Startup America – Dead On Arrival

Posted on February 8, 2011 by steve blank

For its first few decades Silicon Valley was content flying under the radar of Washington politics. It wasn’t until Fairchild and Intel were almost bankrupted by Japanese semiconductor manufacturers in the early 1980’s that they formed Silicon Valley’s first lobbying group. Microsoft did not open a Washington office until 1995.

Fast forward to today. The words “startup,” “entrepreneur,” and “innovation” are used fast, loose and furious by both parties in Washington. Last week the White House announced Startup America, a public/private initiative to accelerate accelerate high-growth entrepreneurship in the U.S.  by expanding startups access to capital (with two $1 billion programs); creating a national network of entrepreneurship education, commercializing federally-funded research and development programs and getting rid of tax and paperwork barriers for startups.

What’s not to like?

My observation. Startup America is a mashup of very smart programs by very smart people but not a strategy. It made for a great photo op, press announcement and impassioned speeches. (Heck, who wouldn’t go to the White House if the President called.) It engaged the best and the brightest who all bring enormous energy and talent to offer the country. The technorati were effusive in their praise.

I hope it succeeds. But I predict despite all of Washingtons’ good intentions, it’s dead on arrival.

Dead On Arrival
I got a call from a recruiter looking for a CEO for the Startup America Partnership. Looking at the job spec reminded me what it would be like to lead the official rules committee for the Union of Anarchists.

There are three problems. First, an entrepreneurship initiative needs to be an integral part of both a coherent economic policy and a national innovation policy – one that creates jobs for Main Street versus Wall Street. It should address not only the creation of new jobs, but also the continued hemorrhaging of jobs and entire strategic industries offshore.

Second, trying to create Startup America without understanding and articulating the distinctions among the four types of entrepreneurship (described later) means we have no roadmap of where to place the bets on job growth, innovation, legislation and incentives.

Third, the notion of a public/private partnership without giving entrepreneurs a seat at the policy table inside the White House is like telling the passengers they can fly the plane from their seats. It has zero authority, budget or influence. It’s the national cheerleader for startups.

The Four Types of Entrepreneurship
“Startup,” “entrepreneur,” and “innovation” now means everything to everyone. Which means in the end they mean nothing. There doesn’t seem to be a coherent policy distinction between small business startups, scalable startups, corporations dealing with disruptive innovation and social entrepreneurs. The words “startup,” “entrepreneur,” and “innovation” mean different things in Silicon Valley, Main Street, Corporate America and Non Profits. Unless the people who actually make policy (rather than the great people who advise them) understand the difference, and can communicate them clearly, the chance of any of the Startup America policies having a substantive effect on innovation, jobs or the gross domestic product is low.

1. Small Business Entrepreneurship
Today, the overwhelming number of entrepreneurs and startups in the United States are still small businesses. There are 5.7 million small businesses in the U.S. They make up 99.7% of all companies and employ 50% of all non-governmental workers.

Small businesses are grocery stores, hairdressers, consultants, travel agents, internet commerce storefronts, carpenters, plumbers, electricians, etc. They are anyone who runs his/her own business. They hire local employees or family. Most are barely profitable. Their definition of success is to feed the family and make a profit, not to take over an industry or build a $100 million business. As they can’t provide the scale to attract venture capital, they fund their businesses via friends/family or small business loans.

2. Scalable Startup Entrepreneurship
Unlike small businesses, scalable startups are what Silicon Valley entrepreneurs and their venture investors do. These entrepreneurs start a company knowing from day one that their vision could change the world. They attract investment from equally crazy financial investors – venture capitalists. They hire the best and the brightest. Their job is to search for a repeatable and scalable business model.  When they find it, their focus on scale requires even more venture capital to fuel rapid expansion.

Scalable startups in innovation clusters (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.) Startup America was focussed on this segment of startups.

3. Large Company Entrepreneurship
Large companies have finite life cycles. Most grow through sustaining innovation, offering new products that are variants around their core products. Changes in customer tastes, new technologies, legislation, new competitors, etc. can create pressure for more disruptive innovation – requiring large companies to create entirely new products sold into new customers in new markets. Existing companies do this by either acquiring innovative companies or attempting to build a disruptive product inside. Ironically, large company size and culture make disruptive innovation extremely difficult to execute.

4. Social Entrepreneurship
Social entrepreneurs are innovators who focus on creating products and services that solve social needs and problems. But unlike scalable startups their goal is to make the world a better place, not to take market share or to create to wealth for the founders. They may be nonprofit, for-profit, or hybrid.

So What?
Each of these four very different business segments require very different educational tools, economic incentives (tax breaks, paperwork/regulation reduction, incentives), etc.  Yet as different as they are, understanding them together is what makes the difference between a jobs and innovation strategy and a disconnected set of tactics.

Go take a look at any of the government organizations talking about entrepreneurship and see how many of its leaders or staff actually started a company or a venture firm. Or had to make a payroll with no money in the bank. We’re trying to kick-start a national initiative on startups, entrepreneurs and innovation with academics, economists and large company executives. Great for policy papers, but probably not optimal for making change.

Rather than having our best and the brightest visit for a day, what we need sitting in the White House (and on both sides of the aisle in Congress) are people who actually have started, built and grown companies and/or venture firms. (If we’re serious about this stuff we should have some headcount equivalence to the influence bankers have.)

Next time the talent shows up for a Startup America initiative, they ought to be getting offices not sound bites.

Lessons Learned

  • Lots of credit in trying to “talk-the-talk” of startups
  • No evidence that Washington yet understands the types of entrepreneurs and startups; how they differ, and how they can form a cohesive and integrated jobs and innovation strategy
  • Not much will happen until entrepreneurs and VC’s have a seat at the table

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Filed under: Technology, Venture Capital | 53 Comments »

VC’s Are Not Your Friends

Posted on February 3, 2011 by steve blank

One of the biggest mistakes entrepreneurs make is not understanding the relationship they have with their investors. At times they confuse VC’s with their friends.

Lets Go to Lunch
At Rocket Science our video game company was struggling. Hubris, bad CEO decisions (mine) and a fundamental lack of understanding that we were in a “hits-based” entertainment business not in a Silicon Valley technology company were slowly killing us.

One day I got a call from my two investors, “Hey Steve, we’re both going to be up in San Francisco, lets grab lunch.” I liked my two investors. I’d known them for years, they were smart, trying to figure out the video game market with me, (in hindsight a business that none of us knew anything about and shouldn’t have been in,) coached me when needed, etc. Our board meetings were collegial and often fun.

We were just about to have a board meeting in another week to talk about raising another round of financing to keep our struggling disaster afloat. I had assumed that my VC’s were behind me. Thinking we were having a social call, I was completely unprepared for the discussion. (Lesson – never take a VC meeting without knowing the agenda.)

“Steve, we thought we’d tell you this before the board meeting, but both our firms are going to pass on leading your next round.” I was speechless. I felt like I had just been kicked in the gut and stabbed in the back These were my lead investors. It was the ultimate vote of no confidence. If they passed the odds of anyone in the entire country funding us was zero. I knew they had been questioning our ability to stay afloat as a company in the board meetings so this wasn’t a complete surprise but I would have expected some offer a bridge loan or some sign of support. (I finally got them to agree if I could find someone else to lead the round they would put in a token amount to say they were still supportive.)

“Is this about me as the CEO?” I asked. “I’ll resign if you guys think you can hire someone else you want to back.” They looked a bit sheepish and replied, “No it’s not you. You should stay and run the company. However, we realized that we’ve backed a business we don’t know much about, the company is a money sink and both our firms have no stomach for this industry.”

“But I thought you guys were my friends?!” You’re supposed to support me!! I said out of utter frustration.

VC’s Are Not Your Friends
I had just gotten a very expensive reminder. I liked my board members. They liked me. But while I was just seeing a single board member, I was just one of twenty companies in their current fund portfolio. Their fiduciary responsibility was to manage a portfolio of investments for their limited partners. And what they promised their own investors was that they would invest money in deals that would grow in value and achieve liquidity. As much as they liked me as the entrepreneur, they couldn’t throw good money after bad when they thought the deal went south.

I wish I could tell you I understood this all at the time. I didn’t. I was angry, took it personally for a long time (past the demise of Rocket Science) until I realized they were right.

While the best VC’s treat entrepreneurs like you are their most important customer, and they add tremendous value to your startup (recruiting, strategy, coaching, connections, etc.) they are not doing it out of the goodness of their hearts. Entrepreneurs need to understand that VC’s are simply a sophisticated form of financial investors who in turn need to satisfy their own investors. At the end of the day VC’s have to provide their limited partners with great returns or they aren’t going to be able to raise another fund.

If you succeed so do they. Great VC’s do everything they can to make you successful. But just like your bank, credit card company, mortgage holder, etc. they are not confused where their long term loyalty lies.

It’s not with you.

Postscript
The irony is 15 years later, no longer doing startups, these two VC’s truly have become my friends. We have lunch often, teach together and swap war stories of the day they pulled my funding.

It wasn’t an easy lesson.

Lessons Learned

  • You see one VC, they see 20 CEO’s
  • Don’t confuse your business with your VC’s business
  • Your interests are aligned if you both see the same path to liquidity
  • Don’t confuse being friendly with your VC’s with VC’s as your friend

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Filed under: Rocket Science Games, Venture Capital | 31 Comments »

The 47th (-46) International Business Model Competition

Posted on January 27, 2011 by steve blank

Utah may be known for many things, but who would have thought that Utah, and particularly Brigham Young University (BYU), would be participating in the transformation of entrepreneurship?

I spent last weekend in Utah at BYU as a guest of Professor Nathan Furr, (a former Ph.D. student of our MS&E department at Stanford,) where they are set on being a leader in developing the management science of entrepreneurship. The most visible step was the first International Business Model Competition, hosted by the BYU Rollins Center for Entrepreneurship and Technology.

What’s A Startup?
We’ve been teaching that the difference between a startup and an existing company is that existing companies executebusiness models, while startups searchfor a business model. (Or more accurately, startups are a temporary organization designed to search for a scalable and repeatable business model.) Therefore the very foundations of teaching entrepreneurship should start with how to search for a business model.

This startup search process is the business model / customer development / agile development solution stack. This solution stack proposes that entrepreneurs should first map their assumptions (their business model) and then test whether these hypotheses are accurate, outside in the field (customer development) and then use an iterative and incremental development methodology (agile development) to build the product. When founders discover their assumptions are wrong, as they inevitably will, the result isn’t a crisis, it’s a learning event called a pivot — and an opportunity to update the business model.

Business Model Versus Business Plan
The traditional business plan is an essential organizing and planning document to launch new products in existing companies with known customers and markets. But this same document is a bad fit when used in a startup, as the customers and market are unknown. A business plan in a startup becomes an exercise in creative writing with a series of guesses about a customer problem and the product solution. Most business plans are worse than useless in preparing an entrepreneur for the real world as “no business plan survives first contact with customers.”

I suggested that if we wanted to hold competitions that actually emulated the real world (rather than what’s easy to grade) entrepreneurship educators should hold competitions that emulate what entrepreneurs actually encounter – chaos, uncertainty and unknowns. A business model competition would emulate the “out of the building” experience of real entrepreneurs executing the customer development / business model / agile stack.

The 47th (-46) Annual Business Model Competition
From the seed of this initial idea last summer Professor Nathan Furr, and his team at BYU created a global business model competition, receiving over 60 submissions from across the world. Alexander Osterwalder, Professor Furr and I were the judges for selecting the winner from the final 4 contestants. The finals were held in the packed 800 seat BYU Varsity Theater with lines of students outside unable to get in. It was an eye-opener to see each of the teams take the stage to describe their journey in trying to validate each of the 9 parts of a business model, rather than the static theory of a business plan.

Each team used the business model canvas and customer development stack to go from initial hypotheses, getting outside the building to validate their ideas with customers, and going through multiple pivots to find a validated business model. The winner was Gamegnat, a gaming information portal (take a look at their presentation here.) At the end of the competition Gavin Christensen, managing director of Kickstart Seed Fund said, “This is going to change the way we invest.” A nice testament to the visible difference in the quality of every teams presentation. The competition was an inspiration to the students, mentors and teaching teams.

Utah: Entrepreneurial Surprises
While I was in Utah, my host kept me busy with a series of talks. I spoke at lunch to a room of 400 entrepreneurs and investors from the region about the business model / customer development stack. I was quite surprised to find the depth and interest in innovation and sheer number of startups that I saw. I was even more surprised to learn that University of Utah has gone from being ranked 94th in the U.S. for startups created from university intellectual property to number one.

When I met with the faculty and Deans at BYU they were proud to tell me that they were number one in the U.S. for startups, licenses, and patent applications per research dollar. BYU has embraced an e-school approach, changing their curriculum to develop and teach the ideas in the business model / customer development stack. Their vision is to make the Business Model Competition an even larger international event, creating competitions at partner schools and providing the materials and insight to create a network of business model competitions culminating in an international finals event. And they are ready to share!

Keep your eye out for more details about creating your own competition, or contact Nathan Furr directly.

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Filed under: Business Model versus Business Plan, Teaching, Venture Capital | 8 Comments »

Startup Suicide – Rewriting the Code

Posted on January 25, 2011 by steve blank

The benefits of customer and agile development and minimum features set are continuous customer feedback, rapid iteration and little wasted code. But over time if developers aren’t careful, code written to find early customers can become unwieldy, difficult to maintain and incapable of scaling. Ironically it becomes the antithesis of agile. And the magnitude of the problem increases exponentially with the success of the company. The logical solution? “Re-architect and re-write” the product.

For a company in a rapidly changing market, that’s usually the beginning of the end.

It Seems Logical
I just had lunch (at my favorite Greek restaurant in Palo Alto forgetting it looked like a VC meetup) with a friend who was technical founder of his company and is now its chairman. He hired an operating exec as the CEO a few years ago. We caught up on how the company was doing (“very well, thank you, after five years, the company is now at a $50M run rate,”) but he wanted to talk about a problem that was on his mind. “As we’ve grown we’ve become less and less responsive to changing market and customer needs. While our revenue is looking good, we can be out of business in two years if we can’t keep up with our customer’s rapid shifts in platforms. Our CEO doesn’t have a technology background, but he’s frustrated he can’t get the new features and platforms he wants (Facebook, iPhone and Android, etc.) At the last board meeting our VP of engineering explained that the root of our problems was ‘our code has accumulated a ton of “technical debt,’ it’s really ugly code, and it’s not the way we would have done it today. He told the board that the only way to to deliver these changes is to re-write our product.” My friend added, “It sounds logical to the CEO so he’s about to approve the project.”

Shooting Yourself in the Head
“Well didn’t the board read him the riot act when they heard this?” I asked. “No,” my friend replied, sadly shaking his head, “the rest of the board said it sounded like a good idea.”

With a few more questions I learned that the code base, which had now grown large, still had vestiges of the original exploratory code written back in the early days when the company was in the discovery phase of Customer Development. Engineering designs made back then with the aim of figuring out the product were not the right designs for the company’s current task of expanding to new platforms.

I reminded my friend that I’ve never been an engineering manager so any advice I could give him was just from someone who had seen the movie before.

The Siren Song to CEO’s Who Aren’t Technical
CEO’s face the “rewrite” problem at least once in their tenure. If they’re an operating exec brought in to replace a founding technical CEO, then it looks like an easy decision – just listen to your engineering VP compare the schedule for a rewrite (short) against the schedule of adapting the old code to the new purpose (long.) In reality this is a fools choice. The engineering team may know the difficulty and problems adapting the old code, but has no idea what difficulties and problems it will face writing a new code base.

A CEO who had lived through a debacle of a rewrite or understood the complexity of the code would know that with the original engineering team no longer there, the odds of making the old mistakes over again are high. Add to that introducing new mistakes that weren’t there the first time, Murphy’s law says that unbridled optimism will likely turn the 1-year rewrite into a multi-year project.

My observation was that the CEO and VP of Engineering were confusing cause and effect. The customers aren’t asking for new code. They are asking for new features and platforms –now. Customers couldn’t care less whether it was delivered via spaghetti code, alien spacecraft or a completely new product. While the code rewrite is going on, competitors who aren’t enamored with architectural purity will be adding features, platforms, customers and market share. The difference between being able to add them now versus a year or more in the future might be the difference between growing revenue and going out of business.

Who Wants to Work on The Old Product
Perhaps the most dangerous side-effect of embarking on a code rewrite is that the decision condemns the old code before a viable alternative exists. Who is going to want to work on the old code with all its problems when the VP Engineering and CEO have declared the new code to be the future of the company?  The old code is as good as dead the moment management introduces the word “rewrite.”  As a consequence, the CEO has no fallback. If the VP Engineering’s schedule ends up taking four years instead of one year, there is no way to make incremental progress on the new features during that time.

What we have is a failure of imagination
I suggested that this looked like a failure of imagination in the VP of Engineering  – made worse by a CEO who’s never lived through a code rewrite – and compounded by a board that also doesn’t get it and hasn’t challenged either of them for a creative solution.

My suggestion to my friend? Given how dynamic and competitive the market is, this move is a company-killer. The heuristic should be don’t rewrite the code base in businesses where time to market is critical and customer needs shift rapidly.” Rewrites may make sense in markets where the competitive cycle time is long.

I suggest that he lay down on the tracks in front of this train at the board meeting. Force the CEO to articulate what features and platforms he needs by when, and what measures he has in place to manage schedule risk. Figure out whether a completely different engineering approach was possible. (Refactor only the modules for the features that were needed now? Rewrite the new platforms on a different code-base? Start a separate skunk works team for the new platforms?  etc.)

Lessons Learned

  • Not all code rewrites are the same.  When the market is stable and changes are infrequent, you may have time to rewrite.
  • When markets/customers/competitors are shifting rapidly, you don’t get to declare a “time-out” because your code is ugly.
  • This is when you need to understand 1) what problem are you solving (hint it’s not the code) and 2) how to creatively fix what’s needed.
  • Making the wrong choice can crater your company.
  • This is worth a brawl at the board meeting.

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Filed under: Customer Development, Technology, Venture Capital | 88 Comments »

The Bad Board Member

Posted on January 19, 2011 by steve blank

Over the last 40 years the U.S. has evolved an entrepreneurial ecosystem with two of the most unlikely partners – venture capital investors and technology entrepreneurs. This alliance has led to an explosion of technology innovation, scalable startups and job creation.

Tied at the hip, VC’s and entrepreneurs take large risks together. VC’s invest in startups with minimal tangible assets and no certainty about the product’s viability, market size or customer adoption. Entrepreneurs face all that, and add one more risk to their list: the bad board member.

The Bad Board Member
I had coffee last week with one of my ex students. 30 months ago he raised a Series A venture round from two name brand Silicon Valley VC firms. It was early in the day, but he looked tired. “I need some advice about my board. I get along great with one of the VC’s, but the other one, Bob, is making my life miserable. Nothing I do is right in his eyes.” He looked pained as he continued. “We never had any personal chemistry, and it’s gotten so bad in the last six months, our board meetings are just hell. They consist of Bob beating me up regardless of whether the results are good or bad. I can’t tell if he’s trying to get me to quit, fire me and bring on a new CEO or is just a miserable human being.”

My antenna went up when I heard that Bob was his board member because the senior partner who led the investment said he was too busy to take another board seat (and right after the closing had assigned Bob to take the seat for his firm.)

Uh oh, I thought. I lived through this one. Admittedly, my ex student was quirky, bordering on eccentric, but he had a long and successful track record in Silicon Valley delivering complex products before he went back to get his MBA. He was a great engineering manager and recruited, hired and inspired a world-class team. This was his first CEO job. He said that Bob described him to others on the board as the “crazy aunt you hide in the closet when the guests come.”

We went through the status of the company, and at least from the outside it sounded good. In fact it sounded great: three major versions of the product shipped, multiple iterations and a few pivots under their belt, revenue was growing even faster than plan.

“Well you just need to talk to your other board members and ask for their counsel,” I offered.  “I did! I’ve talked to the other VC and he told me it’s a problem that I just need to work out with Bob.“ Hmm, this wasn’t sounding good. “Why don’t you go back to the partner who led the deal and ask for his advice?”

The look on his face told me I knew what the answer would be. “Why do you think I’m having breakfast with you?  I did just that, and do you know what he said?” I sat there thinking I knew exactly what the senior VC said because I had heard it myself when I was an entrepreneur. “The senior partner at the firm said he wasn’t going to get involved in “chemistry” issues.” Sounding both sad and frustrated he said, “What do I do now? I built a great company, and I think I’m being set up to be fired.”

The VC Lemon Law
Every Venture Capitalist I’ve heard talk about founder/board member problems treats them like they only happen in other funds. “Great VC’s in brand name firms don’t have these problems” is the line I hear.

The venture capital industry is in denial.

The problem is as bad in large brand name funds as in the smaller firms. While most board problems arise from founder performance issues, naiveté or disagreements about strategy, a number are created by bad behavior on the part of a board member. Yet while a VC can remove a founder who misbehaves, there is no corresponding recourse when a VC is the source of the problem.

Astonishingly, there’s no professional standards in the venture capital industry that acknowledges this problem even exists. Not only does the industry lack a code of conduct, but individual venture firms lack avenues for founders/CEOs to bring these problems to light. There’s no ombudsman or 3rd party in a firm to hear an objective review, and no remedy to deal with a partner’s bad behavior. (And why would there be if the problems are only with the founders.)

The rationale seems to be rooted in both tradition and math. Like doctors VC’s tend to bury their mistakes. If a partner screws up a single company in a portfolio it’s not the end of the world since they have 20-30 companies in a fund.  If a single partner has a consistently terrible track record, he or she just won’t be invited into the next fund.  But in the meantime this bad board member has left a trail of broken companies. When it comes time to understand individual partner performance, information asymmetry is at play – like bad doctors, knowledge about a partner’s performance is limited—and entrepreneurs rarely have a say in the matter even if they do have some knowledge.

Finally, there’s more than a whiff of noblesse oblige at play. If firms believe that VC’s always act responsibly and the problems are always with the founders, they don’t need to worry about bad board member behavior. They can continue to pretend it never occurs.

The reality is that the VC business has expanded from the clubby group of 20 or so firms that sat on Sand Hill Road 40 years ago into an industry of ~400.  My hope is that they realize that with that expansion comes a different set of responsibilities.

Lessons Learned

  • Most Entrepreneur/VC clashes arise from founder performance issues
  • Infrequently the cause is bad behavior from a board member
  • Currently founders have no recourse
  • After 40 years of growth the VC industry still operates with “small club” rules and mindset

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Filed under: Venture Capital | 29 Comments »

Creating the Next Silicon Valley – The Chilean Experiment

Posted on January 4, 2011 by steve blank

I spent two weeks of December in Chile as a guest of Professor Cristóbal García, Director of EmprendeUC at the Catholic University of Chile, which just signed up a 3-year collaboration partnership with Stanford’s Technology Ventures Program. I did a keynote on innovation hubs at the newly created DoFuture program, spoke at Santiago’s Startup Weekend on Customer and Agile Development, and at a Conference in Patagonia supported by the Ministry of Economy’s Innovation Division.

I got smarter about the world outside of Silicon Valley, met some wonderful people who made me feel part of their family and shared some thoughts about entrepreneurship.

This post is a personal view of what I saw in what I call “Chilecon Valley” — in no way does it represent the views of the fine institutions I teach at. Read this with all the usual caveats: visiting a place for a few weeks doesn’t make you an expert (heck I’ve lived in Silicon Valley for over 30 years and I’m still surprised), I’m not an economist, and the odds are I misunderstood or misinterpreted what I saw or just didn’t see enough.

Creating the Next Silicon Valley – The Chilean Experiment
Chile has decided that it wants to be an innovation hub in South America.

In my short time in Chile, I spent time meeting with:

The good news:
Entrepreneurship and innovation is being talked about continually in Chile. This isn’t some small-time effort. The country is dead serious in all levels of government and universities about making this happen. They’ve been thinking hard and smart about the lessons to be learned not only from Silicon Valley, but with only 16 million people, they are also looking for lessons from other small innovation clusters such as Israel, Singapore and Finland. These countries are great models of countries too small to sustain startups of scale on just domestic consumption yet have managed to create innovation with a global reach.

What needs work:
As an outsider I was incredibly impressed with how far Chile has progressed in making the country an innovation hub. However I had questions about the challenges that still needed to be addressed.

Venture Capital
Perhaps it was just who I was meeting, but for a country so focused on innovation and startups the lack of venture capitalists was noticeable. Given the interesting things going on in the engineering labs I visited and the startups I met, one would have thought the place would have been crawling with VC’s fighting over deals. Instead it felt like the government – through CORFO – was doing most of the risk capital investing. Given that great VC’s are much, much more than just a bag of money, this means that startups lack experienced board members with practical experience. There seemed to be very few who knew how to coach entrepreneurs and to build companies. Finally, it wasn’t clear if everyone was on the same page; that for a Chilean startup to scale it was going to have to reach past Chile and go global. There seemed to be few tools, techniques and strategies to do so.

A sign of progress will be when some of the CORFO guys leave the government and start their own VC firms.

Corporate Connections
Entrepreneurship in Chile seems to be disconnected from the country’s largest industries and core resources. The clearest example is the country’s copper mining industry, which contributes 20% of the Chilean Gross Domestic Product. (Chile produces 35% of the world’s mined cooper.) The largest company, the state-run Chilean National Copper Corp CODELCO, has $23 billion in sales. Yet the copper companies import nearly 100% of the advanced technology they use. Interestingly, CODELCO is required to contribute 10% of its revenues to the armed forces, but the mining industry seems to have little or no connection with innovation and entrepreneurship efforts in universities and startups. (Perhaps it’s because the Ministry responsible for Mining is separate from the Ministry responsible for the Economy and Innovation.)

I suggested that Chile’s mining industry could contribute to building innovation leadership by funding a multi-tiered initiative in the country’s leading universities:

  1. Professional management training (obvious and immediate payback)
  2. Applied engineering (top 10 annual challenges from the mining companies)
  3. Basic research (copper based materials science, robotics, materials handling)

Small Business versus Scalable Startup versus Corporate Entrepreneurship
There’s confusion in both the Government and Universities about the difference between small business entrepreneurship (startups designed to be family businesses,) scalable startup entrepreneurship (startups designed from day one to scale big inside Chile and then expand globally) and corporate entrepreneurship.

I suggested that they think about educating (and funding) each class of entrepreneurs differently and realize different regions of Chile have different needs.  In Santiago the concept that startups are not smaller versions of large companies and traditional business school classes and methods don’t apply, is starting to take hold and will help shape how they educate entrepreneurs. In contrast, over lunch with the governor of Ultima Esperanza (the “Last Hope” province on the Southern tip of Chile,) it became clear that there’s a pressing need for training and education in small business entrepreneurship, dramatically different then the scalable startup education wanted in Santiago.

These three types of entrepreneurship need to be explicitly recognized, encouraged and managed.

A Magnet For Talent
My sense is that Chile has not yet “declared a major.” Saying that you support entrepreneurship and innovation is a start, but the sentence needs to be finished. Entrepreneurship and innovation in what field?  Where will Chile establish technical and innovative leadership?  Is the only way they will attract talent by paying entrepreneurs to come to the country? Or will students and entrepreneurs come to Chile because it is one of the best places in the world for innovation in certain specific industries (pick your favorite – alternative energy? materials science? food science? cellulose outputs? video games and film? South American web commerce hub? automated mining? UAV’s? etc.)

Already there are multiple centers of excellence in the engineering schools in Santiago with strong entrepreneurial professors. Yet no dean, provost or government minister seems to want to issue a declarative sentence that says, “For the next five years we’re going to focus on building world-class leadership in these three areas.” (Perhaps because the cost of a public failure is so high in Chile. See below.)

I suggested that what seems to be missing is a stated goal for Chile to become a magnet for talent in specific domains. Why will people from South America stream to Chile, besides its magnificent geography?  In what fields will Chile’s universities and entrepreneurial culture create such an irresistible pull?

A Culture that does not accept failure
Chileans I met were concerned that their culture was not accepting of business and/or personal failure. This is not the land of second chances where failure means you are an experienced entrepreneur. Partially due to a lack of bankruptcy or commercial courts, the bankruptcy process in Chile is draconian. In discussions with accounting and financial professionals, I learned that getting caught up in it feels like a Dickens’s novel, it can take years to shut down a company.

In addition, in Chile the cost of personal failure is high. If you fail, you’ve failed your family, your community and your country. As a result, societal pressures favor people who avoid risky ventures. Because its entrepreneurs are unlikely to make commitments or definitive statements which they know might be risky, i.e. “we’re going to be a leader in our market” or “our startup will be $100 million in five years,” Chile can’t foster the “reality distortion field” that underlies a dynamic entrepreneurial culture.

I suggested that perhaps using a science analogy could help change Chilean perspectives about the risk and experimentation it takes to build new ventures. Entrepreneurship and incubators could be described as an “Innovation Laboratory”  – similar to a scientific laboratory where entrepreneurs develop and test hypothesis (iterative guesses) about new business models. And like science, starting a new venture is not a linear process but one that involves failures, dead ends and changes in direction.

Lessons From the Valley
At one of my presentations the audience was a mix of deans of multiple schools at Catholic University, government officials from the Ministry of the Economy, active entrepreneurs and students. I offered that Silicon Valley’s rise was serendipitous, that you can’t reverse engineer an accidental Entrepreneurial Cluster formed in the Cold War. However, we can point out the elements that made our valley successful, and point out the ones that may be helpful in Chile; the role of Universities and defense-driven university R&D, the rise of venture capital, a failure-tolerant culture and the emerging science of entrepreneurial education. Slides 22, 36, 97 and 117 are the key points.

Come To Chilecon Valley
If you’re serious about understanding centers of entrepreneurship outside the U.S., Chile is now one of the required stops. The progress in the last few years has been nothing short of outstanding.

I’ll be back.

Lessons Learned

  • Chile is trying to engineer an entrepreneurial cluster as a National policy
  • They’ve gotten off to a good start with a committed Ministry of the Economy
  • The universities are on board with passionate faculty and excited students
  • The country needs to build a deeper Venture Capital industry
  • Chilean core industries need to view entrepreneurship as an asset, and technological innovation as an opportunity to leap forward
  • Second chances are hard to come by in current Chilean business climate and culture

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Filed under: Teaching, Venture Capital | 36 Comments »

The VC Pitch – Confusing the Destination with the Journey

Posted on November 30, 2010 by steve blank

Too often we are so preoccupied with the destination, we forget the journey.
Unknown

Entrepreneurs hear that VC pitches ought to be short, 10-20 slides.  What most don’t know is that there is no way they can deliver a presentation that short by just “writing” the slide deck.

You Got to be Kidding
An entrepreneur I’ve known for a long time came by the ranch over Thanksgiving break to show me the first pass of his new startup slide deck.

My eyes were glazed by slide 9. It was over 35 slides long, with each slide feeling like it had 12 lines of 10-point type. It had a problem statement going back to the invention of the telephone, an opportunity claiming to exceed the Gross National Product and it had every possible product feature with enough left over for three other startups products.

My first reaction was, “you got to be kidding.” Yet I was hearing the pitch from an experienced entrepreneur with multiple wins under his belt. He had raised money from name-brand VC’s in past startups and knew what a fundable VC slide deck looked like.  What was going on?

Then I remembered, every slide deck I ever wrote started out just like this.

The Slide Deck As A Brainstorming Tool
Most startups ideas are not built in an afternoon, typically they are the sum of seemingly disparate and discrete pieces of information, and a pattern recognition algorithm continuously running in a founders head.

What I was seeing was an entrepreneur using a slide deck as a way to collect his thoughts.  The slides were his brainstorming tool.  He was using them to think through the impact of the idea he had, and was trying on for size the potential opportunity and trying to use the slides to spec his features.

The difference between this entrepreneur and a novice was that he knew his presentation wasn’t ready to show to a VC; he was using it to share his thinking with me to get more feedback on his business model.

We talked about how much of his presentation were just hypotheses (most but not all,) what hypotheses he could quickly test outside the building (assumptions about minimum feature set, pricing and customer archetypes) and how to turn some of the hypotheses into facts.  I pointed him to my “Lessons Learned” slide decks that turn a standard VC pitch into something more informative.  He left with both of us knowing that he was months away (and lots of customer feedback) from being ready for a VC pitch.

Advice From People Who Get Bored Easy
Most of the advice founders get about Venture Capital slide decks are from the recipients of the presentations – the VC’s – letting you know how they want to see the final deck. And most of their recommendations are essentially “show us your business plan in PowerPoint.” Few VC’s have experienced the process a founder uses to get their idea into 10-slides. And none of them tell you how.

If you find yourself trying to shoehorn your 35-slide presentation into a “VC-ready” format, you don’t know enough yet. And you won’t know any more by sitting in your office surfing the web and writing more slides. Get out of the building and talk to potential users and customers. The irony is the more you know, the easier it is to make your presentation short and concise.

Lessons Learned

  • Long slide decks are indicative of you thinking out loud;
  • Get out of the building and get smarter.
  • The more you know (versus guess) the shorter the deck.
  • Most VC’s are looking for the “give us the business plan in PowerPoint”
  • Give them a “Lessons Learned” VC presentation.

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Filed under: Venture Capital | 12 Comments »

When It’s Darkest Men See the Stars

Posted on November 24, 2010 by steve blank

When It’s Darkest Men See the Stars
Ralph Waldo Emerson

This Thanksgiving it might seem that there’s a lot less to be thankful for. One out of ten of Americans is out of work. The common wisdom says that the chickens have all come home to roost from a disastrous series of economic decisions including outsourcing the manufacture of America’s physical goods. The United States is now a debtor nation to China and that the bill is about to come due. The pundits say the American dream is dead and this next decade will see the further decline and fall of the West and in particular of the United States.

It may be that all the doomsayers are right.

But I don’t think so.

Let me offer my prediction. There’s a chance that the common wisdom is very, very wrong. That the second decade of the 21st century may turn out to be the West’s and in particular the United States’ finest hour.

I believe that we will look back at this decade as the beginning of an economic revolution as important as the scientific revolution in the 16th century and the industrial revolution in the 18th century. We’re standing at the beginning of the entrepreneurial revolution. This doesn’t mean just more technology stuff, though we’ll get that. This is a revolution that will permanently reshape business as we know it and more importantly, change the quality of life across the entire planet for all who come after us.

There’s Something Happening Here, What It Is Ain’t Exactly Clear
The story to date is a familiar one. Over the last half a century, Silicon Valley has grown into the leading technology and innovation cluster for the United States and the world. Silicon Valley has amused us, connected (and separated us) as never before, made businesses more efficient and led to the wholesale transformation of entire industries (bookstores, video rentals, newspapers, etc.)

Wave after wave of hardware, software, biotech and cleantech products have emerged from what has become “ground zero” of entrepreneurial and startup culture. Silicon Valley emerged by the serendipitous intersection of:

  • Cold war research in microwaves and electronics at Stanford University,
  • a Stanford Dean of Engineering who encouraged startup culture over pure academic research,
  • Cold war military and intelligence funding driving microwave and military products for the defense industry in the 1950’s,
  • a single Bell Labs researcher deciding to start his semiconductor company next to Stanford in the 1950’s which led to
  • the wave of semiconductor startups in the 1960’s/70’s,
  • the emergence of venture capital as a professional industry,
  • the personal computer revolution in 1980’s,
  • the rise of the Internet in the 1990’s and finally
  • the wave of internet commerce applications in the first decade of the 21st century.

The pattern for the valley seemed to be clear. Each new wave of innovation was like punctuated equilibrium – just when you thought the wave had run its course into stasis, a sudden shift and radical change into a new family of technology emerged.

The Barriers to Entrepreneurship
While startups continued to innovate in each new wave of technology, the rate of innovation was constrained by limitations we only now can understand. Only in the last few years do we appreciate that startups in the past were constrained by:

  1. long technology development cycles (how long it takes from idea to product),
  2. the high cost of getting to first customers (how many dollars to build the product),
  3. the structure of the venture capital industry (a limited number of VC firms each needing to invest millions per startups),
  4. the expertise about how to build startups  (clustered in specific regions like Silicon Valley, Boston, New York, etc.),
  5. the failure rate of new ventures (startups had no formal rules and were a hit or miss proposition),
  6. the slow adoption rate of new technologies by the government and large companies.

The Democratization of Entrepreneurship
What’s happening is something more profound than a change in technology. What’s happening is that all the things that have been limits to startups and innovation are being removed.  At once.  Starting now.

Compressing the Product Development Cycle
In the past, the time to build a first product release was measured in months or even years as startups executed the founder’s vision of what customers wanted. This meant building every possible feature the founding team envisioned into a monolithic “release” of the product. Yet time after time, after the product shipped, startups would find that customers didn’t use or want most of the features.  The founders were simply wrong about their assumptions about customer needs. The effort that went into making all those unused features was wasted.

Today startups have begun to build products differently.  Instead of building the maximum number of features, they look to deliver a minimum feature set in the shortest period of time.  This lets them deliver a first version of the product to customers in a fraction on the time.

For products that are simply “bits” delivered over the web, a first product can be shipped in weeks rather than years.

Startups Built For Thousands Rather than Millions of Dollars
Startups traditionally required millions of dollars of funding just to get their first product to customers. A company developing software would have to buy computers and license software from other companies and hire the staff to run and maintain it. A hardware startup had to spend money building prototypes and equipping a factory to manufacture the product.

Today open source software has slashed the cost of software development from millions of dollars to thousands. For consumer hardware, no startup has to build their own factory as the costs are absorbed by offshore manufacturers.

The cost of getting the first product out the door for an Internet commerce startup has dropped by a factor of a ten or more in the last decade.

The New Structure of the Venture Capital industry
The plummeting cost of getting a first product to market (particularly for Internet startups) has shaken up the venture capital industry. Venture capital used to be a tight club clustered around formal firms located in Silicon Valley, Boston, and New York. While those firms are still there (and getting larger), the pool of money that invests risk capital in startups has expanded, and a new class of investors has emerged. New groups of VC’s, super angels, smaller than the traditional multi-hundred million dollar VC fund, can make small investments necessary to get a consumer internet startup launched. These angels make lots of early bets and double-down when early results appear. (And the results do appear years earlier then in a traditional startup.)

In addition to super angels, incubators like Y Combinator, TechStars and the 100+ plus others worldwide like them have begun to formalize seed-investing. They pay expenses in a formal 3-month program while a startup builds something impressive enough to raise money on a larger scale.

Finally, venture capital and angel investing is no longer a U.S. or Euro-centric phenomenon. Risk capital has emerged in China, India and other countries where risk taking, innovation and liquidity is encouraged, on a scale previously only seen in the U.S.

The emergence of incubators and super angels have dramatically expanded the sources of seed capital. The globalization of entrepreneurship means the worldwide pool of potential startups has increased at least ten fold since the turn of this century.

Entrepreneurship as Its Own Management Science
Over the last ten years, entrepreneurs began to understand that startups were not simply smaller versions of large companies. While companies execute business models, startups search for a business model. (Or more accurately, startups are a temporary organization designed to search for a scalable and repeatable businessmodel.)

Instead of adopting the management techniques of large companies, which too often stifle innovation in a young start up, entrepreneurs began to develop their own management tools. Using the business model / customer development / agile development solution stack, entrepreneurs first map their assumptions (their business model) and then test these hypotheses with customers outside in the field (customer development) and use an iterative and incremental development methodology (agile development) to build the product. When founders discover their assumptions are wrong, as they inevitably will, the result isn’t a crisis, it’s a learning event called a pivot — and an opportunity to change the business model.

The result, startups now have tools that speed up the search for customers, reduce time to market and slash the cost of development.

Consumer Internet Driving Innovation
In the 1950’s and ‘60’s U.S. Defense and Intelligence organizations drove the pace of innovation in Silicon Valley by providing research and development dollars to universities, and purchased weapons systems that used the valley’s first microwave and semiconductor components. In the 1970’s, 80’s and 90’s, momentum shifted to the enterprise as large businesses supported innovation in PC’s, communications hardware and enterprise software. Government and the enterprise are now followers rather than leaders. Today, it’s the consumer – specifically consumer Internet companies – that are the drivers of innovation. When the product and channel are bits, adoption by 10’s and 100’s of millions users can happen in years versus decades.

The Entrepreneurial Singularity
The barriers to entrepreneurship are not just being removed. In each case they’re being replaced by innovations that are speeding up each step, some by a factor of ten. For example, Internet commerce startups the time needed to get the first product to market has been cut by a factor of ten, the dollars needed to get the first product to market cut by a factor of ten, the number of sources of initial capital for entrepreneurs has increased by a factor of ten, etc.

And while innovation is moving at Internet speed, this won’t be limited to just internet commerce startups. It will spread to the enterprise and ultimately every other business segment.

When It’s Darkest Men See the Stars
The economic downturn in the United States has had an unexpected consequence for startups – it has created more of them. Young and old, innovators who are unemployed or underemployed now face less risk in starting a company.  They have a lot less to lose and a lot more to gain.

If we are at the cusp of a revolution as important as the scientific and industrial revolutions what does it mean? Revolutions are not obvious when they happen. When James Watt started the industrial revolution with the steam engine in 1775 no one said, “This is the day everything changes.”  When Karl Benz drove around Mannheim in 1885, no one said, “There will be 500 million of these driving around in a century.” And certainly in 1958 when Noyce and Kilby invented the integrated circuit, the idea of a quintillion (10 to the 18th) transistors being produced each year seemed ludicrous.

Yet it’s possible that we’ll look back to this decade as the beginning of our own revolution. We may remember this as the time when scientific discoveries and technological breakthroughs were integrated into the fabric of society faster than they had ever been before. When the speed of how businesses operated changed forever. As the time when we reinvented the American economy and our Gross Domestic Product began to take off and the U.S. and the world reached a level of wealth never seen before.  It may be the dawn of a new era for a new American economy built on entrepreneurship and innovation.

One that our children will look back on and marvel that when it was the darkest, we saw the stars.

Happy Thanksgiving.
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Filed under: Customer Development, Customer Development Manifesto, Venture Capital | 80 Comments »

The Rise of the Lean VC – Consumer Internet Gets Its Own Investors

Posted on August 5, 2010 by steve blank

Consumer Internet investing seems to have split off from traditional Venture Capital, and is creating a new category of VC’s: Lean VC’s.  I think you can blame Customer and Agile Development for a small part of it.

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

Filed under: Customer Development, Venture Capital | 24 Comments »

The New Deal – A Founding CEOs Value is Non Linear

Posted on July 19, 2010 by steve blank

As a founder I fought with VC’s over vesting as they brought in a new CEO and walked me out the door. As a board member I negotiated with founding CEO’s over vesting when I thought it was their time to go. At best this is an argument where no one wins, at worst it’s like a nasty divorce.

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.

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