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More on "Tough Questions"

In my last post, I advised entrepreneurs seeking VC funding to think carefully about choosing their co-founders. I claimed this decision is often gotten wrong and that, not infrequently, one or more co-founders leave the company with an amount of founder’s equity disproportionate to their contribution (in the eyes of their co-founders). Finally, I noted that, in this situation, the “remaining” co-founders almost always bear the economic brunt. 

How to avoid this? I wish I had a crisp, clean and clear answer. Like a lot of other important questions in life, however, the answers are messy, ambiguous and highly context-dependent. All of us, VC’s and entrepreneurs alike, wish we could just call up “Central Casting” and order “the perfect startup team”. But, of course, we can’t. That said, there are some useful ways to think about this situation, and, below, I’ve set out some guidelines that a VC will likely use in evaluating this aspect of a startup. I hope these will be helpful to entrepreneurs as they’re building out their co-founding teams.

As I mentioned in my last post, founders don’t always pick their co-founders with a beady, cold-eyed, calculating gaze, and with a tough-minded focus on who can actually make the biggest contribution to the Company over its lifetime. Instead, co-founders are often picked because they are friends, or like-minded, or “great people, the kind you’d pick if you were in a foxhole under fire”. For any entrepreneur contemplating starting a company, there is an interesting and helpful analysis of this “choosing-who-to-work-with” phenomenon in a June 2005 Harvard Business Review article entitled “Competent Jerks, Lovable Fools, and the Formation of Social Networks”. If you don’t have access to a hard copy, you can purchase reprints online at: 

.http://harvardbusinessonline.hbsp.harvard.edu/b02/en/common/item_detail.jhtml?id=R0506E 

Starting a company is an act of courage. It’s also tremendously complicated. Almost always, the elements that are “unique” to a particular startup are as important as the elements that are “common” across the universe of startups. As with any set of simple guidelines, the ones below should be considered with a grain of salt. When applying them to your startup, keep your common sense hat on tight at all times. 

1. Incomplete Team vs. the Wrong Team Member? 

A key question any founder seeking VC financing needs to answer is “How complete does my team have to be?” On the one hand, experienced teams with domain expertise covering the principal startup business functions (e.g., product development) are very attractive to VC’s. On the other hand (as I’ve previously posted), teams with the “wrong” people on board are less attractive. A person can be “wrong” for a startup (in this sense) either because (1) he has insufficient business experience, talent or maturity for dealing with the swirling, chaotic world that surrounds every startup, or (2) he is in charge of a business function that no startup needs (e.g., a CFO). So, how should a founder think about this quandary…….? 

As I’ve previously posted (10 Commandments for Entrepreneurs), picking the right VC firm is critically important for any entrepreneur seeking VC funding. VC firms (as well as the individual partners within them) have investing passions for certain markets, as well as areas of market expertise, that will affect their interest in, and appropriateness for, any particular startup. In a similar way, VC firms (and the individual partners within them) have different levels of comfort in dealing with incomplete startup teams (and very early stage deals). When making your list of VC firms to approach, do whatever it takes to find out whether a particular VC firm has the right appetite for a startup at your stage of development. 

As an example, at my firm, Mayfield, we are very comfortable with early stage startups – which almost by definition have “incomplete” teams. Recently, we calculated that over 20% our investments in the past 5 years were companies “incubated” at Mayfield, where the founding team consisted of 1-2 people. Even at Mayfield, however, comfort with incubations or seed financings varies among different Managing Directors (as it will with any VC firm). It also varies – even among the Managing Directors who are comfortable with “seed” stage companies -- according to their workloads. Seed/incubations require lots of work, and don’t always generate a commensurately greater return. So, do your homework. 

I’ll end Guideline #1 with the following rule of thumb (NOT a commandment): for a VC firm that is comfortable with early stage startups, an incomplete startup team is preferable to a team with the wrong team members. 

Why?

First, VC’s pride themselves (some are even good at it) on being good at helping their companies recruit. If a startup has an attractive couple of founders and a terrific business idea, a VC can imagine how additional, world-class team members could be recruited to fill out the team (as you might expect, the more incomplete the team is, the more important will be the judgment about how easy recruiting will be). 

Second, as I wrote earlier, it’s always hard to transition the “wrong” co-founder out of the Company – it’s also economically unattractive to the remaining co-founders. 

2. Is My Org Chart "Contorted"? 

We’ve all seen a “standard” organization chart. It has (1) the CEO at the top, (2) Four to eight Vice-presidents below, each in charge of a business function and reporting to the CEO, (3) Directors in the reporting chain below the Vice-presidents, and (4) a variety of folks with different (and non-standard) titles in the reporting chain below the Directors. 

I would claim that this “standard” org chart is actually a good template to follow in organizing a startup through, say, the first 40 people. I’m not sure if the converse is true, but I can say (without having done a rigorous study) that, in my 25 years of working with startups, there is an interestingly strong correlation between (1) startups with org charts that were “contorted” in some way (compared to the “standard” one) and (2) startups that ended up with some kind of founder trouble. Thus, if there are “odd” lines of reporting, or if there are “odd” titles that don’t fit in a standard org chart, it usually raises a red flag. If you’re having trouble fitting one of your co-founders into a standard org chart, you should think about whether he’s the right person (or, at least, in the right role). 

A few examples may make this clearer: 

(1) almost no startup “needs”, and most startups don’t have, a “Chairman”; the office has no real meaning in a setting where most of the board members represent major stockholder interests (including holders of founders’ stock); rarely, it might make sense to give the Chairman title to an outside board member who brings particular prestige and gravitas to the Company, and who is “active” in helping the Company in some way; otherwise, it’s usually window dressing and no startup should have window dressing; so a startup with one founder as the CEO and another as the “Chairman” feels to the VC like window dressing intended to assuage an ego rather than a tough-minded business decision. My advice to founders: avoid extraneous uses of Chairman. 

(2) Almost no early-stage startup seeking VC funding should ever have one founder as the “CEO” and another as “President” or “Chief Operating Officer”. This is almost always a sign of title inflation (usually to assuage someone’s ego). Almost guaranteed, any startup that has both a CEO and a President/COO has the wrong person in one or the other (or both) of those roles. This sort of title inflation and proliferation is almost always – like most other “contortions” of the standard org chart – a red flag to VC’s. Can easily be taken to indicate that some of the co-founders are more worried about titles (and ego’s) than success. 

(3) In case I haven’t beaten the “excessive” Vice-presidents issue to death, here’s a final note: almost no startup seeking VC funding should ever have anyone with the title of “Executive Vice-president” or “Senior Vice-president”. Maybe when your startup has 1,000 employees, but not when it’s just getting off the ground. In my 25 years of experience, both as a lawyer representing startups, as well as a VC investing in them, this particular kind of title inflation has almost always been a bad sign: either that someone (the one with the high falutin’ title) is overly concerned with ego and resume-building instead of rolling up his sleeves and actually working, or that “room” in the org chart is being “cleared out” for someone else, who though not ready, nevertheless demands it. 

Another thing founders often fail to realize: not every member of the founding team has to be a Vice-president (or higher). It’s OK to have “TBD” in a number of the Vice-president “boxes” in the org chart of a startup (and elsewhere). For example, don’t worry if you have a great Director of Engineering but no Vice-president of Engineering in your startup. Any Director worth his salt should be able to manage a startup engineering team through 6-8 people, particularly if the CEO has technical experience. In this situation, the VC’s question will be: will the combination of the CEO, the Director of Engineering and the company idea be attractive to a great Vice-president of Engineering when hiring one becomes appropriate. 

Moreover, some Vice-president boxes in the “standard” startup org chart should be empty. Example: almost never is it appropriate for a startup to have a Vice-president of Finance/CFO. 

We have, VC’s and entrepreneurs together, created a somewhat “macho” culture around the act of starting a company. As part of this, entrepreneurs are expected to have a “can-do” attitude, high levels of self-confidence, etc., etc. While some of this is actually productive and helpful, it can also – like any ideology carried too far – be counter-productive and unhelpful. A small, but important, example of this is the concern entrepreneurs have about ever putting “Interim” before their title on the org chart. It’s easy to see how an entrepreneur could assume that a VC would view this as a lack of self-confidence, or as evidence of some other “un-macho” attributes.  My advice, however, is to not be afraid of putting “Interim” in front of anyone’s title when it’s reasonable to assume that an early task of the startup is to recruit someone else to that role. This is particularly, but not exclusively, true of the CEO role. VC’s love entrepreneurs with the self-confidence and guts to start a company, as well as the wisdom to realize that they’ll need help. 

3. Can All My “Vice-President” Co-founders Recruit World-class Talent? 

In their early days, most technology startups don’t need more than one, maybe two, people in any business function other than Product Development/Engineering. Even in a startup, a principal (not the only) job of a Vice-president is to recruit. So, not infrequently, the only Vice-president a startup will need is a Vice-president of Product Development/Engineering (and, as noted above, not always even that).

If one has other co-founders with the title of “Vice-president”, one should be very comfortable that they will be able, when the time comes, to recruit high-quality talent to work for them. In this regard, there are two old, hackneyed maxims that founders should nevertheless repeat to themselves when considering their co-founding team: (1) “A” quality people only want to work for other “A” quality people, and (2) while “A” quality people hire other “A” quality people, “B” quality people hire “C” quality people. Given the difficulty (and economic consequences of) “transitioning” a co-founder out of the Company, make sure any co-founder you make a Vice-president is an “A” quality person. Otherwise, you could have a problem.

Some Tough Questions You Should Ask

If you want to raise money from VC’s, here’s a really tough, really important question you ought to ask yourself very early in the process: “How many co-founders should I have?” Having the wrong “answer” to this question can make your life difficult in some subtle (and odd) ways. Plus, unlike some miscalculations, here the wrong answer hurts only the founders, not the VC or later employees. Here’s how to look for the right answer.

Although entrepreneurs are motivated by things in addition to money, money’s important to everyone I’ve ever met trying to start a company. Monetary rewards in a startup, as everyone knows, ultimately derive from ownership of stock (not salaries or bonuses). Since there can never be more than 100% of the founders’ stock available for allocation, every co-founder should focus on ensuring that the allocation best matches the realistic, expected contributions of each founder to the success of the Company. 

In Silicon Valley (assume it’s the same in other startup regions), “founders” have a bunch of iconic attributes, some good, some bad.

Although we don’t, we should have a statue dedicated to “The Startup Founder” prominently displayed somewhere in Silicon Valley. Founders are passionate about their businesses, and will run through brick walls to make them succeed. In large part, Silicon Valley’s success is attributable to this passion and “never-say-die” attitude.

That’s the good part. 

Founders are also “expensive” in terms of equity (usually, and sometimes even rightfully, to reward them for taking the risk in joining a startup). Founders are harder than normal employees to transition out of the Company (not legally, just emotionally: “How can we fire Joe? He’s a founder.) Just like most people (including VC’s), founders usually have skills and experiences that are narrower than they, themselves, believe (even sincerely). And finally, founders don’t always pick their co-founders with a beady, cold-eyed, highly calculating gaze with a tough-minded focus on who can actually make the biggest contribution to the Company. Often, co-founders are picked because they are friends, or like-minded, or “great people, the kind you’d pick if you were in a foxhole under fire”. 

That’s the bad part. 

Let me illustrate the problem with a hypothetical (though not uncommon) four-person startup. 

Four friends decide to start a new company. After some jockeying (since they’re “peers” at their current company), they finally settle on the following titles, roles and percentages of the equity: (1) President and CEO (35%), (2) VP Marketing (25%), (3) VP Engineering (25%) and (4) VP Finance/CFO (15%).

To them, it seems logical to have these four (eventually) important business functions covered by the founding team. Moreover, these responsibilities roughly match their (perceived) skills and experiences, although none of them has ever had a title higher than Director, and none has ever had general management experience (i.e., responsibility for a complete P&L). 

They work hard on their business plan and actually come up with a very interesting idea. 

Having studied the “Ten Commandments for Entrepreneurs” at www.allensblog.typepad.com and mastered its lessons (sorry, had to do it), off they go to Sand Hill Road.

Because the idea’s interesting, they quickly arrange several first meetings at top-tier VC firms, but receive no call-backs. They know that the odds of getting VC financing are low, but can’t figure out why they are having no success at all. Without exception, their first meetings have been energetic and enthusiastic – and no one has pointed out any blind spots in their planning or preparation. 

As it turns out, the VC’s actually liked their idea a lot. The VC’s also actually liked two of the four founders (marketing and engineering) a lot, although no VC they met believed that either of them was ready for a “real” VP role. Unfortunately, when asked, the marketing founder and the engineering founder were defensive about deserving “their chance to step up to the VP level”. That paled, however, in comparison to the defensiveness of the CEO when questioned about his future role in the Company. Finally, the CFO couldn’t really describe what kinds of CFO-like duties he would perform for the first two years. Every duty he did describe could be done by a competent, high-level office manager. 

Spotted the problem….? 

Actually, there are several: (1) the CEO and CFO, who owned 50% of the founders’ stock, were not appropriate for their roles, (2) neither of the “continuing” founders was really ready for a VP role (and was defensive about the issue) and, though less importantly, (3) no startup needs a VP Finance/CFO. 

From the VC’s perspective, this is a deeply “broken” situation, despite the interesting business idea. And since the “broken-ness” involves founders (with all the iconic complexity that entails), “fixing” the situation involves some really hard work and tough decisions. Given the tensions (and lurid myths) that surround VC’s replacing founders, any VC with decent deal flow will simply move on to some other interesting startup that doesn’t have these problems. 

What’s the big deal? 

First, it is extremely difficult to transition a founder out of “their” company. Moreover, as hard as it is for the Board of Directors to make such a transition, it’s virtually impossible for the other, continuing co-founders to do it. After all, they were friends and “peers” who took a huge risk together, as well as a blood oath: “All for One and One for All!”. 

Second, even if it can be done, it’s usually “expensive” in terms of founders’ equity. Frequently, all founders have some form of accelerated vesting (or full vesting) of their founder’s stock if they leave the Company otherwise than by voluntary resignation. In our example, if some VC had loved the business idea enough to undertake the tough job of reorganizing the founding team, the departing founders would have taken as much as 50% of the founders’ stock with them. 

It’s important to note that it is NOT the VC or angel investor who gets screwed here – it IS the continuing co-founders. How so? Think about it for a second… 

When considering an investment, any investor, whether VC, angel or otherwise, will place a pre-money valuation on the Company when they offer to invest. That’s what they think the Company’s worth, regardless of who owns the founders’ stock (a slight oversimplification). If a good chunk of the founders’ equity is in the hands of co-founders no longer with the Company (and therefore who won’t contribute to its success), it doesn’t alter the investors valuation calculation. So, the continuing founders will end up with substantially less equity than they “deserve” – but not because the VC’s were unfair. 

In fact, it can actually be worse than this for the continuing founders. If enough stock has left the Company in the hands of the departed co-founders (in our hypothetical, up to 50%), an investor may simply decide that there isn’t enough equity left to properly motivate the continuing founders (calculating what additional stock must be reserved for future hires). In this case, the top-tier VC simply moves on to an equally interesting, but less troublesome, situation. 

What would have been a better strategy for this startup? Like everything else important in life, it depends…… 

In my next post, I’m going to suggest some things for entrepreneurs to consider as they put their founding teams together. 

Hopefully, they'll help.

In the meantime, however, before you prick your fingers and take the startup company blood oath, do the tough part and carefully evaluate who is on the founding team – you owe it to each other.

"Managing" Your Board of Directors

First, sorry to have been absent for so long.  Work and home have both been very busy.

Anyway, back in the saddle, and determined to post more frequently.

I'm working on several additional bits of advice for enterpreneurs that didn't fit the (somewhat artificial) constraints of the "Ten Commandments" in my past posts, and will get those out over the next week or so.

As I spent some time today, getting my blog-life organized after my layoff, I ran across this this advice for CEO's from a good friend of mine, John Kernan.  John has been a successful serial entrepreneur for probably 40 or more years, most recently with a KP and Accel-backed company called Lightspan (Lightspan merged with Plato Learning, and John now does angel investing and board service).  John has, over the years, run companies that have been wildly successful, as well as a couple that have failed.  Over this long career, John developed a set of "rules" that help a CEO keep his (or her) board focused on helping move the Company forward.

I've worked with CEO's for roughly 25 years, as a lawyer and as a VC, and John is the best CEO I've ever met at "managing" his board of directors.  In today's world, the term "managing", when used  in connection with an information-intensive process (like CEO/Board relations), frequently takes on a negative connotation.  I mean something different and positive.

What the 10 rules listed below are aimed at doing is helping the CEO use the Board of Directors in a way that best helps the Company make progress -- not by hiding information (you'll see below John's advice on dealing with bad news), but by being aware that one's board of directors, like any group of human beings, can be organized in a way that is constructive -- or not.  Successful CEO's realize this and proactively try to get their boards to operate in a way that best helps the Company -- it will not come as a surprise to anyone that Boards don't necessarily self-organize into highly efficient, constructive, high-powered and helpful groups of advisors.

Here's his take on how to do this.  I mostly agree with John.  Both to amplify some of his remarks, however, as well as make some additional points (and take issue with a couple of his "rules") I'm going to add some additional thoughts over the next week or so.

1. NEVER have the board meetng "at" the board meeting.  ALWAYS call every director a few days before the meeting and run every important issue by them to get their input, Also update them on company performance, especially the bad news, and let them "beat you up" privately. That way, the meeting can focus in a constructive fashion on problem-solving and building the Company for the future. 

2. Maximum Powerpoint show is four slides from any presenter, especially yourself. This should be the limit of director interest in detail. 

3. Provide complete access for the board to everyone and everything in the Company. They will rarely use it, but it's a great comfort to them to know you are not trying to hide anything. 

4. Have your key team members do almost all the presentations. It gives them exposure and allows you to make sage comments along with the rest of the board. A perfect board meeting is when 10% of the talking is done by the CEO, 60% by the team, and 30% by the directors. 

5. Carefully consider every director's input and take good notes at the meeting. These people have lots of experience and many great contacts. But you make the final decisions (and if you don't, they will start to look for someone who will). 

6. Give the Directors projects in their areas of expertise. It's free consulting and they usually do a good job. 

7. Get in front of the board on tough decisions like top management changes, including changes to your own role. If it's going to happen, make it your idea. 

8. For VC directors, try to picture how they are describing your Company to their partners, and what questions their partners are asking. Your job is to make each director a hero to their partners (or corporate boss). 

9. Remember it's Company first, team second, you last. You win when everybody wins, not when just you win. 

10. Make a friend of every board member. Send them interesting deal ideas you turn up, learn about their interests, make the board a "look forward to" experience for everyone. 

If you work hard, always act in good faith and in the best interest of the Company -- and if you follow these 10 rules -- most VC's will still be interested in financing your next deal, even if the Company tanks.

And if the Company is a success, they will be throwing money at you!

 

Commandment #10: Control the Meeting (But Be Smart About It)

In a VC meeting, first thing to remember:  Your goal is to get the next meeting (See: Commandment #3).

Second thing to remember:  That’s not your audience’s goal.

The goal of the audience is to decide whether it’s “worth it” (see below) to schedule a second meeting (their opportunity cost, and, to a limited degree, yours).  For this, they will inevitably ask a bunch of questions (see Commandment #8: Know what you don’t know, and admit it).  Questions can be good, bad or distracting (a form of “bad”).  The wrong approach to answering questions can be fatal to the second meeting.  This Commandment offers advice on ways to handle this situation.

Caveat:  As I’ve written previously, the dance between entrepreneurs and VC’s is not “fair” – at least not in the “cosmic” sense of disappointed entrepreneurs.  Several commentators on this blog have, as expected, taken me to task for openly stating this (“arrogance” being one of the kinder epithets).  In general, when offering advice about a system is not “fair”, you can take two approaches: (1) how to change the system, or (2) how to navigate the system, “as-is”, to your immediate, practical benefit.  Unapologetically, my approach is the second.  Not that the first approach is not worthwhile; it likely is.  It’s just not the approach of this blog.

So, you’re going to get questions (as previously mentioned, you’re usually in trouble if you don’t).  Questions usually come from a variety of motivations, “Good” and “Other”.

“Good” motivations include the following:  (1) questions designed to see if you know your market, technology, competitive dynamics, risks well enough for the VC to invest money in you (i.e., the kinds of questions you would pose to anyone asking you for money), (2) questions designed to see how you handle “tough” questions (a form of “stress” interview – startups are hard; you want to back people who – at the very least -- can handle tough questions) and (3) questions to elicit one or more facts that will enable the VC to decide whether to marshal the resources for (more charitable way of saying “incur the opportunity costs” of) additional meetings.

“Other” motivations vary, but here’s one example.  Like all human beings (including entrepreneurs), VC’s have egos.  The human ego is not, shall we say, always at it’s best in a “competitive” situation like a VC meeting where there is a premium on being (or appearing) “smart” in front of a bunch of other smart people (including the entrepreneur).  (For more on this, see Commandment #3: Know Your Audience.)  You will, on occasion, run into someone in a VC meeting, who seems dead-set on pursuing a line of questioning that shows how much the questioner knows, but is a side-show to the main event: your business presentation.  There are others, as well.  For your purposes, however, questions derived from all “other” motivation are similar – they are a distraction and you need to deal with them, and move on, so you get through your presentation (See all prior Commandments).

How do you do this?  Because situations differ so widely, I don’t have “one-size-fits-all” advice.  But, here are some tips.

Make sure you understand the question!

There are at least two important reasons for this. 

First, VC’s are highly (and negatively) sensitized to entrepreneurs who don’t (or by their behavior appear not to) listen.  Indeed, a proven way for entrepreneurs to avoid all the fuss and bother of actually getting money from a VC is to give this impression. 

[N.B.: Because I can hear the flame-throwers being fired up, let me be clear:  this is NOT to say that VC’s have all the answers, NOT to say VC’s are always right, NOT to say VC’s are good listeners, NOT to say VC’s aren’t often arrogant, NOT to say that entrepreneurs should merely agree with whatever the VC says, or otherwise be subservient in the meeting with the all-knowing VC.  This IS to say, however, that openly and honestly engaging in a conversation, and really listening to the person with whom you’re conversing is a good thing to do.  As I’ve noted in numerous prior posts, VC’s are no better than this than anyone else (maybe worse), but they’ve got the money.]

Second, often entrepreneurs and questioners go at it, wasting precious meeting time, only to conclude that they don’t actually disagree on some fundamental matter.

Usually disagreements are either “factual” (I don’t believe some fact you assert) or “judgmental” (even if I agree with your factual assertions, I don’t agree with your conclusion).  Over the course of several meetings, these ultimately require different handling.  But for the first meeting (where you’re trying to get the second meeting), I would suggest that “discretion is the better part of valor” -- no matter which type of disagreement.

When someone asks you a question in a VC meeting, you (or someone on your team) should start a little timer going in your head.  If you’re starting to spend a wildly disproportionate amount of your allotted hour on a particular point or line of questioning, you (or your team-mate) should make the decision to move on.   There are probably numerous ways of politely doing this, and – as with all other advice in these Commandments – you need to find your own “voice”, but something along the following lines may be a helpful place to start.

“I think I understand your concern on this point, but let me make sure whether or not I do (and explain the nature of the concern or disagreement).  While it is an important point that we think we can explain to your satisfaction, why don’t we take it off-line?  We absolutely want to make sure we give you a complete and thoughtful answer, but we do want to make sure that we have time to present our entire idea to you before the meeting’s over.”

Assuming the questioner is not a complete jerk, this (or something like it) will usually work, and the presentation can proceed.  If it doesn’t work (i.e., the questioner is just a jerk), then move on to a different VC firm.

Now, in “moving on”, your work’s just started.  Go back and read Commandment #8.  The advice there also applies in many ways to this situation.  That is, (1) note the disagreement, (2) after the meeting go gather your facts and your (logical) arguments and (3) quickly and succinctly follow up with the questioner and your proponent within the VC firm (if they’re different).  This shows a number of characteristics that VC’s like: diligence, thoughtfulness, “eye-on-the-prize” thinking, etc.

In any particular situation, you’ll need to make your own micro-judgment about which way to go.  If you’ve followed the previous Commandments (e.g., knowledgeable VC partner, background on the attendees, etc.), however, you’ve at least got a start.  And you’re ahead of the game just because you know that some questions are distractions -- and need special handling. 

Keep in mind, that you can easily have a pyrrhic victory in your first meeting.  You do NOT want to thoroughly and conclusively rebut a time-consuming challenge from someone, but run out of time to get through the presentation and win the prize: the next meeting.  If you are spending too much time on an issue (unless it is THE absolute key issue – which is rare) then figure out a strategy to move on.

Good luck getting that next meeting (and your funding).  Entrepreneurs make the world go ‘round and, without them, VC’s would have to go get honest jobs!

Commandment #9: Be Like Goldilocks

Any VC who doesn’t grill you on “the competition”, either in the initial meeting or during due diligence, fails the VC IQ test.  Understanding how to think about – and present -- the competition, therefore, is important to getting VC funding.  Here are some thoughts.

Competition is, what I call, a “Goldilocks” phenomenon.  You don’t want too much (no surprise here) and you don’t want too little (hmm, surprise?) – you want it just right.

It’s probably easy for entrepreneurs to understand why too much competition is a bad thing:

·        Competition for Funding.  By this, I don’t mean that there isn’t literally “enough” money to fund multiple startups in a single niche (on the contrary, one of the problems of the current early stage venture capital ecosystem is that there’s too much money chasing early stage deals). It’s more nuanced than that (and not as self-serving as it always sounds on first blush to entrepreneurs).  Several actual reasons:

o       because most top-tier VC firms don’t invest in companies that compete too closely (longer discussion in a future post), a startup that has numerous existing startup competitors actually may actually have a much shorter list of top-tier VC’s to approach;  given the odds of any particular VC firm funding any particular startup, this can have a dramatic adverse effect

o       Though apostasy to entrepreneurs, it’s actually quite hard to distinguish among startups going after the same space, if there are a lot of them.  When this occurs, every startup suffers from the “least common denominator” effect -- and inevitably seems less interesting; and

o       Many VC’s simply won’t fund the 4^th or 5^th company in a space.

·        Competition for Talent:  Pretty straightforward.  Commandment #8 asserts that “it’s all about the team”.  Where talent is concerned, two bad things happen when there are too many competitors:

o       talent gets spread too thin; and

o       good talent stays away because the space is too “crowded”.

·        Competition for “Market” Attention:  In a market with numerous competitors, any single startup will have a tough time gaining the attention of important consultants, analysts, pundits, columnists, reviewers, press, etc.  Partly, it’s the confusion (and the extra effort required to make sense of the competitive dynamic), and partly it’s the “least common denominator” problem mentioned above.

·        Customer Confusion:  Much the same thing.  Quite often, customers faced with numerous competing products or services find it too costly and confusing to differentiate.  Remember:  purchase decisions have costs.  When the costs are too high (because of confusion about what product or service is the best fit or value), it’s always bad news.  At best, the purchasing decision is delayed (as the competitors confuse the customer base by bashing each other).  At worst, the customer makes the “safe” choice and buys the product or service from the “most trusted” vendor – usually a large, established competitor with a vaporware or highly inferior product or service. 

·        Customer Leverage:  Smart customers also play off startups against each other to get the best deal.   Since the value of an early, marquee, reference customer is so important to a startup, the customer has all the leverage here.

·        IPO Opportunity:  For established companies, public markets don’t like markets with too many competitors because competition drives down margins and earnings.  For startups trying to go public, that’s also true, but another concern also comes into play.  To go public and achieve an efficient market for its stock, a startup needs coverage by sell-side analysts.  Even in the “good old days” when there were lots of analysts, it was not easy for startups going public to obtain broad analyst coverage (other than from the underwriters).  Nowadays, it’s much worse, given the dramatic decrease in the number of sell-side analysts.

·        M&A Opportunity:  In many markets (e.g., “core” enterprise ERP applications, or, increasingly, consumer internet businesses), the dominant players provide the main liquidity option through mergers and acquisitions.  While actual strategies differ, often the dominant players in a market will buy the 2^nd or 3^rd leading startup, rather than the leader.  Leaders often think they can go public as an alternative, and therefore demand a premium acquisition price.  Startups in the 2^nd or 3^rd position feel more vulnerable, and therefore feel pressure to sell for a lower price.  Once each of the dominant players has made an acquisition in a market, it’s often “game over” for the other competitors who remain independent, even the market leader.  Why?  Even for companies selling a technology-based product or service, the marketing, distribution and sales (or in consumer internet parlance, “customer acquisition”) muscle of a larger company is often more important than any particular technology.  A cheaper, inferior product or service in the hands of a powerful distribution system often defeats a better product or service being sold by a startup, even the (pre-acquisition) leader.  So, in a crowded market with dominant incumbents, if you’re not acquired, you’re toast.  Smart acquirers use this leverage to their advantage.  The more startups to play off against each other, the better.

[Quick sidebar

:  Having said all this, however, the history of venture capital is replete with instances where promising markets are imprudently (and even stupidly) over-funded.  VC’s (like entrepreneurs and other people) don’t always do the smart thing.]

Given all the bad things I just wrote about too much competition, one might assume (some entrepreneurs do) that “…if having a lot’s bad, then having none must be great…”.  This is wrong for a couple of reasons:

• Though I’ve never seen it, I suppose that there may be cases, very rarely, in which a startup has a truly unique and original business idea – and therefore has no competition.  Most startups, however (no matter how innovative), do.  Given the inefficiencies in the information marketplace about startups, entrepreneurs may not know about all their competitors, but they’re almost always out there.   I know, from my entrepreneur friends, that this is painful for entrepreneurs to hear – and understandably so.  Because they’re human beings, and therefore subject to the same motivations (and foibles) as the rest of us, it’s hard for entrepreneurs to make the enormous sacrifices necessary for success if some little corner of their mind doesn’t think that they have a deep, fundamental insight into a market that no one else does.

• Given this, if a startup asserts that they don’t have many (any) competitors, they hurt their case, no matter what.  Either:  (1) the VC won’t believe them, and will think that they simply haven’t done enough competitive due diligence (and are therefore not worth backing) or (2) the VC will believe them and conclude that, if there aren’t any competitors, it must not be that large or interesting a market.

So, if too much competition is bad and too little (or any) competition is bad, what’s the entrepreneur to do?

Couple of things:

• Do your competitive due diligence.  By dint of their position in the deal flow, VC’s in the top-tier firms often know a lot about who the startup competitors are in a given market.  VC’s expect (and reasonably so) that good entrepreneurs, even though they’re usually not as deep in the deal flow, will be very well informed about their competitors, and to have thoughtful, balanced analyses of their strengths and weaknesses.

• Don’t be Afraid to List Your Competitors:  From the VC’s perspective, it’s much more impressive to hear a thoughtful, careful, balanced analysis of a crowded competitive landscape, than it is to hear one that omits many of the competitors (the worst) or naively concludes that all the competitors are “losers” (for one reason or another).  VC’s will fund startups that have competitors.  Don’t be afraid to point them out.

In summary, as you develop your business ideas, and begin to think through your investment pitch to the VC’s, remember the following; it’ll help: 

• Having too many competitors is always bad.  If you have too many, consider another startup idea, painful as that is.

• Having too few competitors is usually bad.  If you have too few, consider whether the market’s that interesting.

• Having some competitors is good.  It validates the market opportunity.  BUT,  know who the competiors are and understand their weaknesses AS WELL AS their strengths.  VC’s are most impressed by entrepreneurs who know who their competitors are and know a lot about them -- and have a healthy respect for them.

Commandment #8: Know What You Don’t Know – and Admit It

If all questions about your startup had well-known, easy answers, you’d be on your IPO roadshow, not meeting with early stage VC’s.  Most good, early-stage VC’s don’t expect entrepreneurs to know everything, but they do expect entrepreneurs to know what they don’t know and to be upfront about it.  This Commandment gives advice on how to handle this.

To set the stage:  VC’s invest in people.  You’ve all heard the old saw: “To a VC, what are the three most important things about a startup?”  Answer:  “(1) the team, (2) the team and, (3) most of all, the team.”

By and large, it’s true.

Now, if you followed Commandment #1, you’re meeting with VCs who know something about your area. I know it seems hard for entrepreneurs to believe (especially given some of the comments I’ve gotten), but VC’s are generally smart people (present company excluded).  They can have lots of other unattractive attributes (just like entrepreneurs and other people), but they are, on average, reasonably smart.  Thus, your jaw shouldn’t drop if you find yourself in a VC meeting and you get a question about your business to which you don’t know the answer.  Believe it or not, this sometimes happens.

Here’s some really important advice. 

When this does happen:

            DO: admit (with confidence) that you don’t know the answer

            DO: make a note of the question

            DO: quickly find out the answer to the question

            DO: promptly follow up offline with the VC who asked the question

DO NOT, REPEAT, DO NOT: fake your way through an evasive, oblique, or indirect attempt at an answer.

I know from comments to my blog that some readers reject my proposition that VC’s are, more or less, smart folks.  That’s OK.  Everyone’s entitled to their own view on this matter, and, who knows, they may even be right.  But, even to those doubters (if they want to raise VC money), I implore you to believe that VC’s (smart or not) do have good bullshit detectors – even in areas where they’re not necessarily domain experts.  Often, of course, it’s not even that hard.  Human beings are generally pretty good at reading body language, and body language usually gives away evasive behavior.

To put this in a more positive light, from the VC’s perspective (no VC actually thinks about it this “formalistically”), I offer this little “algorithm”:

·        There’s a “list” of the important questions about any new business idea, some of which are not currently “answerable” (e.g., will the market develop as predicted by the entrepreneur);

·        The entrepreneur should have answers to most of the currently “answerable” questions on this “list” (e.g., why a large incumbent vendor with major brand recognition and a huge cash hoard can’t easily move into the market); and

·        If the entrepreneur doesn’t, he should admit it, and quickly heed the aforementioned advice about follow-up.

Again, VC’s don’t expect entrepreneurs to have all the answers.  As mentioned, if you did, you’d be on your IPO roadshow.  VC’s do, however, expect entrepreneurs to know the “list” of important questions. Failure on this front is the real confidence deflator (though, to say the least, it also doesn’t inspire confidence if an entrepreneur doesn’t know the answers to questions that he should). 

Failure to heed this advice can hurt an entrepreneur in a way that might come as something of a surprise.  VC’s ultimately cannot know nearly as much about your particular business as you do (see numerous references in prior Commandments).  After lots of due diligence meetings, reference checks, customer calls, etc., many funding decisions more or less rest on VC intuitions about the “character” of the entrepreneurs.  This is why VC’s are so much more comfortable backing entrepreneurs they already know. 

Keep in mind, many important questions about a startup are not answerable until the startup answers them (positively or negatively) by executing its business plan.  VC’s, at least the good ones, know this. Thus, if the entrepreneur exhibits evasive behavior when answering a question, the “trustworthiness meter” starts running in reverse.  Believe me, every startup will encounter situations in which the entrepreneur will have to report to the Board of Directors on a tense, critical situation, with highly imperfect information – and, after lots of analysis, the Board’s decision will often rest on beliefs about “character”.

So, for any entrepreneur who wants to raise VC funding, following Commandment #8 -- (1) know a lot, (2) know what you don’t know and (3) admit it when asked -- will get you a lot farther down the road.

Commandment #7: Limit Yourself to the Baker's Dozen

Loyal readers who’ve slogged it out with me so far will know that, partly by “tradition”, and partly due to the Hard Stop (Commandment #2), entrepreneurs usually have about an hour to get their message across in the first meeting with a VC (subsequent meetings vary in length).

Loyal readers also will know that entrepreneurs have lots to do to prepare for that first meeting (Commandments #1 and #2) and make it productive (Commandments #3- #10 (#8, #9 and #10 aren’t posted (or written) yet)).

Now, more bad news: entrepreneurs have to do all this in 13 (or fewer) slides.

I know, I know…..sounds impossible, but do the math:  You have (roughly) an hour.  According to Commandment #2, you should use a few precious minutes to find out “who are all those people”.  Let’s say 5 minutes. That leaves 55 minutes, more or less. 13 slides = <5 minutes/slide.  Not much time.

Plus, you’ll get questions (in fact, 9 times out of 10, it’s a bad sign if you don’t).  This uses up even more of your precious air time (BTW, Commandment #10 (forthcoming) dishes on how to handle questions).

Now, in reality, actual mileage may vary. The “optimal” number of slides in your presentation may not be exactly 13, but the truth is that it can’t be much more than that or bad things happen: (1) you run out of time, (2) you look disorganized or (3) you end up handling the last few slides like one of those radio announcers at the end of a drug ad – speeding through 10 pages of fine print about possible side-effects in 3 seconds.  Hard to follow, right?

More constraints:  you don’t even really have all 13 slides to explain your business. In every first presentation to a VC, a few slides on stuff other than explaining the business are mandatory: (1) the team, (2) the competition (more on this in forthcoming Commandment #9) and (3) the financial projections. So, you really have about 10 slides to do your thing.

Remember, in the “religion” of getting VC financing, simplicity is a cardinal virtue. Keep this – as well as Commandment #3: Tease, Don’t Overwhelm – in mind.

All this said, we’ve done deals at Mayfield where, despite a lousy initial presentation (takes one to know one; I’m a lousy presenter myself), it was nevertheless clear that the entrepreneur had a great idea.  But, is it ever helpful to meet a startup team that has clearly, cleanly and crisply distilled a complicated message down to 13 slides (or fewer). 

Following Ten Commandments in only 13 slides is really hard.  If you can do it, however, you’ve helped yourself more than you probably know.

Commandment #6: Explain Your New Idea by Analogy To, or Contrast With, Old Ideas

To date, I’ve tried to couch the ideas in the “Ten Commandments” as objectively as possible.  No doubt, I’ve only partly succeeded, but in this post I’m admitting upfront that the following advice is likely to be idiosyncratic to me, and may not apply to every VC you ever pitch to.  So, use it only if it feels good in your own “voice”.

In Commandment # 5, I urged entrepreneurs to describe the “It” early (and explained why).  I suggested that a way to do this was frame the description as an answer to the question: “What problem are you trying to solve?”.  Commandment #6 is, sort of, the next step in that process of making clear to the audience how your “It” solves the problem. 

One way to describe “It” quickly and cogently, I find, is to analogize to, or contrast your “It” with, the other, existing “It’s” out there.  Sometimes (most likely, the “contrast” situation), the other “It” is a product or service that you’re going to kill off, replace, compete with, complement, or relate to in some direct way because your “It” and the other “It’s” are solving problems in the same or similar markets.

Sometimes, however, it’s useful to analogize your “It” to an “It” from an unrelated market.   This works best when the other “It” is a popular “social artifact” – such as Blog, Google, TiVo, Podcast, etc. (good way to tell this is when the “social artifact” formerly just a noun, has morphed into a verb due to its popularity).

An example:  One of my companies, Pluck (www.pluck.com) has a very interesting set of capabilities, in some ways structured around the core application of an RSS newsreader.  Among a bunch of other features and functionality, Pluck enables (I promise this advertisement will be brief) users to save, store and file web content in ways that allow groups of collaborators to access, over extended periods, the data stored in a collectively accessible place.  This, plus the other features of the product, is a complex set of capabilities to explain quickly.  When the team pitched Mayfield on their deal, they described this unique ability to “time shift” access by groups to stored web content as “Tivo for the Web”, and that phrase turned out to be a great way to initially place Pluck in an already understood mental category for my partners and me. 

Needless to say, “TiVo for the Web” is not a complete description of Pluck, and, like all figures of speech that seek to explain by emphasizing analogies between otherwise different things, you can push it too far.  Care should also be taken not to fall into, what I call, the “Hollywood trap”.  According to friends in the film business, the spoofs of Hollywood in which the principal way of pitching a new movie idea is to describe it as the mélange of two (or more) earlier films (e.g., “Son of Dracula meets Bride of Frankenstein”) is actually fairly accurate.  As the foregoing parenthetical shows, it’s easy for this to slide downhill into farce, so use discretion.

Think about this technique, however, as a potentially useful way to help you get to the point fast.  I recently met with a startup that pitched their wares as: “podcasting for cell phones”.  For a bunch of reasons, I didn’t think the business was a good one, but, nevertheless, I immediately had a sense for what they were trying to do.

Another interesting application of this that I recently saw was described as “eBay meets CNN”, a sort of “a news site (portal) for amateur (newsworthy) videos where viewers rate the videos to move them up or down in the popularity queue”.  Here, the entrepreneur (a Mayfield EIR) decided for various reasons not to pursue the idea, but it was easy to quickly see what he had in mind – and start to frame some of the due diligence questions one would want to ask.

I’d actually be interested in hearing from readers other examples of this type of thing – and whether they find it useful as either an “elevator pitch” technique (if they’re entrepreneurs) or as a quick way to categorize the new “It” (if they’re VC’s).

Intermission

Halfway home…..and I’ve gotten tons more input from readers than I ever thought.  As I round the horn, and start on the last five Commandments, I wanted to reflect a little on the comments that readers have left.  I promise a more thoughtful perspective when the entire 10 are finished.

It’s been almost a couple of months since I’ve posted, which several readers have pointed out to me (embarrassingly, but truth be told, also slightly gratifyingly – you mean someone is actually reading it??!!).  I’ve been busy at work and home, but aim to pick back up the pace.  As partial recompense, I thought I’d offer a snippet of a conversation I had down at the DEMO conference a couple of weeks ago with Walt Mossberg, who writes the Personal Technology column for the WSJ.

Walt and I were having lunch, and, the talk eventually turned to blogs -- and then to my blog (which Walt hadn’t read).  He asked me about it, plus a bunch of other questions about blogging.  I told him that I was in trouble because I’d made several rookie blogger mistakes. 

They included doing a series of numerically-related posts (the “Ten” Commandments for Entrepreneurs) that hadn’t taken into account the “reverse” chronological order in which one’s posts appear in a blog. What I should’ve done, like David Letterman’s Top 10 Lists, is to have started with Commandment #10 and worked down to Commandment #1.  That way, readers new to the blog could read the posts in a more natural way, from Commandment #1 “down” to Commandment #10, instead of seemingly backwards.

But the bigger, MUCH bigger, mistake, I said, had been to promise readers TEN Commandments instead of, say, “Several” Commandments, or “A Few” Commandments – in case (as happened) I got too busy to post, got writer’s block, stepped in front of a bus, etc., etc. 

Walt then looked at me with his patented “you’re an idiot” look….Why?  Because, he said, experienced journalists never, NEVER, announce a multi-part series (especially one that has an explicit number of installments) before they’ve written all of them.  In fact, it turns out that most of the leading newspapers and magazines won’t even print the first of a multi-part article until all installments have been turned in, edited and finalized for printing. They’ve learned from past mistakes, I guess.

Wish I’d thought of that before launching into something called the Ten Commandments.

Anyway, onward and upward.

I’ve received a number of suggestions on my blog, mostly on the Ten Commandments, some of which I’ve listed (and commented on) below.

One of the most interesting, from a pseudonymous VC whom I know of, is that I write a companion series:  “Ten Commandments for VC’s”.  I will seriously consider this.  To help, I invite suggestions from any reader on what they’d include on the list.  I’m sure there are lots of entrepreneurs out there with stories they’d like to share back to the VC community.

Another suggestion was to respond to comments to my posts.  One regular reader/commentator, Vanilla Chin, takes me to task on this.  I assume “Vanilla Chin” is a pseudonym since I can’t find that name (except in connection with other comments on blogs) on Google, in the Internet Archive or at Yahoo People (yes, I know there are other, even free, sites but, at some point, it’s not worth it).  In any event, I plead guilty to Mr. or Ms. Chin’s charge, but also plead the extenuating circumstances of being very busy at work and home.

Vanilla Chin has been a very interesting reader:  sometimes scolding and sometimes supportive (in the face of attacks by Harry Kiwi (see below)).  He’s also one of the more thoughtful respondents to posts, frequently raising concerns about my advice from the entrepreneur’s perspective.  I’m tempted to respond to him or her, but I’ve decided to adopt a rule proposed by Dan Gillmor (which I’m not sure he, himself, always follows), which is:  don’t respond to comments from anyone using a pseudonym.  So, please identify yourself if you want to start a dialogue; otherwise, especially given the time it consumes, I can’t do it.

Throughout the first Five Commandments, I’ve tried to make clear that I’m not defending VC behavior in any way.  Most readers who’ve given me any feedback (either in comments to a post or in a direct email to me), seem to have, more or less, gotten that point, although several have accused me of arrogance (some pseudonymously, some using their real names).  This has made me realize that, despite a lot of effort, it’s hard to describe (sometimes) arrogant behavior without readers, some at least, thinking the writer is, himself, arrogant.

In this regard, it's important to remember that the game, "Raising Venture Capital", is not played on a level playing field.  In some ways that’s not “fair” to the entrepreneur, and I’ve never pretended it is.  But it is a fact of life.  In writing the Commandments, what I’ve tried to do is give “little”, helpful suggestions to entrepreneurs about how to optimize their chances for winning the game on this unlevel playing field.  I sometimes wonder whether – instead of the "Ten Commandments" -- I should have called them “Several Small Suggestions to Help Entrepreneurs Do Their Best When Interacting With VC’s in the Unfair Game of Raising Money”.

Finally, one reader, whose screen name is Harry Kiwi, really has it in for the VC community, and me as a representative of it (not that there aren’t occasional good reasons).  You can read his comments next to the related posts.  I have to say that I found his comments to be ad hominem and entirely off the mark, at least relative to my intended message.  I’ve also searched for “Harry Kiwi” in Google, Internet Archive and Yahoo People, but, likewise, come up empty-handed.  Dan Gillmor also warns of “trolls”, like Harry, and it is amazing how one person, especially one who only comments pseudonymously, can really lessen the whole experience, at least for the blogger.

In any event, Harry’s been the only commentator who’s tested my initial (and still standing) resolve to not block (or delete) posts from anyone unless they’re really over the top.  On a couple of occasions, he’s come close, but I consider the “open-ness” of the blog one of its most important attributes, so, for now, I’m hanging in there with the resolve intact.

Anyway, I never expected even to have to think about rules like this for my blog, because I never expected anyone to read it.  So, thanks to all of you, except Harry, who have.

Commandment #6 coming up tomorrow.

Commandment #5: Create the "Aha" Early

A long time ago (“last century”, as my teenage kids delight in saying), I took the California Bar exam -- along with 3,000 – 4,000 other applicants (as a probably not very good sign, last year over 8,000 applicants took it).  While studying for the Bar Exam, I received a helpful piece of advice that I offer up as the 5^th Commandment.

On the final day of preparations, my professor told a very nervous classroom:

“…remember the following as you start to write:  (1) your answer will be graded by a very busy practicing lawyer who makes about $3 per answer that they grade, (2) your answer will be graded on the bus, train or plane, or late at night in front of the TV, or when the grader is tired, and (3) your answer will be the 150^th answer to the exact same question that the grader has read in the past couple of days.”

“What does that grader want from you when your answer book comes off the unread pile and is opened?”

“Get to the point -- FAST!”

Having been on both sides of the table over the past 25 years, I can tell you that failure to heed this bit of advice is one of the leading causes of short, unproductive meetings between entrepreneurs and VC’s.

NOTE #1:  As I’ve posted numerous times (though some readers seem not to have noticed), this is NOT a defense or apology for VC behavior.  Having witnessed it from both sides, I know that VC behavior in meetings can be good (occasionally), bad (often) or ugly (sometimes).  That said, the goal of these 10 Commandments is to offer up some frank advice to entrepreneurs to help them do the best job they can when raising money from VC’s.

NOTE #2: Having represented entrepreneurs for ~20 years, I know that they pour their hearts and souls into their business plans and presentations.

NOTE #3:  I am not, myself, a good presenter.

Now, back to the action…

If you read Commandment #3, you know that the goal of the first meeting is to get the second meeting.  You probably also know that much of what VC’s do for a living is sit through presentations – lots of them.   Because of this, no matter how hard one tries, it’s easy -- just like the Bar Exam grader on their 150^th answer -- to lose interest in a presentation if it doesn’t get to the point – FAST.  This may be good, bad or ugly, but it’s a brute fact of life that entrepreneurs who want to optimize their chances for success should keep in mind.

When I practiced law, I used to tell my clients that, by the second slide, the VC should know what “it” is that their company is going to do.  “It” will be different for each startup, obviously, but the goal of the presentation should be to provoke an “aha” in the VC as early as possible in the presentation.  I know from my own experience that if I don’t understand what “it” is early, I get “stuck” trying to figure that out, and don’t pay close attention to the ongoing presentation.  This is not just me – it’s true for all VC’s.  Some of us are just more polite than others.

So, how does one do this? 

Having sat through my share of presentations, I can say there are lots of good ways.  In the next paragraph, I’m going to make a (not brilliantly original) suggestion, but the most important thing in a presentation is that it be in the presenters “voice”, not mine or anyone else’s.  So, find a way that’s comfortable for you, but DO find a way.

When sitting through a presentation, I find it quite helpful to have “it” explained as the answer to some variant of the following question:  “What problem is my startup solving?”

So to maximize your chance for a second meeting, do something that I know is really, really hard:  concisely and clearly answer that question.

You’ll be glad you did.