When you start a company, you step out into the void. It’s all on you.
Building a company is not the same as building a product (as CRV’s Izhar Armony says in an awesome interview here). The former is much more difficult, and in the end, requires a deep management team and significant capital to fund.
And, when you get going, you come up with an idea, raise some capital and pressure-test something. You’re running an experiment. You may be sizing a market, building a product, or deploying something at low levels to test product-market fit. And, if that works out, the market rewards you by letting you raise more money at a higher valuation.
If not, you fail.
Much has been reported about the low success rate of start-ups (an example from me here), and so I won’t dwell on that. But, I do want to focus on the very human part of company sausage-making.
I just spoke with one of our CEOs, whose business is really starting to develop. But, it has been a lot of work to navigate the market, mature the product, keep the team aligned and the investors excited. I this week met with two of our Kepha 2 seed companies. They’re on string budgets testing ideas, and now feel that they have something. The stress levels have been very high for all three companies, but they’re now starting to see some daylight break through the fog. They’re feeling an incredible rush.
When I look at the three companies, they all are in different spaces, have different cultures, and different business plans. But, they all have this common: they kept their burn rates incredibly low in order to buy time to figure things out. They resisted living large and instead kept focused on the essentials in order to try and achieve a valuation inflection point.
I try to coach my founders on the following: yes, you’re making progress, but not all progress is created equal. With your limited capital, what is a valuation inflection point that will dramatically increase the odds of success? Not just a little bit, but by a lot?
Then, break down the steps needed to achieve that inflection point. People who are in high-stamina fields, such as professional athletes or elite soldiers, master this. They’re not thinking of the long season or the week during which you get no sleep at Navy SEAL training. They just focus on the here and now.
Progress is achieved one day at a time.
I really enjoy Fred Wilson’s blog and read it avidly.
Recently, he wrote about the importance of having enough capital as a VC to invest in multiple rounds, and also, having the guts to lead an inside round in your winners. I completely agree, given the payoff structures that exist for start-ups.
What’s always been true about VC is that you are dealing with “asymmetric outcomes” in a portfolio. It is a hits-driven business whereby a small percentage of your investments generate 90%+ of the gains. (And, this has enormous ramifications for entrepreneurs, as I explain below.)
So, a symmetric investment approach really doesn’t work when the outcomes are asymmetric; for example, investing in just one round only can lead to a good multiple on the money invested in that one particular company, but it won’t move the needle on a fund.
Moreover, what’s very challenging in VC is that it often takes a long time before you know if a company is going to be a winner. So, in the meantime, you use your best judgment to keep supporting companies to a valuation inflection point.
What does this mean for entrepreneurs? I think anything you can do to show your Board that you’re making progress and keeping the burn rate relatively low is key. You can and should up the burn once you have very predictable user acquisition processes and, ideally, monetization. But, before that, you’re still in the “figure it out” mode, and you should try to prolong the runway as much as possible.
Also, what if you already have a winner? We encourage our founders in those cases to keep going. Don’t sell the company. Go public and be a big company. Raise the valuation and sell some of your shares in a secondary to take money off the table if you’re worried about risk, but as much as possible, keep going.
Go public and then establish a currency by which you can buy other companies. Get bigger, and then, if a great offer comes after you’re public, it’s a great situation for you.
But, by then, you will have earned multiple premia on your stock price: a premium from the private markets as your revenues become scalable and predictable, a premium from the public market as you go public, and a premium from an acquirer who buys you (e.g., Trulia just sold recently at 2x their public market cap).
You’re in a game with asymmetric outcomes. Most entrepreneurs get only one true winner in a career. It may be the best horse you ride in your whole career.
So, if you have a winner, keep going!
Red Sox owner John Henry, who runs a hedge fund, recently talked about baseball trades. He think the best trades are the ones the fans don’t like. In other words, they are contrarian moves.
All this made me think about entrepreneurship. When do you hold vs. fold? Are you being unreasonable and, in fact, crazy if you give up? Or, are you simply being “gritty” by staying course?
Honestly, I personally believe the “hold vs. fold” thought process is the key decision that an entrepreneur and his/her Board has to make. And, you have to make it more than once in a company’s life. IMO, it’s the “management alpha” that generates superior risk-adjusted investment returns.
I really liked the comments about being a contrarian, how you do really well as a founder or a VC when you’re not pursuing what others are. It takes a lot of internal strength to be OK when other people don’t like your idea.
In fact, I remember at one point there was a particular VC firm going through some tough times. Some friends worked there, and they were pretty stressed out. They tried to restructure some of their funds, and their LPs voted against it. There was fall-out, and some prestigious LPs spoke very loudly that they were dropping the VC firm.
But, the VC firm mentioned above persevered. And, it invested in Facebook, which has been the most successful VC investment of all time.
The VC? Jim Breyer.
“What are you up to this summer?” I asked.
“Taking off for two months,” he said.
“I’m getting a kidney transplant.”
I recently visited my favorite wine shop, Marty’s, and reconnected there with Peter Tryba (up top, with his daughter). He is the head of the wine department and has picked out for me some incredible and extremely cost-effective wines from around the world.
Peter’s kidneys have failed, and he needs an organ transplant. He is hoping it will happen in August. Unfortunately, a kidney transplant isn’t easy to do. There’s a lot of lost time at a job. So, I was hoping you’d join me and support Peter (click here to donate). He doesn’t know that I blog for fun and that I’m writing about him, and so, let’s make his day?
What’s amazing about Peter’s situation is that a social media campaign helped surface a potential kidney donor (it’s much better if your new kidney is sourced from someone still alive). Isn’t that insanely altruistic, that someone will donate one of his/her two kidneys and go through a very challenging surgical procedure?
I can promise you that kidney transplants can change a person’s life. My mother had one. I won’t bore you with the dangers and debilitating effects of dialysis, which you need if your kidneys fail. It really and truly sucks. A kidney transplant is completely transformative, a new lease on life.
I can truly say that Peter is an incredibly thoughtful, humble and awesome person. Please give.
Best of luck, Peter. We all are rooting for you! My thoughts and prayers for you and your family.
Last week, I really enjoyed meeting up with Kitt George, Dennis Keohane and M.E. Francis for a “Beers with…” video interview. I was supposed to do the inaugural one last spring, but I had given up alcohol for Lent. The clip is here.
The New England Venture Capital Association (NEVCA) originated the idea, and I think it is awesome that the series has taken on a life of its own.
My only rules for the taping was that I would not drink alone and I would pay for the drinks. So, yes Directr, Beta Boston and NEVCA, your colleagues were daytime-drinking.
I think the Internet and social media have really changed how entrepreneurs and VCs interact. I remember when I started in the business in 1998, and many entrepreneurs wrote letters to VCs, whose addresses they looked up in the Pratt’s Guide, an industry directory. Now, people connect easily via LinkedIn or Twitter.
I’m entering my last year as a member of the Association’s Board, and I’ve been really impressed with what Kitt and C.A. Webb have done. I really hope one of them runs for public office, frankly.
I’ll miss working with them, but hey, we always can meet again over beer at 2 p.m., right?