Fred Destin

Premature Scaling Kills Startups: the Genome Data

The new Startup Genome project tries to bring structure and data to the following question: why do so many companies die from premature scaling ? I was impressed by the first report the Startup Genome team produced so when Bjoern asked me to comment I was more than happy to comply.

The first Startup Genome Report dealt with understanding causes of failure during the Lean, iterative phase of a startup's lifecycle.  This time, they decided to attack the complex and more nebulous area in a startup's life when a company decides that it's ready to scale and gets it wrong.  All companies get it wrong to a certain degree and as Ben Horowitz rightly pointed out, "product-market fit is not a discrete event".  [Reminder: If you only read one blog, read his].  The interest of the report lies in looking at data and trying to systematically determine when these errors lead to ultimate failure.

In their own words:

Startups are temporary organizations designed to scale into large companies. Early stage startups are designed to search for product/market fit under conditions of extreme uncertainty. Late stage startups are designed to search for a repeatable and scalable business model and then scale into large companies designed to execute under conditions of high certainty.

A startup can maximize its speed of progress by keeping the 5 core dimensions of a startup Customer, Product, Team, Business Model and Financials in balance. The art of high growth entrepreneurship is to master the chaos of getting each of these 5 dimensions to move in time and concert with one another.

Most startup failures can be explained by one or more of these dimensions falling out of tune with the others.In our dataset we found that 70% of startups scaled prematurely along some dimension. While this number seemed high, this may go a long way towards explaining the 90% failure rate of startups.

I encourage entrepreneurs to think through the full Lifecycle all the time and I think this is a great initiative.  I jotted down some of the reasons why I see companies scaling before they're ready to throw some quotes at Bjorn:

• Illusions of product market fit or price discovery: The classic mistake is to confuse a few early adopters with a market.  This was perfectly documented by Geoffrey Moore and is still relevant today.  Not being able to replicate early successes also occurs in consumer businesses, usually through the rapid degradation of customer acquisition and conversion economics.  It's one thing to spend $50K a month through online marketing channels with high marketing efficiency, but quite another to spend 5 or 10 times that amount without shooting the economic contribution of each new user or consumer.
• Confusing Founder Heroics with a Repeatable Model: As Peter Lynch famously said, "go for businesses that any idiot could run, because some day one will".  The parallel here is that it is an easy mistake to assume that hired salespeople or marketing people will be able to replicate the same rate of success as an incredibly motivated, tenacious and compelling founding team did in the early days.  Of course that's rarely true.  The commercial proposition needs to be baked enough and repeatable enough that possibly less talented and less determined sales organisations will be able to shift product efficiently enough.
• Unprofitable Scaling / Absence of operating leverage: You may be able to sell more faster, but you might not be ready to scale profitably.  The more customers you get, the more bugs, new requests and support issues start to bog your infrastructure down and ultimately come back to rest on the door of your salesguy.  I have lived through one experience of a company that had not understood that it had a total quality problem on its hands and kept ploughing money into the front of the funnel, to no discernible end.
• The Tail Wagging the Dog (Board Pressure): You've raised a fair bit of money on the back of an ambitious set of projections, anod now you feel compelled to hit these numbers.  Never mind that the market may change or that you may discover these new verticals aren't as easy to crack as you thought, it will be difficult to go back to the board and tell them you won't spend the new cash, or hit the numbers.

The Priebatsch versus Lauzon debate, as old as startups

Scvngr's Chief Ninja, speaking at the recent Nantucket conference, clearly made a few people uncomfortable with his (fun) pronouncements about how every startup should raise as much money as early as possible.  Whilst I enjoyed his wit and style, I was twisting in my seat, though nowhere near as much as the other young founder on the panel, Matt Lauzon.  He seemed a little sick. 

When Matt took him up on it and said he would never advise founders to do this, there was a perfect Green Goblin versus Spiderman moment between Mr Orange who's clearly going for a $1BN or bust, where the management team is made up of a Chief Ninja, a bunch of Rockstars, a Pixel Czar and so on (did I mention the King of Bling) whilst Mr Black patiently incubated at Highland and puts his Customer Support Gals front and center of his website.

The point on these two is that you have, on the one hand, a momentum player who wants to own the market yesterday and will throw everything he's got at it, and another who's on a consistent and possibly more mundane path of building team, culture, repeatability (and talks a lot less about it).

Style aside (I do like a bit of camp in my startups), I know where I'd put my money and I'd certainly never advise young founders to raise as much as they can as early as they can, but let's just look at what the data says.

Report Conclusions

You should really get the report, but let's just say that it reads as a homily to

(a) being highly consistent, measured and systematic in progress along all the core axes of execution (customer, product, team, finance, mode)

(b) constraining yourself until you're really hurting for resources, including people and capital

Borrowing from The Master (in Germany: Das Guru) on the excellent RWW: 

• The team size of startups that scale prematurely is 3 times bigger than the consistent startups at the same stage
• 74% of high growth Internet startups fail due to premature scaling
• Startups that scale properly grow about 20 times faster than startups that scale prematurely
• 93% of startups that scale prematurely never break the $100k revenue per month threshold

Before the Lean Startup was codified so beautifully (the elegance of the theoretical model has to make you smile, does it not ?), we at Atlas used to call this Prove / Build / Scale.  It was not a perfect framework, and initiatives like this are key to bringing a rigorous and systematic approach to company building, so it can be taught as a form of management science.

Me ?  I will read, learn, and do as usual: forget all the lessons in the world and go with "data-augmented instinct" in my decision making.

Go crush it.  Let's make these stats better.

Startup Lifecycle - Lean to Fat, Launch to Scale - Video

The video and accompanying presentation gather much of the current thinking around building startups from scratch to scale.

This was my annual contribution to Seedcamp, in the form of a new Prezi and accompanying commentary on Startup Lifecycle, which I presented at Seedcamp Ljubljana.

An awesome editing job was done by Lecture Hub using flowplayer and you can now enjoy the synchronized presentation and slides on their site.

A lot of credit to God (SG Blank), Jesus (Eric Ries) and Mary (Alex Osterwalder, sorry Alex) as well as Tom Eisenmann for references and structure, David Skok for his awesome visuals and sense of economy and DaveMcClure for the Startup Metrics FTW.    We're also trying to get beyond just Lean you can also dig into Scaling (e.g. see my answer on Quora).

And since I'm still having a bit of trouble typing, I borrowed the blog post of a super Seedcamp startup (that I voted for hard but you cannot win them all) called Blossom.io to give you a sense of what's covered.  I trust Thomas won't send me a cease and desist.  If you are looking for Lean Project Management, check them out.

I look forward to any comments -- ping me over mail, this blog will migrate soon and not sure I can (be bothered to) migrate the comments over with me.

Start

• Pick the right co-founder
• Do reverse vesting — It’s founder friendly
• Borrow & steal — minimize cost, more time for product/market fit

Launch

• Be Lean — The Lean Startup, Running Lean, Business Model Canvas
• Focus on providing value to your customer
• Use validated learning, pivots & iterations to achieve product/market-fit ASAP

Build

• You can’t manage what you can’t measure
• Initially focus on activation and retention (funnels, KISSmetrics, …)
• Be data informed, not data driven. Brush up on your statistics skills
• Use your intuition for important decisions (see the big picture), use analytics to optimize

Chasm

• Aggressive investment before product/market-fit can be dangerous
• To grow you need to cross the chasm from early adopters to the early majority
• Read Crossing the Chasm and/or Inside the Tornado by Geoffrey A. Moore

Scale

• Build a repeatable customer process
• Build a solid infrastructure for billing & deployments
• Fight organizational creep and automate stuff
• Grow the team and company culture

CFOs in startups: you need to OWN the cash problem

Last few weeks I was in the South of France waiting for my kit to arrive to the Port of Boston.  By chance I hooked with a good friend of mine who's enjoying a season off after selling the last company he was involved in (he's on his third exit, bless him).

We talked business for a bit and about his next role.  When I asked him whether he wanted to be CFO in a startup again, his response was blunt and immediate: "I was never a CFO, I was The Fixer.  Young companies don't need CFO's. they're just a VC's wet dream to allow them to sleep at night".

He hit it on the head: once a company has raised a decent amount of money (say for argument's sake $15M), investors may feel jittery and start fantasizing about a "really senior CFO" who can "take the company all the way" (meaning usually IPO or exit) but more importantly who can be a "good steward" of all the money they have put in.  Whether that is the right thing for the business is a different matter.  His point was simple and correct: "before you've got a really large company on your hands, you really don't need a CFO.  You just need a  good controller.  You need really serious scale before a "real" CFO makes any sense".

It made me thing of two related points that I do think matter, which is that you need to:

• Keep it light on top management: We need (talented) Indians and not just chiefs.  I have seen this a number of times: a tendency to grow the management team too fast, based on the notion that if the company is going to be ready for scale we need A+ heavyweights. The reality is often different, you take longer to grow then you anticipate or you get too many skilled managers ahead of your real needs, sometimes demotivating your young talent in the process or creating a "corporate" layer (argh).  After all if you hire managers, they manage.  Very often you can run a startup better with a very few execs and a lot of really talented young ones.  Alex and Doug at Zoopla grow the management team very slowly and it pays off.    The team at PriceMinister all grew into their management roles over time (all it takes is 10,000 hours of practice, right ?).
• Always keep your eye on cash (dynamically): Ken Morse, who was running until recently the MIT Entrepreneurship Center, used to put it simply: CIMITYM in other words "Cash Is More Important Than Your Mother".  I don't know whether it's his creation or an old saying, but the point is simple: you can run your business without your mum but not without her cash.  In startups the only real sin is running out of cash, and the cardinal sin is running out of cash UNEXPECTEDLY.  So whilst you may not need a CFO, you sure need someone who understands cash-flow and can give you the confidence to know when it's running out.  If it sounds obvious to you, think again.  Many entrepreneurs have not gone through the process of creating companies before and find rolling cash forecasts both mind-numbingly boring and actually hard to do.  But when your companies starts to scale non-linearly, and assuming the evolution of your working capital is somewhat hard to forecast, it can get dicey.  Get yourself a good Chief Cash Officer, to quote Fred Wilson.  [BTW as an aside if you go on Fred Wilson or Brad Feld's blog you will find that they have written about pretty much everything in the past (eg this), it's depressing.  Often I don't bother to check:-)  I guess I am just sampling]

In a nutshell:

• You probably don't need a senior CFO for quite a while
• If you need a business partner, find one but don't require him to be an accountant too
• What you do need a Chief Cash Officer, whatever he or she is called.  If you've run a retail business in the past on 2% margin, then do it yourself :-)
• Remember, no ones gives a s*** about your EBITDA and your reporting when you're a startup: you need accurate rolling cash forecasts

As an Entrepreneur, Cash is ALWAYS your problem.  Own it.

Saving time in preparing for board meetings

Some of the startup companies I work with do awesome board presentations.  Stylish visualisations, tons of data.  I suppose it's because most of them are consumer facing businesses, but boy are they good at communicating.  I always feel very sorry for the poor souls who have to prepare this every 5-10 weeks and, yes, wonder if their time (and my money) is being well spent.  Personally, I don't like weighty board packs and I do not wish to inflict slide preparation upon anyone.  I think there are simple ways to deliver what investors want and spend less time doing it. 

Here are some recommendations for entrepreneurs and CEOs:

• Spend time agreeing on KPI's upfront.  Make it explicit and achieve consensus with your board and investors as to which KPI's are really, truly critical in measuring the business.  At Zoopla, COO Doug Monro and I built an initial set of suggested KPI's which we brainstormed as a board; we then pruned the list down to the absolute core.  Successful small businesses need not be run on a gazillion of heatmaps, the right and preferably short set of indicators will do.   In my portfolio, PriceMinister is the only exception but Pierre and his team have built an incredibly easy-to-read set of operational KPI's printed with colour coding on large foldout sheets; it gives a wonderful graphical depiction of what is now a fairly complex business and allows you to focus in on the trouble areas immediately.  Probably as a result of this attention to detail, PriceMinister, a large and mature business, is run on extremely tight and accurate monthly targets.  Pierre and his team, in fact, hardly ever need any help at all running their business.
• Spend time agreeing on financial formatting and accounting methods upfront. Agree upfront on how you want the financials presented, how you account for revenues and costs etc. and run it past your auditor to ensure he/she will like it too.  Decide how you want to blend operating and financial KPI's to present the most useful view of the business.  It's much easier to align internal reporting with what you want to see and what auditors will agree to back than to get slapped during the audit or by a potential acquirer and have to explain to your investors why you net revenue line was overstated.
• Make sure operating KPI's and financial reporting go hand in hand.   If you get into the habit of reporting starting from your operating KPI's and building up towards your financials and do this well, you are defacto providing a diagnostic of over or under-performance as you go, saving time and avoiding misalignment.  This is especially useful when you have late-stage investors who are prone to manage/control businesses through the lens of financial reporting only.  Again at Zoopla we have two set of KPI's, one tracking site and product engagement and one tracking our sales and monetisation and gradually baking in the financials.  Two pages, that's all we need.
• Use the same exact indicators and dashboard for the board as you do for running the business.  Bifurcating the two is what's done in many companies and frankly I don't get it.  The board report should really be the same or a cut down version of your operating dashboards.  If you force investors to understand and look at the same numbers as you, you are also forcing them to understand the business in a deeper way.
• Delegate and automate.  Anything anyone else can do within the company, get them to do it.  Any repeatable task you can automate through technology, do so.  Don't have a PA ?  Your investors have some of the world's best PAs: get them to organise the board meetings for you. 
• Only use Powerpoint where it's truly useful.  If you have a well designed set of KPI's that runs in Excel, then simply print the Excel sheet or mail it to your board members; they will survive.  Life is too short to be designing long powerpoints.  If you have to, use simple, blank formats that you can design and print easily.  If you want to wow your board withe beauty of your logos and brand excellence, do a short demo :-)
• Be highly consistent and repetitive.  Boards need training.  They need consistency in agendas, board style and flow and in materials and metrics used.  Apart from the one or two special topics you want to discuss, keep agenda and board pack always identical.  A well designed board process should really not change that often.

And with that, back to work.  Have a few over-designed board packs to read :-)

PS: If you want good advice on the actual running of the meeting, read the indefatigable Mark: http://www.bothsidesofthetable.com/2010/02/12/running-more-effective-board-meetings-at-startups/

In praise of the (self-aware) Maverick

On a flight from Geneva to London, I find myself reflecting on the type of founder profile that I like to work with.  They tend not to conform to any classic profile.

In venture land, probably over 50% of investors have an MBA of some description.  They tend to be Stanford, MIT or Centrale whizzes with a Harvard or Insead MBA.  They were usually president of the Private Equity club, or similar.  They were born to greatness :-)

Many of us shy away from such profiles in the entrepreneurs that we back, and I certainly do.  We like guys who do not fit the mould, who do not know what they don't know.  After all, the bizarre notion that a company of ten people can take on Apple or Google is based on "suspension of disbelief".  It takes a special kind of person to spread that special kind of blind faith to those around them.

Real Mavericks

If I look back at people that impressed me over the last few years (focusing on entrepreneurs I did not back), they would include

• Kristian Segestrale, who tells you with a straight face he's going to be bigger than EA and some come across as credible
• Martin Lorenzon and Daniel Ek, with Daniel underselling with absolute grace and Martin telling me with absolute confidence that the pre-money on his Series A "will be north of €40M"
• Peter Ohnemus, a formidable sales guy with no off switch who has an uncanny ability to make you want to work with him
• Alexander Straub, who has never failed to send me a follow-up mail to convince me to give Truphone a try, every single time we speak
• and of course, Niklas Zennstrom

These guys don't play buy your rules, they can be both likeable and arrogant, both deeply knowledgeable and highly ignorant, brilliant and unnerving.  But they definitely share a common trait of maverickness.  In VC speak, they are likely to be "hard to manage", "abrasive", "difficult to align".  In other words, they are going to be hard work.  But they also have that unique spirit that sets them completely apart, entering new markets that they sometimes know almost nothing about with the absolute certainty that they can revolutionize it.

So being a maverick is a virtue I respond to at a very emotional, animal level, and that I appreciate in company founders.

The need for emotional intelligence

As a founder, what you do with your "maverickness" of course, will probably play a bit part in determine how successful you become.  If you are unique, driven, somehow exceptional at harnessing a vision, there are also probably of areas when you are going to be terrible or at the very least can be handled much better by others.  The trouble is that you may have a tendency to run your company like a benevolent dictatorship and are such a good communicator that not many people can stand in your way.  If you are assertive, driven, action-oriented with a dislike for routine, you're not likely to be the good administrator that your company will at some point require.

Which is why we need our mavericks to have a high degree of self awareness and emotional intelligence.  Those that can leverage their maverickness into building fantastic organisations and recognise their limits are the ones who can really scale all the way.

Some further thoughts on this:

• Anticipate your fall. "Founder transition" is avoidable if you anticipate it.  In most cases, you are unlikely to be the right CEO long-term for the company because the skillset is , but you can be.  Take the example of Chris Ahlberg, founder of Spotfire, who created a strong partnership with an experienced exec called Rock Gnatovich on the way to making Spotfire a success.  Identify early where you're bad, be ruthless in your self-assessment, and complement yourself early on.  If you are fantastic at product vision, setting direction, motivating the team, closing sales and evangelising the product, great.  If you're really not into negotiating salary increases, designing long-running workflows or even managing the board don't.  Get outstanding, senior help - competency matters too.
• Fill the gaps.  Like most brilliant personalities, you're likely to be excellent at some things and absolutely terrible at others.  You have to embrace yourself, recognise your weaknesses, even communicate around them.   One of the easiest ways to avoid information asymmetry about your own failings is to publicise them.  You also have to learn to harness your weaknesses.  To paraphrase Aristotle, "being angry is easy, but being angry at the right person, at the right time and with the right intensity is very hard".
• Invite contradiction.  This for me is very important, including from a board perspective.  Whilst as the maverick leader you are likely to be right about many things and feel that you play the major role in determining the outcome of your company, you are often likely to have a chip on your shoulder that is part of your motivation and may blind you to dissonant advice.  Again, if you are that good, you should contradict your natural instinct and ask instead  "how will we fail", "where is the chink in our armour" or simply "what can we do better" ?
• Build diversity around you.  It's impossible not to be impressed by the plethora of companies started by PayPal alumni (Tesla, YouTube, LinkedIn etc).  It's often be said to me that the root of success there was a deliberate and systematic policy of attracting highly varied talent to the company.  Maverickness by itself does not a company build.  The less obvious qualities of consistency, repeatability and incredible professionalism in a company's operations usually need to be brought in, with the art being to protect the unique alchemy that allows a company to be disruptive, its "disruption ethos" if you like.  Many venture disasters stem from "vc running a company into the ground" (founder version) by bringing on expensive corporate types who stifle the company's ability to innovate and execute.  More on this in a later post.
• Don't be a hero.  I have witnessed that one of the hardest things to do for brilliant founders is to accept failure.  Yet in the life of a startup, there are ALWAYS times when your company teeters on the edge, and it is in these defining moments when great companies are made.  As Marten Mickos once told me on receiving the Next Gem award, "a diamond is made of carbon, compressed really, really hard".  The thing about failure though is that it's not absolute, it builds up over time.  If you are trying to take on too much in the face of mounting adversity, are not able to share your concerns and your minor failures, are not able to recognise that building a company is never a solo effort, you might be setting yourself up for a burnout, a major bust-up with your team or your investors, and a terminal failure of your business.

In praise of the Maverick

From an investor standpoint, I will choose the maverick founder over the more sedate kind any time.  The primal urge to build something of note, the passion to succeed in the face of adversity are fundamental to me.  I know the overhead and tension of dealing with the relationship will be higher; but I consider it's my job to foster an environment of mutual respect and trust where maverickness is allowed to flourish, whilst at the same time the sound foundation for building and scaling a sustainable business is being laid. 

In fact, to my mind managing that tension is at the heart of what makes venture capital challenging, interesting and ultimately successful.

Related Reading

A brilliant entry from Ben Horowitz on the preference for founder CEO's : http://bhorowitz.com/2010/04/28/why-we-prefer-founding-ceos/

Fred Wilson on "stepping up" from CEO to Chairman: http://www.avc.com/a_vc/2007/02/when_the_founde.html

The real risk to our startups' way of life

Beware, this is my uplifting post for the week !  It was triggered by this interesting interactive map of Avian influenza risk published by Maplecroft, a CSR research and advisory firm.

 
Recently we have all been too aware of the immediate impact that flying restrictions can have on our startup companies, particularly those not based in a nexus of activity like the Bay Area or 128.  When that deal with Time Warner is just waiting to be signed but you just can't get to New York, you know the local competitors are going to find a way to get back in...

Whilst the focus is on terror right now, Avian Influenza is the more disruptive threat hanging over our heads.

We are still in a situation of human infection with no confirmed human-to-human (H-H) spread.  Current actions are essentially limited to Tamiflu stockpiling and accelerated vaccine research.  As soon as small clusters of sick people appear with some H-H transmission, you can be certain that airports will start to implement containtment at very high speed.  Phase II may be upon us right now, according to this but tempered by this (I don't read the mainstream press anymore for a reason ;-)).  That's when the disruption to our global businesses will really start.  You do not need to reach pandemic stage before public events get cancelled and governments offices shut down ... you get the picture.  I am sure Oliver Stone has bought the rights already.

Given that this is a likely event, I think all businesses should start to think carefully about they can keep operating in the event of a crisis.  When do you stop asking your team to come to the office, assuming it is still accessible ?  Is everyone aware of continuity  mechanisms ?  Can all  employees work remotely ? Can you reasonably require of your team that they keep using Mass Transit ?  What if your critical vendors are impacted ?

The priorities should be safety of team and families first, continuity of the business second, and so on.   But all CFOs / CAOs should have a think of their contingency plans and create a set of recommendations for their team.   The FSA has a plan, so should you.

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