we can scale a profitable business?

I’ll offer that both entrepreneurs and VC’s have the wrong model for founding CEO equity compensation. The customary vesting model has founders vest their stock over 4-years, and when the founding CEO gets in over their head the VC’s bring in professional management. More often than not the founding CEO leaves the company. The fallacy is believing that a founders value is evenly distributed over four years. We now have three decades of experience that says otherwise.

Preparing For Chaos
Every VC knows that the founding CEO is the individual you throw into the chaotic battle of a startup. Investors are praying they’ve backed a founder who can think creatively and independently, because more often than not, conditions on the ground change so rapidly that the original well-thought-out business plan becomes irrelevant. They’re hoping they funded a CEO who can manage chaos and uncertainty, is biased for action and isn’t waiting around for someone else to tell them what to do. They’re betting that the founding CEO can quickly separate the crucial from the irrelevant, synthesize the output, and use this intelligence to create islands of order in the all-out chaos of a startup. And that they’ll emerge from this fog of war with a scalable business model.

They also know that most founding CEO’s don’t scale past the early stage.

That’s the source of the trouble. Most founding CEO’s don’t know that they’re cannon fodder in the search for a business model.

It’s My Idea and Hard Work
Some founding CEOs believe the value they bring to their startup is their idea and the time and energy they put into their company. In their mind, since they thought of the idea of the company, spec’d the product, found the first customers and worked their tails off, they are entitled to vest all their stock over time and run their company.

Where’s My Liquidity Event
Some VC’s feel that if a startup has grown past the founder’s ability to manage and scale (and hasn’t had a liquidity event,) they should be able to remove the founding CEO and (at best) walk them out the door with only the stock they vested to that day.

It’s About Finding the Business Model
I’ll posit that both views are wrong. Lets start with what the real job of the founding CEO’s job is: to find a repeatable and scalable business model. The goal of your business model can be revenue, or profits, or users, or click-throughs (or even just to get the technology into production) – whatever the founders and their investors have agreed upon.

If you don’t find this business model there is no company.

The odds are if the founder is going to find the first business model it’s going to be in the first few years. Yet the traditional vesting model ignores this. It assumes that founders contributions are linear over 4-years. Not only is this unfair it has the founding CEO focussed on the wrong goal – hanging on as long as they can to vest their stock. Why on earth would investors want to have the incentives set up this way? 30 years of accumulated experience says these perverse incentives actually diminishes the value of their investment.

It’s time to rethink how we vest stock for founding CEOs.

The New Deal
The founding CEO vesting model should start with a new deal between VC’s and founders. Recognize that a founders value is non-linear over 4 years and heavily weighted towards the chaotic first few years. Agree that the founder is being rewarded not just for the idea or technology of the company but rather for finding a way to make money.

Founding CEO’s need to agree that it’s rare that founders are the right people to take a startup through the transition to build and scale it into a company. Instead, it’s likely that after they do the hard work of finding the business model, the company will need to hire their replacement to grow the company to the next level.

The New Founding CEO Vesting Model
Therefore, if the founding CEO gets the company to a repeatable business model they deserve to vest all their stock if they are removed. If they fail to find a business model, by taking investors money they’ve implicitly agreed they can be walked out the door. (But can keep the stock they’ve vested to date.) Specifying what the metrics are for a repeatable business model is what the board and founders should be doing in the first place. This new deal would keep everyone focused on the search for the model.

I’ll suggest that this new deal more accurately reflects the time-weighted contributions that founding CEO’s make and more accurately aligns founders and investors interests.

Lessons Learned

The job of the startup CEO is to find a repeatable/scalable business model.

The contribution of the founding CEO is not linear over 4-years.

If the founding CEO gets the company to a repeatable business model they deserve to vest all their stock if they are removed.

Accountants shouldn’t be putting together the vesting schedule.

Here’s why.

The Golden Age for Entrepreneurs and VC’s
The two decades from 1979 when pension funds fueled the expansion of venture capital to 2000 when the dot-com bubble burst were the Golden Age for entrepreneurs and venture capital firms. VC’s were making investments every other financially prudent institution wouldn’t touch – and they were printing money.

The system worked in predictable and profitable ways. VC’s invested their limited partners’ “risk capital” in a portfolio of startups in exchange for illiquid stock. Most of the startups they invested in either died by running out of money before they found a scalable business model or ended up in the “land of the living dead” by never growing (failing to Pivot.)

Startup lifecycle in an IPO Market

But a few startups succeeded and grew into profitable companies. Their venture investors made money by selling their share of these successful companies at a large multiple over what they originally paid for it. One of the ways most predictable ways for an investor to sell these shares was to take a company “public.” (Until 1995 startups going public typically had a track record of revenue and profits. Netscape’s 1995 IPO changed the rules. Suddenly there was a public market for companies with limited revenue and no profit. This was the beginning of the 5-year dot-com bubble.)

During the decade between 1991 and 2000, nearly 2000 venture backed companies went public. Take a look at the chart below. (It includes venture funded startups in all industries, from software to biotech. Source: NVCA.)

Number of Venture Backed Liquidity Events 1991-2000

The size of the red bars (IPO’s) versus blue (mergers and acquisitions) illustrates that while venture-backed startups did get acquired, the IPO market was booming.

Free At Last
Going public did two things for your company. Your company had money in the bank to expand your business, scaling the company from the “build” stage into the “grow” stage. But even more important, your VC’s  could sell off their ownership of your company. This changed their interest from managing your board for their liquidity to managing the board for all shareholders.  Most VC’s would get off of boards of companies that went public.

Success Means That You’re Acquired
The public markets for venture-backed technology stocks never really recovered after the collapse of the dot-com boom. Fast forward to today and take a look at the last ten years of  IPO’s and M&A’s in the chart below, and you’ll see why life is different for entrepreneurs.

Number of Venture Backed Liquidity Events 2000-2010

Depending on your industry, in this decade it’s 5 to 10x less likely that your company will have an IPO as an exit. And what the chart doesn’t show is that the dollar amount of the deals are significantly smaller than the last decade.

Since there’s no public market for the shares your venture investor has bought in your startup, the most reasonable way for a venture firm to make money is to have you sell your company to another company. But unlike an IPO where you sold stock to the public and got to run your company, in an acquisition your company is gone, and the odds are in a year or so you will be too.

Startup Lifecycle Today

VC “Plan B”
None of this has gone unnoticed by the venture community. Some of the old-line venture firms have changed their strategy, but some are still locked into last decade’s model while the partners are living off of their management fees and go through cargo cult like rituals. You can tell who they are by how often they remind you “this is the year the IPO market will come back.” (If the limited partners of these VC’s acted like real fiduciaries rather than waiting for the end of life of the fund, more than half of old-line venture firms would have shut themselves down today.)

New, agile and adroit venture firms with new business models have emerged to deal with the reality that 1) web 2.0 startups require significantly less capital to start, 2) exits for venture firms are predominately acquisitions, and 3) a venture firm with a smaller fund <$150M matches these exits. Floodgate, Greycroft, Union Square Ventures, True Ventures, etc. are example of this class of firm. (Raising a VC fund in this environment had it’s own perils.) And the explosion of private Angel firms continues to fuel this new ecosystem.

Other VC’s who invest in Information Technology have taken a different approach. They’ve created virtual IPO’s for founders and employees via late-stage private financing. It has put a per user dollar value on these sites and these few startups will be the next likely IPO candidates. In their short time as a fund, Andreessen Horowitz seems to be on top of this game with their investments in Facebook, Skype and Zynga.

What About Us?
But not all industries are as capital efficient as the Web or Information Technology. Biotech, medical devices, semiconductors, communications and CleanTech require significantly more capital to build and scale before they can generate profits. It’s in these industries that the lack of a public market has taken the heaviest toll on entrepreneurs and their startups. Great companies with innovative ideas have simply died not having the cash to scale. VC’s who would have normally kept writing checks were faced with no public exits and cut them off.

Some of these industries have turned to the U.S government for funding. Elon Musk has not only tapped the feds for his electric car startup Tesla, but also received hundreds of millions for his space launch company – SpaceX. Other Clean Tech companies have tried this approach as well. Yet while the U.S. government doles out funds to connected entrepreneurs, it lacks an integrated strategy to deal with the lack of public market financing for critical growth industries.

It may be that these entrepreneurial industries suffer the same fate as manufacturing in the U.S.- they die out of benign neglect and a lack of a coherent understanding of the role of risk capital in our national interest.

What Does it Mean to an Entrepreneur?
If you’re starting a software company, your exit is most likely a sale to a larger company. This decade has been a Darwinian filter – only the very best companies will survive as standalone companies.

If you’re starting a company in other, capital intensive industries, it’s no longer just about having great technology. You need a plan for partnership and long term funding from day one.

In either case Customer Development provides entrepreneurs with a methodology for being capital efficient.

We live in interesting times.

Lessons Learned

• Advice that’s more than 5 years old is obsolete.
• Software startups are most likely to exit as an acquisition.
• Being acquired has lots of math challenges about your valuation, amount of money raised, percent of founder ownership, type of investor, etc.
• Non-software companies need to be thinking much deeper and further than ever before about search, build, grow funding strategies.  It’s no longer just about building great technology.
• Customer Development provides entrepreneurs with a methodology for being capital efficient to scale when the funding environment demands it.
• You will probably not survive the acquisition.

There was only one job that I quit when I feared for my life.

Life Is Good
The Vietnam War had just ended and I was out of the Air Force back in college living in Ann Arbor Michigan. Colors other than olive green or camouflage slowly seeped back in my life as “Yes sir, and no sir” faded away. Unlike my previous attempt at college as a pre-med, four years working with electronics convinced me that perhaps I ought to study engineering.

Civilian life was good, the government was paying my tuition and I got a college work/study job in the University of Michigan physics department. After a few weeks, the Physics lab staff realized I knew something about repairing electronics (you try fixing a sodium-iodide scintillation detector without a manual.) I got asked, “Would you like to work at the nuclear reactor?” I thought they were joking. “The university has its own nuclear reactor?”

Oh man, something really new to learn. “Heck yes, sign me up.”

Nuclear Reactors on Campus
Starting in 1953 the U.S. built over a 150 research reactors. Much smaller than the ~500-1,500 megawatt nuclear reactors that generate electricity, by the late 1960s these 1 to 10 megawatt reactors were in 58 U.S. universities. In addition, 40 foreign countries got research reactors in exchange for a commitment to not develop nuclear weapons. (But these reactors used weapons grade Uranium-235 for their cores, and by the late 1970’s we realized it wasn’t a good idea to be shipping highly enriched uranium overseas.)

My first day in the reactor electronics lab I got a lecture from the health physics department. I was given a film-badge (a dosimeter to measure whole body radiation) and taught how to use the hand and foot monitors (to prevent radioactive contamination from spreading outside the containment dome.)

Scram
Lots of things could go wrong in a nuclear reactor – loss of cooling, power failure, jammed control rods, reactor power excursions, etc. While a reactor failure can’t create a nuclear explosion, if its core is uncovered long enough it can generate enough heat to melt itself, with all kind of nasty consequences (see Three Mile Island and Chernobyl.) To “scram” a reactor means an emergency shutdown by inserting neutron-absorbing control rods into the core. This stops the nuclear chain reaction. My job in the reactor electronics lab was to rebuild the reactor “scram system.”

Ford Nuclear Reactor at the Phoenix Lab

The scram system had three parts: the mechanical part (the control rod drives and electromagnetic latches), the electronic part (comparators circuits and trip logic), and the sensors (to measure neutron flux, core temperature, pool water level, etc.)

The 20-year old electronics in our existing scram system were based on vacuum tubes and had the annoying habit of scramming the reactor every time a thunderstorm was nearby. And summertime in the Midwest has lots of thunderstorms. The Nuclear Regulatory Commission had approved a transistorized version of the electronics. My job was to build the approved design, retrofit it into the existing power supplies and integrate it with the existing mechanical systems and sensors.

But first I was going to see the reactor.

Cerenkov radiation
Over time I would get used to visiting the reactor, but the first visit was awe-inspiring. Entering the containment building through the air lock, my eyes took a few seconds to adjust to the dim light. The first thing I saw was a gigantic mural of the earth rising over the moon painted on the side of the dome. After another few seconds I realized that the mural was illuminated by an unearthly blue glow coming from what looked like a swimming pool below it. My eyes followed the source of the light down to to the pool and there I first saw the 2 MW nuclear reactor in the bottom of the swimming pool – and it was generating its own light. When I could tear my eyes from the pool I noticed that in the far end of the building was a glass wall separating a room bathed in red light, where the reactor operators sat at their console. The lab manager let me stand there for a while as I caught my breath. Hollywood couldn’t have set the scene better.

As we walked towards the pool I learned that the bright blue light was Cerenkov radiation from the reactor core (electrons moving faster than the speed of light in water polarizing the water molecules, which when they turned back to their ground state, emitted photons.) We briefly walked across a bridge that spanned the pool and stood directly over the core of the reactor. Wow. They were going to pay me for this?

Dose Roulette
Over the next few weeks, as I began work on the scram system, I got to know the control room operators and others on the staff. Most of them were ex-Navy reactor technicians or officers. They had been around nukes for years and were bemused to find an ex Air Force guy among them.

One of their weekly rituals was to read the bulletin board for the results of the dosimeter readings. Since most of my time was spent outside the containment dome my radiation exposure numbers were always zero. But there was a bizarre culture of “you’re not a real man until you glow in the dark” among the ex-Navy crew. They would celebrate whoever got the highest dose of the week by making them buy the beer for the rest.

After spending the last four years around microwaves I had become attuned to things that you couldn’t see but could hurt you. In the Air Force I had watched my shop mates not quite understand that principle. On the flightline they would test whether a jamming pod was working by putting their hand on the antenna. If their hand felt warm they declared it was. When I tried to explain that the antenna wasn’t warm, but it was the microwaves cooking their hand, they didn’t believe me. There were no standards for microwave protection. (I always wondered if the Air Force would ever do a study of the incidence of cataracts among radar technicians.)

You Buy The Beer
In a few months I had the new scram system ready for debugging. This required connecting the new electronics to the neutron detectors in the pool that monitored the core. We timed this for the regular downtime when used fuel elements were swapped out and they had lowered the pool water level for easier installation. I remember standing on the bridge right over the reactor core watching as the reactor techs remotely connected up the cables to my electronics. I leaned over the bridge to get a better look. By now the reactor was so familiar that I didn’t think twice of where I was standing.

A week later as I was about to enter the dome, I heard someone congratulate me and ask when I was going to buy the beer. They were pointing to the Health/Safety printout on the wall.  In one week I had managed to get close to my annual allowable radiation dose  (~5 rems?).

In my mandatory talk with the the safety officer to figure out where I got exposed, I remembered hanging out over the core on the bridge. The heavy water in the pool was both a moderator and a radiation shield. With the pool level lowered I shouldn’t have been on the bridge. I had been in the wrong place at the wrong time.

“Don’t do it again” was his advice.

Career Choices
That week I finished up the installation and resigned from the lab. While the radiation dose I received was unlikely to effect my health, the cumulative effect of four years of microwaves and the potential for more unexpected “winning the dosimetery lottery” convinced me to consider alternate jobs in electronics.

In some sense my career in startups was steered by deciding to avoid future jobs with gamma rays or high-power microwaves.

But I sure learned a lot about nuclear reactors.

—————–

Postscript: a year and a half after I left, the power reactor at Three Mile Island had a core meltdown. For years I would worry and wonder if I had wired my scram system correctly.

Lessons Learned

Things you can’t see can hurt you (microwaves, gamma rays, toxic bosses.)

No job is worth your health.

If it seems dangerous or stupid it probably is.

Rules and regulations won’t stop all possible mistakes.

No one but you will tell you it’s time to quit.

Fred Wilson of Union Square Ventures, Jason Calacanis, founder of Mahalo.com, and Mark Suster of GRP Partners, have all weighed in on the nature side – you’re born being an entrepreneur or you’re not.

Vivek Wadhwa, Director of Research, Center for Entrepreneurship at Duke, the Kauffmann Foundation for Entreprenuership and others have the opposing view – you can teach people to be entrepreneurial.

I weighed in on the subject in a previous post.

Mark Suster, Vivek Wadhwa and Patrick Chung, Partner of New Enterprises Associates debated the subject on April 21st at Stanford. I’ll was the moderator (referee).

Take a look at the video below.

I thought it was a pretty good talk and worth listening to.

Full Circle from Yosemite
Nine years ago I took my young daughters on a 7-day pack trip riding mules at 10,000 feet to the Yosemite High-Sierra camps. Granite mountains and alpine green meadows during the day, unblinking stars in the frigid August nights. At a campsite almost two miles high our daughters adopted a young couple, and over the campfire I found out they were Stanford MBA’s and entrepreneurs. Instead of ghost stories they were the first to hear the ideas of what would become Customer Development.

Fast forward to today. One of those students, Shawn Carolan, is now a partner at Menlo Ventures. When we were looking for funding for IMVU (the company where Eric Ries first implemented Customer and Agile Development and where the Lean Startup was born,) I thought of Shawn. He became the first venture investor and “present at the creation.” If you’re doing Customer Development/Lean Startup, Shawn is a great guy to have as an investor.  He’s lived it and gets it.

Recently, Shawn invited me to share the Customer Development story at Menlo Ventures annual CEO conference.

(I’ll show you the slides a bit later in this post.)

Let’s Get Together Every 15 Years
About a month ago I got a phone call from Alan Patricof of Greycroft Partners who saw the article about Lean Startups in the NY Times and invited me to talk at their CEO conference. After a few minutes on the phone, Alan and I realized that we had met 15 years ago when his firm looked at investing in my last startup, E.piphany.

It’s kind of hard not to know who Alan Patricof is. He built APAX Partners into one of the largest VC firms on the East Coast and in Europe. He started a new venture firm when he realized that that the rules had changed for the venture business – VC’s could no longer expect the same kind of returns they got in the past through an IPO. Instead, he realized that most VC-backed startups would exit through a merger or acquisition- at a sale price of $20 to $100 million.

One of the benefits of speaking at this conference was getting to know VC’s on the east coast and LA. The Greycroft team and Mark Suster of GRP Partners provided lots of local color. (Mark had an amusing summary of the conference here.  Mark is the guy I would call if I was doing a deal in LA and his blog should be on your reading list.)

You are Here
When I was in a startup, I remember being so focused on my daily tasks of getting customers and running the business that I had no time to consider “why” I was doing what I was doing. I had even less time to consider how to differentiate what were the right things to do in startup versus a larger company. The talk I gave to the startup CEO’s at both Menlo Ventures and Greycroft Partners was a big picture perspective about how startups differ from large companies and where customer and agile development fit. The talk integrated a series of posts I’ve written since the beginning of 2010: “What is entrepreneurship? The Four types of entrepreneurial organizations, Innovation and entrepreneurship in large companies and The role Pivots play in Customer Development.

18-Hour Flight for a 45 Minute Talk
Truth be told, I went to NY for the Greycroft conference because I was already heading east to Tel Aviv for a 45 minute talk. While flying 18 hours to give a 45-minute talk might not seem rational, in fact it provided the rationale to visit a part of the world my wife and I had never seen. I turned the 45-minute invitation into a three week trip. New York to Cairo, Aswan, Abu Simbel, Luxor, Tel Aviv, Haifa, Tiberias and Jerusalem.

As a country, Israel has the highest ratio of scalable startups per capita. A high percentage of Israeli startups are founded by entrepreneurs who served in Unit 8200 and military intelligence. They are agile, resourceful and aggressive. In the dot-com bubble Israel had more technology companies listed on the NASDQ exchange than all of Europe. Today Israeli companies solve technology problems then typically sell out to a larger U.S. firm.

While this is an enviable track record, my talk observed that solving just the technology problems and selling out meant that Israeli companies did not become adept at understanding customer needs. (And in Israel you can’t just get out of the building to understand customers, you need to get out of the country.) Given the current Israeli economic and venture climate having great technology is no longer enough. I observed that this may be the time for Israel to take entrepreneurship to the next step and teach their startups the skills needed to grow from flipping technology startups to building enduring companies.

I used the metaphor of fighter pilots (who have to constantly adapt in real-time) versus military intelligence (who have time to analyze and debate the right answer.) John Boyd of OODA Loop fame got a starring role in the talk.

It went over like a lead balloon.

(Slides 43-49 and 81-89 are the ones that differ from the Greycroft presentation.)

BTW, the schedule of my future talks are now on Plancast.

Posts will resume in July.

Egyptian Fallujah on the nile at Luxor

Is Your VC Founder Friendly?
How do you figure out which VC firm is best for you?  Here are five questions to consider.

1. What startup stage do they typically invest in?
2. Do they “get” Customer Development?
3. Who do they have as advisors?
4. How many of their founders are still with their company?
5. Will they tailor your vesting to your contribution as a founder?

What Startup Stage Do they Invest In?
Ask potential investors which stage they invest in.

Certain VC’s like the new class of Super-Angels and small VC funds specialize in the early stage of a startup where you are searching for a business model. And some larger funds that specialize in later stage deals may have a partner or two who likes to invest at this stage. (Some VC’s invest solely on technology breakthroughs and assume they’ll find a market later.)

Early stage investors have different insights then those investing in a later stage. They understand that now’s not the time to hire a senior VP of Sales to start to scale the sales force or to look for a finance department to create income statements that say zero each month. These VC’s are skilled in helping you search for the business model.

If they haven’t done many early deals before a business model is found, ask them why they are interested in you?  Is it for your technology? Your potential business model?

Do They Get Customer Development?
For a founder there’s nothing worse than searching for a business model day after day and then sitting in a board meeting with a VC who asks about some detail of year 5 of your revenue plan.

Ask potential investors, how will they measure progress for the company and you as a CEO? Do they have metrics and a methodology they use for early stage companies that differs from companies that have already found a business model?  Have they heard about Customer Development? Lean Startups? Can they tell you what you should be doing in Customer Discovery and Customer Validation? If not, do they have a better methodology?

Who Do They Hang With?
Investors who have successful ex-founders who you can call for advice, grab a coffee with or get on your advisory board is a good sign. (And a sign that their ex-founders still like them.)

VC’s who have ex-CEO’s who took over from the founder and built the startup into a multi- $100 million company can give great advice about your growing company’s infrastructure, but if you are still searching for your first customer, they may not be much help. (In fact, unless they’ve been founders themselves they usually provide bad advice.) VC’s with formerly high-ranking government officials and Fortune 1000 CEO’s as advisors may be wonderful to help you grow your company in a later stage but not helpful now. (Unfortunately the odds of you being the CEO at this future stage are pretty low.)

How many of their founders are still with their company?
Most early stage VC’s are betting on the founders to both deliver the product and to find the business model. At this stage, firing the founder is not a strategy, it’s an act of desperation.

By the time the company gets to the build-stage (the Transition) what differentiates VC’s is how many turn the founders into builders versus relying on bringing in new, more experienced management to lead the transition. As a founder, you should ask: What percentage of the firm’s companies still have founders as the CEOs?  In any active role?  If the number is less than 25%, you may want to think twice. Ask to talk to some of the founders who are no longer with their startups. I’ll bet you get some interesting stories.

Will The VC Tailor Your Vesting to Your Contribution?
Most founders don’t make it past the build stage in a startup. Almost invariably the new CEO will comes in and complain about how disorganized the place is and then does a wonderful job in putting policies and procedures in place. Yet none of this would be possible if the founder hadn’t created the company in the first place. Typical vesting of your stock is over a four-year period, yet the founder’s contribution is heavily weighted to the first few years.

Over the years I’ve become a bigger and bigger believer in some sort of accelerated vesting for the founders tied to finding the business model. There have been suggestions of a different class of stock for founders here and good general advice in VentureHacks here.

———

All these suggestions are written as if you had a choice of who to take money from. Most of the time you’ll take whosever check will cash. But if you do have a choice, asking these questions will keep you from being surprised in a board meeting.

Lessons Learned

What phase of the company lifecycle are you?

What phase do your VC’s typically invest in?

What type of advisors does your VC have?

What percentage of this firm’s former founders are still running their companies?

What metrics are they going to use to measure progress in a board meeting?

Small Business Entrepreneurship
My parents came to the United States through Ellis Island in steerage in sight of the Statue of Liberty. As immigrants their biggest dream was opening a small grocery store on the Lower East Side of New York City, which they did in 1939. They didn’t aspire to open a chain of grocery stores, just to feed their family.

My parents were no less of an entrepreneur than I was. They went on an uncharted course, took entrepreneurial risk and only made money if the business succeeded. The only capital available to them was their own savings and what they could borrow from relatives. Both my parents worked as hard as any Silicon Valley entrepreneur but with a different definition of a successful business model; when they made a profit, they could feed our family. When business was bad they figured out why, adapted and worked harder still. They were only accountable to one and other.

Today, the overwhelming number of entrepreneurs and startups in the United States are still small businesses.

Scalable Startup Entrepreneurship
Unlike my parents, Fred Durham and his partner Maheesh Jain started the now $100+ million CafePress, knowing they wanted to build a large company. Founded in offices smaller than my parents grocery store, Fred and Maheesh’s vision was to provide a home for artists who made personalized products assembled in a just-in-time factory that today delivers a customized gift each second. Once they found a profitable business model they realized that scale required external venture capital to fuel rapid expansion. With venture capital came accountability to board members, forecasts, and other people’s agendas. Success for a scalable startup is a three-times (or more) return on the investor’s money – either by a public offering of stock or by selling the company.

Scalable startups in technology centers (Silicon Valley, Shanghai, New York, Bangalore, Israel, etc.) make up a small percentage of entrepreneurs and startups but because of the outsize returns attract almost all the risk capital (and press.)

Large Company Entrepreneurship
At the end of 1980, IBM decided to compete in the rapidly growing personal computer market. They were smart enough to realize that IBM’s existing processes and procedures wouldn’t be agile enough to innovate in this new market. The company established their new PC division (called Entry Systems), as a Skunk Works in Boca Raton Florida a 1000 miles from IBM headquarters. This small group consisted of 12 engineers and designers under the direction of Don Estridge. Success for this new division meant generating substantial revenue and profit for company.

The division developed the IBM PC and announced it in less than a year. Three years later the division had sold 1 million PC’s, had 9500 people and a billion dollars in sales.

Don Estridge’s paycheck and funding for the division came from IBM and he reported up the organization, but in his own division he was no less entrepreneurial than Michael Dell or Steve Jobs – or Fred Durham or my parents.

Social Entrepreneurship
Irfan Alam, a 27-year-old from the Indian state of Bihar started the Sammaan Foundation to transform the lives of 10 million rickshaw-pullers in India. Irfan got banks to finance rickshaw-pullers and designed rickshaws that can shelve newspapers, mineral water bottles and other essentials for rickshaw passengers. These rickshaws carry ads and the pullers get 50% of the ad revenue, the remainder going to Sammaan. The rickshaw-pullers end up as owners after re-paying the bank loan in installments. Irfan started off with 100 such rickshaws in 2007 and have 300,000 today.

Irfan doesn’t take a salary but he is as focused on scalability, asset leverage, return on investment and growth metrics as any Silicon Valley entrepreneur ever was.

Summary
If you put the four entrepreneurs in the room you would understand what they had in common- they were resilient, agile, tenacious and passionate – the four most common traits of any class of entrepreneur.

Also in common, each of their businesses initially were searching for a business model, and each was instinctively executing a customer discovery and validation process.

Yet there are obvious differences in each type; personal risk, size of vision and goal.

More on this later.

Lessons Learned

Four different types of entrepreneurship: Small Business, Scalable, Large Company, Social.

All searching for a sustainable business model.

Regardless of type, entrepreneurs have common characteristics: resilient, agile, tenacious and passionate.

Differences include level of tolerance of personal risk, size and scale of the vision and their personal financial goal.

There’s nothing harder than making radical changes when the numbers look great.

Lifecycle
The company’s two co-founders had created a new technology and an innovative business strategy. The engineering co-founder had created a consumer electronics security product that created an entirely new category. The other founder, the business guy, managed to get its product legislated into consumer electronics devices. After the initial few years of technical innovation, they found their business model in licensing and over the next decade and a half grew into a $200 million company.

As the revenues grew, engineering continued to pursue sustaining innovations- incremental improvements on its core technologies.

At the same time its business strategy became operational execution focused on licensing and legal to collect royalties.

Execution
Over time the co-founder responsible for the original business innovations departed. While a large loss, it wasn’t fatal as the company now was executing a repeatable business model.  The new CEO was promoted from inside the company and did an excellent job of running the company. Even though the company was in Silicon Valley, he ran it like it was in Kansas: no frills, no hype, no crazy expenditures, just year after year of increasing revenue and profits. And year after year he managed to come out on top renewing the licensing contracts with Hollywood studios, (who were no pushovers in negotiations). It was impressive.

We Think We Need Some Technology Advice
To their credit, the board and CEO realized that this business model couldn’t continue forever. They acquired a small, innovative company in what they thought was an adjacent market. The acquisition turned out to be a culture clash of titanic proportions, kind of like the irresistible force meets the immovable object, as the great startup founder ran headlong into the excellent operating guy. Neither company really understood what it would take to integrate such different worldviews. (More on this in another post.)

In the middle of this acquisition, both the board (who were finance and Hollywood executives) and the CEO realized that while they were physically in Silicon Valley, they were missing someone familiar with business innovation in technology companies.

This is when I joined the board.

Distracted
After a few months on the board trying to understand the difficulties of integrating the new acquisition, I realized that this was just a side-show. The real issue was that was that the instincts of the board and CEO were right. There were tectonic shifts happening outside the company – changes in markets, technology, platforms, regulations, etc -and outside their control. Worse, these shifts were outside the company’s control, because unlike the original co-founder, now gone, who managed to get their technology written into legislation, no one was working the same magic on the next generation of digital standards online or in the cloud.

We realized that the company had three to five years left before its licensing business would drop by half. As a board we slowly came to the conclusion we’d have to reinvent the company, and we didn’t have much time. The CEO agreed.

Reinvention
Over the next few years, the company built an internal engineering department, and expanded its business development team in search of a new strategy and new companies to acquire.

To the outside world, things still looked great; year over year, revenue and profits were still increasing.

At each board meeting, we’d hear about new products and approve new acquisitions while we were increasingly worrying about when revenues of our core product would start declining.

The world outside the company was changing faster than we could. The new strategies and acquisitions ended up as slight variations on the ones we were already executing.

We seemed to be out of big ideas.

Time For a Change
The problem was, the company needed to think like a startup again. The current team was too focused and ironically too steeped in our current business to imagine radical reinvention.

We concluded that we needed a new CEO and new board members.

There’s nothing harder than changing strategy with a CEO who the board admires, with revenues seemingly increasing. Yet the consequences of ignoring the shifts in the market, technology and regulation is a going out of business strategy.

This was a tough call for the board as we liked the CEO, and he was the one who had asked us to join the board.

As one could imagine, the existing CEO didn’t agree. “I’ve done everything you guys have asked. Our revenue is still growing and we are acquiring all the new companies.”

While the CEO is the responsible executive for operating the company on a daily basis, ultimately it’s the responsibility of the board of the directors to hire and fire the CEO. The board is responsible to the shareholders and all the stakeholders for the ultimate survival of the company. Our call was that it was going to take a new set of eyes to get the elephant to dance.

Postscript
The new CEO turned the company on its head, divested most of the acquisitions, made other acquisitions worth billions of dollars, refocused the company, changed out most of the board and senior management.

And he even renamed the company.

Revenue doubled in the last 3 years and the market cap is approaching $4 billion as he reinvented the company.

A tough call but the right one for the shareholders.

Lessons Learned

Just because a company is profitable doesn’t mean its core businesses isn’t crumbling under its feet.

Big companies are dead long before they close the doors.

Ultimately it’s because the board of directors doesn’t act in time.

The dilemma is how to make sure that the board is not just a cheerleader for the CEO when the CEO is the primary recruiter for the board.

Microsoft fits this description.  Their failures in multiple markets is no longer just a failure of management but a failure of board governance. (Hard to fix when the major shareholder is the lifelong friend of his handpicked replacement.)

Companies have a fairly predictable life cycle. They start with an innovation, search for a repeatable business model, build the infrastructure for a company, then grow by efficiently executing the model.

Over time, innovations outside the company (demographic, cultural, new technologies, etc.) outpace an existing company’s business model. The company loses customers, then revenues and profits decline and it eventually gets acquired or goes out of business.  (Looking at the Dow-Jones component companies over time is a graphic example of this.)

Creative Destruction
If you’re an entrepreneur, you spend your time worrying about how to get out of the box on the left and move to the right.  You want to start executing the business model.

Ironically, the best CEO’s in the box on the right are constantly worrying not only how to execute but also how to remain innovative and entrepreneurial.

Innovation and Entrepreneurship in the Enterprise
How large companies can stay innovative and entrepreneurial has been the Holy Grail for authors of business books, business schools, consulting firms, etc.  There’s some great work from lots of authors in this area.  (A short list at the end of this post.)

Over 15 years ago, Clayton Christensen observed that there are two types of innovative strategies for a large company – sustaining and disruptive innovation.  He believed that large companies handle sustaining innovation – evolutionary changes in their markets, products, etc. valued by their existing customers – fairly well.  But most large companies find it hard to deal with disruptive innovation – radical shifts in technology, customers, regulatory changes, etc, that create new markets.

Sustaining Innovation and Entrepreneurship in the Enterprise
If we use our “startup to large company,” diagram, we can see that sustaining innovations occur within a large company’s existing management structures. I’ll offer that the diagram looks something like this.

If you’ve been reading my book on Customer Development and follow my work on Market Type, this type of innovation is best for adding new products to existing markets.

Disruptive Innovation and Entrepreneurship in the Enterprise
Yet most research has shown that disruptive innovation, that is innovations that go after new markets, new customers, new technologies, etc. are best built outside a large company’s existing organization.

This type of organization is best for finding new niches in existing markets or creating entirely new markets.  Why? Disruptive innovation in a large company is attempting to solve two simultaneous unknowns: the customer/market is unknown, and the product feature set is unknown. Just like a startup.

The diagram for managing disruptive innovation in large company looks suspiciously like starting from square one as a startup.

What’s Missing in Innovation and Entrepreneurship in the Enterprise?
After growing past their scrappy startup roots, large companies trying to master disruptive innovation face the ultimate irony; “the Innovator’s DNA” that’s needed has more than likely been purged from the organization. Mastering disruptive innovation in a large company requires:
- different people
- different processes
In fact the people a large firm needs for this kind of innovation looks suspiciously like startup founders and the processes needed look like Customer Development.

Customer and Agile Development (and the Lean Startup) may be the emerging methodologies large companies need to build innovative new products.

More in future posts.

Lessons Learned

Innovation in large company’s come in two forms; sustaining and disruptive

Disruptive innovation in a large company may require processes and individuals that look a lot like those in a startup.

Customer and Agile Development may be the methodologies that large companies need to build innovative new products

Further Reading:
Harvard Business Review Articles
- Meeting the Challenge of Disruptive Change, Clayton Christensen/Michael Overdorf: March/April 2000
- The Quest for Resilience, Gary Hamel/Liisa Valikangas: Sept 2003
- The Ambidextrous Organization, Charles O’Reilly/Michael Tushman: April 2004
- Darwin and the Demon: Innovating Within Established Enterprises, Geoffrey Moore: July/August 2004
- Meeting the Challenge of Corporate Entrepreneurship, David Garvin/Lynne Levesque: Oct 2006
- The Innovators DNA, Jeffrey Dyer, Hal Gregersen, Clayton Christensen: Dec 2009

Books
- Innovators Dilemma & Innovator Solution, Clayton Christensen
- Winning Through Innovation: a Practical Guide to Leading Organizational Change and Renewal, Charles O’Reilly