IEEE Entrepreneurs talk

I was fortunate enough to be invited to present at the IEEE Forum recently at National Semiconductor in Santa Clara. What’s great about these presentations is that you learn so much from the questions entrepreneurs ask, and there is always a new perspective and ideas to share. Personally, I don’t like success talks, they are always too glib, and too often accompanied by super-sized ego. I prefer to talk about failure and learning, and if possible how the failure was recovered and turned into a modicum of success, maybe God forbid even making a little money along the way ;-)

I really enjoy giving my life by misadventure talk, which basically explains how one can stumble into success despite making a bunch of wrong decisions – if you think about just how many decisions a CEO makes in a day, it's not surprising that many of them turn out to be wrong. What's great about startups is that you can change your mind, and second guess decisions and quickly adapt to correct mistakes. When Mark Hurd decided to cut and consolidate design centers in HP, it took a year to formulate a plan, another year to execute, and believe it or not, there wasn’t much of a chance to change his mind along the way, and even if there was, it would have taken another two years to undo - some more recent things can't be undone and more's the pity ...

As entrepreneurs, we go down a lot of rabbit holes (and not a few ratholes as well) in our search for the right products, solutions, businesses, and opportunities. Many of the rabbit holes are dead ends, or lead to the madhatter’s tea party, rather than the magical growth elixir for which we originated the quest – those failed quests are what temper us for eventual success. I have sat through so many presentations by successful entrepreneurs who did everything right, were geniuses, and had market vision so profound that everything worked out exactly as they planned. I read Alice in Wonderland as a kid, so little need to hear more fairy tales now. Engineers are not afraid of failure, nor do they expect to have clairvoyance enough to see every mishap and engineer it out before it becomes a problem – they twist and turn and always have a backup plan because they know failure is an inevitable part of pushing the envelope.

The other epiphany I had while preparing the talk, is drawing on my Aussie entrepreneur’s talk, I realized if I replaced the words “Australian Entrepreneur” with “Laser Jock” then the talk worked for both groups. It's amazing the similarities with the little Aussie battler entrepreneur, and the US laser engineer. We tend to think with solution or technology looking for a problem, we worry about saving money to success, we don’t understand marketing, and we don’t get just how much harder it is to market and sell a product vs design and build it. On the positive side, the similarities are even ore striking. We never give up, always find a way around any problem, are very straightforward in our dealings (and this is not the case with many other types of entrepreneurs), know how to deliver, can create a lot with a little, and are fueled with the passion of belief in what we are doing that transcends all obstacles.

Where Angels fear to tread

I don’t want to add fuel to the fire already ignited by the behavior of a group of super-angels here in Silicon Valley, or to further endorse Ron Conway’s excellent reprimand of that behavior – but, I do want to say that this behavior is rare in the valley – and in fact rather common where I come from. For some reason in other countries Angels, and VCs and PE investors are seen as competitors rather than key pieces of the value chain for startups and their growth. I was at an event in Australia recently, where it was proudly proclaimed that the angel network is so strong that "we don’t need the VCs anymore." As I dug further into this I discovered there is a deeply ingrained belief that Angels are in direct competition with VCs, and this was a big surprise ...

Furthermore, in places like Australia, or the mid-west US, where the VC ecosystem is fragile it's critical for groups to work together even if it is in the form of "coopetition."

At present this entire class of investments is being called into question and if there is to be growth in risk capital to support entrepreneurship all the parts need to work together. Where things get really screwed up, and this is typical of Australian deals, is when a private investor buys a large piece of the company for little cash and then will not allow the company to raise further rounds unless they are at major step ups in valuation. This forces the company to go to more naïve money, and get less and less help from their investors.

These companies become literally uninvestable in any traditional sense and while they often survive in purgatory for a long time, they don’t often give the founders what they had started a company for in the first place. It is not unusual to see a company where the investors own 80-90%, but have only carried the company halfway through the investment cycle. The solution should be simple, to raise more money, but this class of investor won’t stand for dilution and blames the management for their plight.

I have talked before about the numbers that enable venture investments to work--good Angels know these numbers well and make their investment synergistic with them in anticipation of a VC firm paying up for the deal, and taking the Angel along for the ride with the founders.

Typically Angel investments are simple convertible notes, no equity, until the A round gets priced and led by a VC. The Angel gets a substantial discount for taking the early stage risk, and more often than not gets asked to stay on or come onto the BoD because they usually have great domain knowledge that can really help the company. This is the other area where sugar cane farmers and mining millionaires can mess up tech companies because they often insist on BoD seats based on ego, despite bringing no value to the company. This is not to say that such people aren’t great at negotiating deals and selling companies or that they don’t have great business acumen, but the art of growing a tech startup is highly specialized and needs people who have done it before to help entrepreneurs who perhaps haven’t.

In the Internet deal, it's possible to get to success metrics with very little money--one side of this means an Angel or super Angel can fund the company entirely. But I don’t believe this is the right model or even a true model. What can and does happen well with Internet deals is a little bit of cash can quickly tell you if you have a successful idea or not. You can fail fast and cheap.

The failure I think of the Angel approach is not to bring in substantial capital to take advantage of the beachhead and own it before competition gets wind of your success. Some Internet deals can be entirely bootstrapped, yet regardless of the type of business web or traditional they always need money to support growth and strategic initiatives (see Atlassian) – this money comes from VCs or PE or IPO or credit cards ;-)

Every CEO needs to have carried a bag

Usually we CEO's spend most of our time carrying a can ... among other things, but it's really important for any CEO to have been a sales guy at least once in their life. Any entrepreneur is always in sales, selling simultaneously to team, customers, partners, investors and service providers. One of my favorite CEOs started life with a telephone book and cold calling to generate revenue--tough way to start, but what a great grounding in human nature and the importance of making numbers. The idea of meeting a quota is central to the needs of a startup, especially a bootstrapped one that is always months, weeks, or days away from Chapter 11. I know of one CEO who carried his bag all the way to Las Vegas, because he couldn't make payroll, and put what money he had on 11, and made payroll for the year ;-) Not what I mean, of course!

A classic founder situation happens when the investors come into the company and drive hiring of new executives with more experience than the founder to go out and carry his bag from him. Often, this does not work because the founder has an evolved DNA for selling exactly this product and deeply understands and has earned the trust of these customers. The experienced sales people, as good as they may have been elsewhere, just can't deliver the level of customer intimacy that selling to feed your family for years has instilled in the founder. Sometimes, this simply doesn't scale. Now it should be possible to teach this skill to the experienced sales experts, providing of course that they can get over their ego and let the founder help them learn, but of course this is the opposite of what the investors wanted to happen and may not sit so well with them and their egos ;-)

The other great thing about carrying a bag is that it gets you in front of your customers. If you are the founder you are likely to be more strategic than the typical sales person, and this gives you the ability to do that magic that the managers of really great sales people dream of--the strategic upsell. Because you are deeply involved in your customers' problems you have the ability to see solutions where they see only problems. And because you have their trust from your history with them, they will listen to you when you patiently explain why they need to step back and see the entire problem, and while they may buy this one single component today to solve this week's problem, they will have you back in every month for the next two years to buy other components and after all that they will have the entire solution cobbled together from all these transactions and gee wouldn't it make more sense to take a little more time now and solve it all, so they can spend the next two years on making money?

To be sure, this is really hard to do, and it can easily slip into the Osbourne effect (where customers don't buy anything because they are always waiting for the next big innovation to solve all their problems). But, when it does work, the result moves from transactional selling in $10-50k chunks, to $1-2M sales with recurring revenue over multiple year commitments, and the business scales from these repeatable, upsold, presold deals.

What's really fascinating about this, is after the VCs have pulled the founder back from the road to let the professionals fix the messed up sales process, the founder invariably gets put back on the road to save the business and sure enough can reengage with their beloved customers and start bringing home the upsell deals again as those customers welcome him back with open arms and where have you been all this time? Invariably, the reward for this success is that the investors then start searching for a new professional CEO to manage the business so the founder can focus on what they do best--now was that selling the product, or saving the business ;-)

Entrepreneurs are like water

Entrepreneurs are like water: in Australia there is a great shortage of both--but that’s not what I mean. Entrepreneurs have the unique ability to flow around obstacles, and always find the way through to success. Many, many good business people are more like stone, and in many cases being stubborn and inflexible in a negotiation pays off--I know people who have listed their houses at outrageous prices, waiting three or four years for the bigger fool to come along and pay the price. However, that victory comes at a cost--time. Entrepreneurs know that time is the most precious resource (like water). Water will always find away around inflexibility, and in the end water will wear away the stone, but in the short term it will simply flow under, around or in between the cracks and get to its goal faster and with less hassle.

I am in the middle of a difficult negotiation with a large Chinese state-owned enterprise as I write this, and trying to help a startup do a deal with them. Imagine the cultural disconnect in every dimension--small vs. large, US vs China, swift, innovative, agile technology, working in a large slow to move industry, with a very large foreign company where failure is often very very costly.

So far, the entrepreneurs involved have blown up three times; each time we have found basic disconnects on communication and misunderstanding, or lack of knowledge as to how deals are structured differently between the jurisdictions, to be the culprit. Now, of course, the Chinese are the greatest capitalists on earth--extremely skillful negotiators, and known for difficult, long, complex deal structures that evolve many times even after they are agreed and signed. It’s always a fluid contract in China. Which is another reason why entrepreneurs need to be like water. This basic attribute of China, which is so against the grain of western culture is endemic to markets, new technology, and the financing climate--these three elements are the most fluid of all and if entrepreneurs can't adapt quickly, they fail.

In this negotiation, one of the founders is having heartburn with the Chinese style of renegotiation, and being a little like stone--as in stonewalling the deal. While it does not pay to be too flexible in dealing with highly skilled negotiators (i.e., if you bend a little, they grow to expect a lot, so you have to yield a series of decreasing concessions to signal a clear end to negotiation) a stonewall with the Chinese, like the Chinese wall, leads to the Mongol horde at your gates, or at least not a very satisfactory conclusion for either party.

The other way in which entrepreneurs are exactly water is their ability to foster and nurture a deal. Investors thinks it’s the money that waters the seed, which has some truth, but nothing has the ability to deliver growth, raise money, see an opportunity and go after it like an entrepreneur….

The one area where the water analogy fails is that, unlike entrepreneurs, water flows downhill, sinks to the lowest level, tends to stagnate there. Although this fate can befall some unfortunate entrepreneurs generally they are headed in quite a different direction ;-)

Atlassian

There is a little Aussie startup in Sydney that bootstrapped its way to north of $50M in revenue on $10,000 borrowed from the CEO’s dad--you can do this with software, really! They just scored a massive investment from Accel, not Peter Wagner whom many of you know from the telecom days but the later stage fund. You see, these guys took their first VC investment after already achieving profitability and success. An investment of $60M. Come on Aussie ;-)

This investment has caused a furor both here in the Valley, and in Australia. Every software VC I know here has been trying to invest in Atlassian since it broke out of startup mode and delivered some stellar viral growth and managed to make money at the same time--dollars instead of eyeballs, imagine that? The other fascinating thing about Atlassian is it managed to deliver a stellar employee experience in a place where there was little sharing of equity. No, they don’t have a red slide in the foyer, but they managed to re-create a lot of Silicon Valley’s karma and get their employees to invest themselves truly into their startup. Some of the younger employees don’t actually appreciate just how unique their experience is, locally.

Back to the furor. People in Australia are worried that this is another case of Australia’s best and brightest taking everything to the US, and leaving nothing behind. Local investors are asking why didn’t they get a chance to invest? After a few too many beers, the CEO let off a diatribe that at least shows his passion and commitment to his business, but was a little unkind to the local financial ecosystem and VCs ... but let’s face it, he is not alone there.

I have received emails from most of the local VCs saying they have never been pitched for money by this company, and wondering why? I’m sure that’s true; why would Atlassian want that? The company was able to bootstrap its way like most good software companies. To be sure, taking in early stage investment may have accelerated the eight years into perhaps four years, but it doesn’t look like they gave up any market lead, so trading time for equity was a fair deal--certainly they hit the market timing. Knowing VCs, if they had gotten in, there would have been sweaty palms after year three!

To raise $60M an entrepreneur certainly wouldn’t go to VCs on either side of the Pacific, it would be a growth fund like Accel’s, Sequoias’, Oak’s, or just a private equity fund. And there are a boat load of them in Australia and even more in Hong Kong, which is a lot more local than Silicon Valley. There is more than $1 trillion under management in Australia so there is no shortage of cash. Most startups in Oz would have listed on the ASX and raised their capital from mum’s and dad’s pension funds rather than professional investors. So why come here to a venture funds' growth fund?

I actually think this shows great (and sadly rare) foresight on behalf of an Aussie entrepreneur--most believe that it's just the cash that matters, not who you get it from. There is of course one other element of secret sauce in the deals, and that’s paying off the founders--to cement a private equity deal like this in a company with excellent profits, track record, and prospects of growth, you had better hope the founders believe that cash is the sincerest form of flattery. Let’s not forget, it's an entrepreneur’s job to deliver the highest value possible for the company’s stock, not to give investors a sweetheart deal.

Will Atlassian move to the US--sure, why not? In this type of web sales business it is less important where the company HQ is, but for growth, to be close to customers and market, and most importantly for exit, this is the place to be. Will the founders stay on? I hope not, after all wouldn’t it be great if they came here for a while, delivered the value they sold to Accel, and then went back to Australia to bootstrap another one? Perhaps even encourage other entrepreneurs to do the same?

It would be great if they took some local VC investment money, assuming that they could find local investors who could truly add value, maybe some former entrepreneurs who had built businesses like theirs, maybe some investment funds who had success in this space. Who knows, it might even help grow a local ecosystem. In the past 20 years, entrepreneurs from China and India have learned their trade here in the Valley, and then migrated back to replicate their success in their home countries. We need to nurture entrepreneurs, we need to create more of them, it's how economies grow--and if you want statistics--US VC-backed startups generate almost 3x Australia’s GDP. One can also argue that they are responsible for 100% of US job growth--but that’s for another time ...

Put-togethers

This is a bit of a continuation of my previous post on exits. What VCs can do better than most, by virtue of seeing a lot of deals, is to spot an opportunity to merge two companies together to form something much stronger. So as an alternative exit, they can create a strongly investible company that will exit later but at much greater value. If two startups are really products or features, not companies (earlier Blog) then sometimes they can be combined so that 1 + 1 makes 3 ... or even five. This is usually very hard to do, and a sceptic might say putting two crappy companies together makes a really crappy company, but certain VCs really have a knack of pulling it off.

I never appreciated this until I started looking at lots of similar deals, and it really jumps out at you when you see two companies pursuing the same opportunity, and one has really differentiated technology but no "go to market" ability, and the other has a solid operational team but weak IP--or, one company that has survived waiting for a market to emerge because they have the best solution for that market, and another that has a completely different solution for the same market that together would be best of breed and actually make the market emerge by ability to feed an easy low cost solution and stimulate the market to grow, and then segment the market for the better solution later.

What usually kills these deals is the existing investors who may have carried the company for a long time and have very high expectations that are going to be dashed--also the management team has a hard time accepting, and especially having to tell their investors that there is another company out there that has a better solution than they do.

As the new investor trying to be a matchmaker you get the fun task of trying to set a realistic valuation for the combined companies and there usually isn’t enough in the deal for everyone to get a fair piece, especially if the existing investors are short on funds.

I've seen probably four of these in the past year, where you would have loved to combine the two companies to create something really significant and investible, but it was just impossible to negotiate with the existing VCs. As an entrepreneur this is very frustrating because you watch the market need continue to be unmet until another player steps up and creates the solution that could have been yours.

The better outcome happens when the existing VCs realize that there has to be a put-together and start actively looking for such a deal. During the last tech downturn, we saw many of these deals and unfortunately not too many good outcomes because these were mostly driven by need to exit rather than opportunity to create best of breed value.

Done it vs. Read about it

I was having a drink with an old friend who is the best product marketing guy I know, he was also my BoD member and an excellent operating partner at Accel. We were discussing the difficulty in hiring the right VP Sales, VP Marketing, and hardest of all VP Product Management--also called Marketing, Sales and many other things. The product management vertical originated in communications companies, due to a natural need for a highly technical, project management oriented, closer to bridge the gap between sales and marketing. If you think traditionally of marketing as giving aircover so sales can go in and take the territory, then product management supplies recon, logistics, plans the opp, and is often the Seal team that goes in first (or if you prefer a less airforce oriented analogy, marketing sells to groups and can't close anything, sales to individuals and closes them, product management identifies the product, defines the spec, does the initial sales to get the recipe right, and manages the entire process.)

So its really hard to find good people in this role. Actually in any of the customer facing roles-–prior experience is something of an indication of future results, but not that dependable because every startup is unique. Ideally a venture-backed startup is attacking a white space and history doesn't help that much beyond pattern recognition.

One of the key things that a CEO gets shot for is making bad hires, or worse being afraid to hire better people than themselves to enhance the quality and success of the company. I was surprised when I met a young, now quite well known internet CEO and his card read “I’m the CEO .... bitch” – frankly, who cares?

But if being the CEO is so important to someone, then that same ego is going to get in the way of good decision making and great hiring. It's something that VCs look for in any CEO. So how does the CEO win? After all, if they recognize a bad hire, they have to fix it, their investors and BoD will armchair quarterback them and opine sagely that perhaps there is a problem with the CEO and not the new hire ... never mind that it was the same people who helped screen the new hire and approved them ;-)

The California resume, as it's referred to on the East coast, is famous for purporting remarkable achievements and experience, building of great companies, and spectacular exits, most remarkable of which is that they were all achieved either before the candidate left college, or during an internship. While these are easy to spot, the really good sales or marketing person is very hard to distinguish from the really good talker, often it takes until after they have been in the job for a few months.

There is so much excellent training now available, that sales, marketing, and product management roles can be described superbly after doing a few courses and learning key process. This sounds strange, but even seasoned operating guys, like my buddy, can get fooled by the right words. A guy who I worked with years ago, had a gift of remembering every key word his boss used in giving him a task, and then repeated those same key words back to the boss when giving his progress reports, and magically, regardless of progress which was rare in his case, the boss always thought he did a great job.

If and when I ever work out how to avoid making bad hires I promise to let you know, but in the meantime, as with everything else in startups, if you are going to fail fail fast and early, make a change and move on. Don’t procrastinate about reversing a decision already made and firing--its better for the company, it's better for the employee, and it's much better for the CEO.