I’ve been traveling – New York/Cairo/Tel Aviv – for the last three weeks.
Posts will resume in July.
The role of a founding CEO in a startup searching for a business model is radically different than a CEO building and growing a company. Some VC’s get it, others may not. So if you’re the founder of a startup, you may want to consider who you take money from.
Is Your VC Founder Friendly?
How do you figure out which VC firm is best for you? Here are five questions to consider.
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.
- 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?
Who is an entrepreneur really? It turns out that there are four distinct types of entrepreneurial organizations; small businesses, scalable startups, large companies and social entrepreneurs. They all engage in entrepreneurship. Yet entrepreneurs in one class think that the others aren’t the “real” entrepreneurs. This post looks at the differences and similarities and explains why there’s such confusion.
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.
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.
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.
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.
- 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.
It is a rare company that realizes it is time to fire the CEO when the financials are good but the business is fundamentally heading for a cliff. For me, I learned this lesson first hand. I had joined the board of a $200million public company that 15 years earlier had single-handily created an industry. The company had innovated, found a business model, grown successfully but now even as revenues continued to grow, the company was slowly but surely dying.
There’s nothing harder than making radical changes when the numbers look great.
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.
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.
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.
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.
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.
- 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.)
It’s not the strongest of the species that survive, nor the most intelligent, but the one that is most responsive to change.
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.)
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.
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.
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.
More in future posts.
- 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
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
– Innovators Dilemma & Innovator Solution, Clayton Christensen
– Winning Through Innovation: a Practical Guide to Leading Organizational Change and Renewal, Charles O’Reilly