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2
Jan 10
Sat

Year In Review (Part 4)

This is the fourth post in a series. The previous post is here.

6. A tale of three and a half startups & the major lessons I learned

In a nutshell, “venture capital” refers to money and other resources (capital) which are given to new businesses (ventures) in order to help them grow. Venture capitalists, or “VCs”, refers to the people who decide which ventures this capital should be allocated to. Similar to a private equity fund or a mutual fund focused on equities, VCs raise money from investors who want to invest in a particular type of investment. In this case, the start-up industry (young, small companies). VCs put this money into a VC fund which is then invested in a portfolio of start-up companies. In exchange, the VCs take ownership of a part of the start-up and therefore partake in any of its growth.

Silicon Valley is home to the largest VC industry in the world. And since start-ups go hand-in-hand with VC, the Valley is a hotbed of entrepreneurialism. This is not merely a catchphrase, but something which pervades the area. It’s not just that the Valley is inhabited by a mix of intelligent and ambitious people, or that it provides access to a lot of money, or that it contains a world-class university pumping out motivated grads and producing useful research. It’s also that the culture of entrepreneurialism – including its ups but also its downs – is embedded in the very culture of the place.

This is a rare environment. A smaller version exists in Israel, and I suspect China has a rapidly growing VC-funded industry. No place like this exists in Australia. I had the opportunity to get some exposure to the world of start-ups and there are two things I observed that nicely demonstrate this “culture of entrepreneurialism” to which I refer.

Let’s say someone asks you what you do for a living. You tell them that you work for a “start-up”. They do a bit more digging and it turns out that you are working out of your apartment with two other guys, not getting paid anything, and are currently going around asking people for money so you can launch your product, which is a website that allows people to do stuff. In most places in the world, the reaction you’d get would vary from dubiousness to disdain. In contrast, the reaction here is quite different – usually one of genuine interest in what you’re doing. The powerful result of this near-universal social validation is that joining a start-up is a perfectly valid career path here. It encourages people to take risks that they would not have otherwise been taken if these social support structures not been there. The heightened risk appetite that exists in human capital therefore enables start-ups to source talent for less cash (in exchange for equity or the future promise of equity in the form stock options).

The second aspect is that failing holds little to no stigma in the Valley. The vast majority of start-ups fail. And the entrepreneurs who have succeeded often have been previously involved in failed ventures. Instead, the focus here is not on the fact that someone failed, but on the reasons why they failed, and what they learned from the experience. It’s a very supportive atmosphere, and that’s what you need to foster entrepreneurialism.

I was involved in three start-ups, and although none of them turned out to be successful for me, the experience was fantastic and I learned a heap from it. I could write a lot on each of them, but I’m just going to summarize each one.

Reputation.com. The first start-up was created within the framework of an entrepreneurship course at Stanford’s business school. Although it never really got off the ground, it was an interesting experience.  The idea was compelling: to create an online reputation score that would act as a measure of your trustworthiness in fulfilling online transactions, in the same way that a credit score acts as a measure of your ability to repay debts on time. Just as eBay has a “feedback score”, you could have a reputation score that you could take with you to Craigslist, or Kijiji, or any other site where you’re dealing with an unknown counterparty.

The team was an amazing bunch of people – an ex-Air Force MBA with an engineering background, a Sloan fellow who had been at Google since 2002 (and an Olympic-level marathon runner), another MBA with management consulting and start-up experience, and a bunch of adjunct team members including several PhDs in economics and electrical engineering, and a Kellogg MBA grad. As the youngest member of the team, it was valuable seeing the experience of the others in action. For example, the way things were organized, discussed, and resolved with efficiency and professionalism. Working with them was fun.

Unfortunately, the biggest challenge confronting the team was solving the problem we had set out to solve. In the end, we couldn’t work out a way to create a solution that would work – both in a technical and business sense – and after a quarter of tossing many ideas around without result we mutually decided to abandon the venture.

Hedge-me.com. The second start-up was also created within the framework of the same course as the first. Again, the idea was compelling: to allow consumers to construct a portfolio of assets that could be hedged and fit within their investing time frames and risk appetites, without having to pay the fees that hedge funds and mutual funds charge.

The rest of the team was a bright bunch, but inexperienced. I found myself being the oldest member of the team, and the difference in team dynamics was very interesting. I think that experience is often useful for resolving disagreements. Disagreements usually involve something which is uncertain and the people holding differing opinions are to some extent engaging in speculation that the viewpoint they hold is correct. Past experience allows concrete evidence to be provided to back up an opinion so that it is no longer an argument involving speculation. On the other hand, a lack of experience is sometimes beneficial because it allows people to approach problems from perspectives unconstrained by past experience. In any event, the result is that an inexperienced team will tend to produce a lot more heated debate and discussion. (An experienced team may also have much debate and discussion, especially if the experiences of the team members differ, but the debate will more likely be confined to a few key issues.)

There were several big challenges confronting this start-up. Among the forefront were a human resourcing issue (sourcing the engineers to build our product) and a business issue (VCs identified several weaknesses in our business plan we were struggling with). However, this start-up did progress beyond the confines of the business school course, and we had the opportunity to pitch to several VCs which was a valuable (although sometimes mortifying) experience.

Tabulaw. This third start-up was the most progressed out of all of them. I joined after graduation, by which time Tabulaw had incorporated and received seed funding. This venture is ongoing so I’m not going to write anything more about it, other than to say it was a great experience and I learned the most from it. Interestingly, many of the challenges facing Tabulaw were different again to both Reputation.com and Hedge-me.com.

Major lessons learned

Here are four key take-aways from my start-up experience that relate to internet-based start-ups in their pre-funding stages:

1. In the Valley, good ideas are a dime a dozen. What you need is a team that can execute. An aphorism often attributed to an unnamed VC is that a great team executing a mediocre idea is better than a mediocre team executing a great idea. Silicon Valley is full of ideas. And if you come up with an idea, there are probably a dozen other people who have come up with it before you. Even if you’re the first to have a brilliant idea, that counts for zip. The challenge is not coming with an idea, it’s turning it into a business. In fact, the challenge is also knowing which idea to pursue, and which ideas to ignore – focusing on one thing, because a start-up normally doesn’t have the resources to do more. An idea, like talk, is cheap. Execution is action. The idea is just the first step – after that, you have to build a team, figure out the business case, analyze the business’ viability, and a whole host of other non-trivial tasks.

2. Engineers are the most important resource. Not business people, not marketers and, unfortunately for me, not lawyers. Without business people, you might not deliver a great pitch. Without marketers, you might not position your business optimally. But without engineers, you don’t really have a company. This is because an internet company’s product or service is going to be something that the engineers build or supply.

Engineers are expensive and surprisingly difficult to come by, so if you can get some to work for mainly equity, that’s an achievement. This is why my picture of a perfect founding team is a hard core engineer, and a JD/MBA with a hard core engineering background. A founding team of two is desirable. Three is ok. Four or more is generally viewed as too much as it adds an unnecessary layer of complexity to the legal documents (among other things). Non-engineers are important too, but they can be brought on board later, or used on a contracting basis.

3. Prototype, prototype, prototype. Whatever happens, keep driving product development forward. Product development should generally not be dependent on any other type of activity. It can and should occur in parallel with other workflows. Whereas recruitment or fundraising are all dependent upon third parties and can therefore be stalled, product development is primarily an internal process which can always be progressed. This of course assumes that you have engineers that can build the prototype (see point #2 above).

A prototype is a powerful asset during fundraising and recruiting as well. Like my English teacher used to say of good creative writing – show, don’t tell. Not only does a prototype or demo help to convey what you’re trying to achieve, it builds credibility in VCs’ eyes about your ability to execute.

4. Founding a start-up is more than a full-time commitment. I now believe that, unless you are a successful serial entrepreneur, founding a start-up demands full-time commitment. If you don’t need to be (or can’t be) working full-time at the start, then you perhaps don’t need to be a founder from the start.

A large part of being committed stems from simple logistical issues such as working hours and working location. I believe that a regular working location, with a suitable environment is critical. The environment doesn’t have to be sumptuous – if you’re writing software, all you really need is a table, power and net access, and a place you can talk without distractions. A whiteboard might help. This can be a founder’s apartment, or you can also rent a small office (e.g., there are furnished places in Menlo Park with inclusive net access and amenities which comfortably fit 4 or 5 people for under $600/month). I like the idea of an office because it has less distractions than an apartment, and it puts people who have worked in regular jobs before in a familiar frame of mind… in “work mode”, so to speak.

Regular contact hours are also important. Working on a start-up comes with more flexibility than a regular job, but the idea of increased flexibility is deceptive, because it also requires more commitment than a regular job. So while there is flexibility in terms of being able to step out of the office to take care of errands, and being able to work from home, you are still going to be much more productive if everyone is in the same room. Face-to-face communication is the richest form of communication, so being able to instantly bounce ideas off and ask questions to co-workers is really valuable.

VCs demand this level of commitment too, and when they do due diligence on your company, they are going to want to know where everyone stands. I was participating in a pitch to DFJ once, and two of our team members still had a year left to go on their degrees. Tim Draper lobbed us a lot of questions trying to get an idea about our team, as opposed to our business. Questions to team members were as general as, “How did you all meet?”, to being as pointed as, “Are you two dating?” One question he lobbed was, “If you are as passionate about this idea as you say, would you drop out of your university degree to pursue it?”

The half start-up?

I now work at a small internet company in the Bay Area which is not a start-up. It has been around for a decade or so, but last year it was bought out by private equity firms with the view of kicking the business into a new phase of growth. The result is that the working environment is very much like a start-up – the team is still relatively small (but growing) and there are all these new projects being planned and implemented. However, it lacks the layer of bureaucracy that comes with larger organizations. There is also a luxury in that the company is highly profitable, which means it has more flexibility and ability to go out and implement what it wants to. I’m really enjoying it: the people are friendly and talented, the work is stimulating and interesting, and I think the business has great prospects.

Continued in Part 5

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