Tuesday, May 21, 2019

A Brief Guide To Startup Pivots (4 Types Of Pivots)

Most of the times, startup don't work. At some point it may make sense to either (1) give up on your original product and to sell the company, (2) shut down what you are doing and return money to investors, or (3) to pivot. You can read more on making the decision to give up in a future article. This post focuses on pivoting for small, early stage companies (e.g. 10 or fewer people).

A. The Four Types Of Pivots

1. Pivot inside your existing market, without clear new signal.
The most common type of pivot is to change direction in a market you are already in, but without any new information on the market or a new customer segment. This is the most common type of pivot, and the most likely to end badly. In general founders worry too much about sunk cost and the industry knowledge they have built. So when they pivot, they pivot inside their market instead of considering new areas to work in. In general, startups tend to fail due to bad product/market fit (either the product is not differentiated or needed, or the go-to-market does not work, or both).
"When a great team meets a lousy market, market wins
When a lousy team meets a great market, market wins.
When a great team meets a great market, something special happens." 
- Andy Rachleff, founder of Benchmark Capital
By staying the same bad market, the company may be doomed despite the pivot.

2. Reposition or edit down your product. Find behavior in existing product/market and amplify or focus on that (Instagram, Twitch).
Sometimes your overall product is not being adopted, but some component of it is seeing high use or early signal of user excitement. For example, Burbn was a location check-in app with photos, and the photo portion was getting all the attention so the product was edited down into Instagram.

One could argue Instagram was not really a pivot, but really just good product editing.

Relatedly, the Justin.tv team saw early signal in gaming that led to Twitch being spun out. If your product is seeing enthusiastic adoption in a single userbase or use case, it might make sense to focus all your attention on that use case.

The hard part for most companies in this situation is whether to keep their legacy, non-performing business alive. This is done for both emotional reasons (this was your first product) as well as concerns about market interpretation or branding. There are two ways to deal with this:
A. Launch an entirely new or differently branded product or service (Twitch spinning out of Justin.tv).
B. Shut down the original product and focus entirely on the new one (Flickr, which came out of a Stewart Butterfield gaming company[1] or Instagram versus Burbn). If you are pivoting your userbase is tiny, and it will not matter if you shut down.

The downside of keeping the original product alive is the time and attention the product and its customers demand from your team. It may also create a lack of clarity and confusion about your brand and the changes you are making. If your homepage primarily reflects your old product experience your new customers may not engage as deeply. Making a clean break can come by launching a new brand or website or revamping the old one to solely reflect your new direction.

If your legacy business is providing sufficient cash flow to fund a new business it is probably worth keeping and launching a new brand. In other circumstances, you may want to shut it down, sell it, or spin it out. If you really want to give your new direction a shot, you will need to ignore or shut down your prior effort.

2b. Market pivot or product repositioning.
Sometimes it is less about your product, and more about tailoring your marketing and go to market to a different customer base from the one you started with. In many cases this will change the product you build, but sometimes it is as simple as changing your marketing collateral, website, and sales efforts to reflect a new or different customer segment. Are you selling to SMBs but should really sell to big enterprises? Are you selling to consumers but should really be selling to employers?

3. Launch a tool that you used while building your own company (Yammer, Slack).
Some of the most successful pivots (Slack out of Butterfield's second gaming company, or Yammer out of the genealogy site Geni) occurred when a company built an internal tool to run its business, and realized the tool would be valuable to other customers as well. Building something for others, that you need for yourself, is often a successful way to identify a real product or market need. In some of these cases the company is spun out in its own right (Yammer), in others the entire company reconfigures to support the new idea and product direction (Slack). In the case of the spin out, the parent company often maintains some equity portion with the remainder going to a new founding team in the new entity.

In the case of reconfiguring an entire company, the hard part of this sort of pivot is to rebuild the team to be able to build the product or sell into the new market. For example, a consumer team will need to build an enterprise sales and product team from scratch. This may lead to significant employee turnover. If you need to make this transition and do lay offs, do it quickly and be as fair as possible to your employees who supported you in the past.

4. Do something truly new (Twitter, GOAT).
The last form of pivot is the most extreme. In this case you put aside the original product entirely, and start to iterate on new ideas on what to build.

If you are doing a true bottoms-up restart, it is worth seriously considering shutting down the existing company and returning whatever is left of the money raised. Or, selling the company for a small return and starting something again later from scratch. More on this below.

B. When To Shut Down And Restart Versus Pivot
If you are considering doing an entirely new idea from scratch you may also want to restart your company. You should check alignment with your major investors, your co-founders, and your employee on who is on board for this change of direction. In some cases, your cofounders and board (or investors) will be fully supportive and you can get going on the new set of ideas. You may lose employees who no longer believe along the way, but that may be a good thing - you need a core set of true believers to weather the storm. The Grubwithus - > GOAT transition is a good example of a grounds up pivot with the investors and founders all aligned and along for the ride.

In contrast, there may be other times where it makes sense to shut down the company and restart. For example, if the co-founders of the company need to change. Or alternatively, investors no longer want to support the team and its new vision. In this case, it is better to restart the company than to fight how to allocate new equity or with investors who no longer believe.

Often in the case of a restart:
a. The company returns whatever cash is left to its existing investors and shuts down the original company.
b. A new founding team is formed. Sometimes this is the same founders as before, other times it may be a new configuration with equity given to the most important parts of the team. Employees may convert to founders, stay as employees, or decide to leave.
c. The original investors are often offered a major portion of the new company's financing round as a thank you for their original support.
d. The new company goes after its new mission and market.

The podcasting company Odeo went through this process. Ev Williams famously bought out the original investors of the company as Odeo was being shut down. One of Odeo's employees, Jack Dorsey, had come up with an idea for a new social communication product that turned into Twitter. Ev, Jack, and Biz Stone (another employee at Odeo) were considered the founders of the new effort, and the team raised money from both existing investors (some of whom passed on the new company) and new investors. The rest is history.

The benefit of a true restart is it cleans up a lot of potential issues. For example, if existing investors don't believe in the new product direction they have a way to partially cash-out out in an up-front and positive manner.  This gives the founders a clean cap table, rewards investor and employee loyalty, and also allows you to stop working with the people who do not believe anymore.

C. Things To Manage During A Pivot
Pivots are stressful times. If your first product is not working you will need to manage multiple parties to make the transition. Sometimes a pivot will blow up due to ongoing fighting between founders, or with an unruly or angry investor.

Founder conflicts.
The two biggest ways early stage companies die is by running out of money and founder conflicts. During a pivot, the optimal situation is that founders continue to work well together, and if one person is in charge she stays in charge. However, pivots tend to be stressful enough that founder agreements ("you are the final decision maker") may fall apart leading to infighting and an inability to move forward. Often if this happens one of the founders needs to leave.

Employee moral.
During a pivot some employees may rally and do whatever they can to help the company make it through a rough transition. Other employees may become fearful or anxious or lose belief in the company. While you may be able to soothe nerves, it is hard to regain belief. It might be best for all parties if non-believing employees move on to another opportunity if they are no longer pulling for the company. If needed, you may need to do a layoff to conserve cash during a pivot as well as remove unengaged team members.

Investor Unhappiness.
Some investors may get upset of unhappy during a pivot. There are a number of reasons for this. Investors may:
a. Feel misled. If a funding round just happened and the company pivots right after, investors may feel that what they were pitched on and invested is very different from the company they now own part of.

b. Worry about losing money. A junior VC partner may worry they will loose their investment and their career may suffer. An angel may worry about losing their investment (in which case they should not have invested in a startup). Non-bought in, worried people tend to become hard to work with. 

c. May wish the CEO / founders had executed better. Sometimes investors interpret a pivot as the founders being weak. This is usually driven by having a VC who has never started a company and does not understand the reality of a startup. Or the CEO may indeed be weak. Alternatively, the investor may think the new idea or direction is a bad one, and feel trapped along for the ride.

To address investor concerns you should try to bring your investors along on the new direction early in the process. If they drag their feet and are truly unhappy with the new direction, you can propose a restart of the company (see above), a buyout of investors who do not want to be involved anymore, or try to sell the company.

Customer confusion.
If the company does a poor job of shutting down old products or communicating what is happening, the company's customers may be confused about what the company is doing. This is especially bad if new customers are confused and suggests the startup has not made a strong enough break with the past (i.e. changing old website content, creating sub brands, or the like). On average, founders err too often on the side of keeping a legacy product alive in order to save face or for optionality, when in reality they should make the hard decision early to shut it down and move on.

While pivots can be challenging for early stage startups, sometimes they can lead to great outcomes for everyone involved. The key is to manage the various stakeholders (co-founders, employees, investors, customers) through the transition, let go of your legacy past, and focus on creating a bright new company and bright new future.

[1] Honestly, the biggest takeaway on pivoting is that you should back any Stewart Butterfield gaming company, with the hope it eventually pivots. See for instance Slack or Flickr.

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Startup life:

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Thursday, May 9, 2019

Markets Are 10X Bigger Than Ever

Over the last few years the number of people and businesses online has ballooned. Spend on the Internet has grown rapidly as you can now reach billions of people, and hundreds of millions of businesses, in a frictionless way. While in the late 1990s people were scared to put their credit card number into a website, today people use their phones to pay grocery stores and order Ubers. Growth of the internet has spilled over to all classes of software including enterprise SaaS and SMB segments.

This in turn has yielded much larger outcomes than anyone expected for online software companies. The large IPOs of the last year, and the ongoing growth and scaling of prior generation SaaS companies, reflects massive growth and scale of the internet and its usage.

Market caps of some SaaS companies:

Salesforce: $120B 
Workday: $44B
Atlassian: $29B
Shopify: $29B
Stripe (private): $22.5B
Zoom: $19B
Twilio: $16B
Okta: $11B
Dropbox: $10B
Slack (private): $7B (TBD as public company)
Github (acquired for $7.5B)

A similar trends has existed in consumer companies, with a recent slate reaching massive market caps:
Google - $809B
Facebook - $539B
Uber (private for one more day) - $80B
Twitter- $29B
Lyft - $15B
Pinterest - $15B

In general, software markets and businesses are 10X bigger than they were 10-15 years ago. This is due to the liquidity provided by the global internet. A company that would have been a $10-$20M subscale revenue business is now a $100M revenue company, which means many more companies can now be worth $1B or more, and many more SaaS businesses have the potential to be $10B+.

This post reviews some of the numbers showing how much larger the internet is now than it used to be, then the implications for startups and their eventual market caps, and geographic distribution.

First some background.

1. Markets Are Bigger Than Ever In The History Of Humanity.
The images below are all taken from the Internet Trends slides from 2017 and 2018.

Point 1: There are now >3.5 billion people online. This means businesses can reach more customers than ever before via a single channel (literally billions of them!).

Point 2: Almost 3 billion people have smartphones. So people are not only online, but always connected. This make communications applications and products part of day-to-day use, and has also created enterprise pull for related products (Slack, Zoom).
Point 3: WiFi is everywhere. It is now standard for people and businesses to always be connected.

Point 4: People spend so much time online, they expect to do the same for both their personal, and business applications. More people online + always online = more internet customers and bigger than ever services.

Point 5: People spend money where they spend their time. So more money has also flowed online over the last 10 years at a massive rate.

Point 6. Online services can grow at a massive rate due to the global market access of the internet. Below is an image of Zoom meeting minutes per year.

2. Since online markets are bigger than ever, more $1B to $10B software companies can exist.
A big side effect of humanity-scale adoption of the Internet is that businesses can get bigger, faster, then ever before with the internet as the catalyst. Never before have so many people been so accessible in a low cost, low friction manner. This means startups and products can be adopted faster than ever.

The old standard for a software as a services (SaaS) company to go public was $100M in annual recurring revenue, which would imply a $1 billion market cap assuming a reasonable ongoing growth rate.

a. There will be more $1B to $10B+ software companies.
In the past, many niche software companies would tap out at $20M to $50M in revenue. Since markets online are 5-10X bigger than they used be, these same companies will now scale to $100M+ in revenue and a $1B+ market cap. Companies that in the past would have been a $1B market cap company, are suddenly supporting $10B to $20B market caps per the current slate of IPOs.

This does not mean there will be more outliers worth $100 billion or more, but rather that the base revenue a random company can achieve is a few fold higher than just a few years ago due to the growth and liquidity of the Internet.

b. While tech clusters will only grow in importance, there will be more $1B+ companies outside of tech clusters.
Since "niche" software companies can now reach $100M revenue scale more easily, there will be more $1B market cap companies outside of the major tech cities (Bay Area, Bangalore, Beijing, etc.).

This will be confused in popular press and media as "you can start a tech company anywhere" (true) and "Silicon Valley is over" (false). While you can start a $1B+ company most places due to the recent mega scale of the internet, it does not negate the network effect that a tech cluster, or industry town like Silicon Valley has (more on this in a future blog post). The true outlier $10B to $100B+ companies will continue to be started in tech clusters like the (San Francisco) Bay Area, Bangalore, and Beijing (the "3 Bs of tech").

3. Startup Companies Will Grow Faster Than Ever
The growth rate of a company is really just a reflection of its market size and ability to scale its go-to-market. In other words, how many people can I reach in a repeatable fashion? Given the scale and liqudity of reaching people online, and their willingness to buy good and services via the web, companies can now grow to massive scale faster than ever. Not only will companies be bigger than ever, they can get there faster.

Slack is a good example of rapid ramp by a SaaS company. "Bottoms up" distribution, where any employee with a credit card can buy a SaaS service will also accelerate new SaaS adoption.
Note - this trend also holds for DTC product adoption acceleration (see image below).
3. There Is Still A Lot Of Room To Grow

Ecommerce as a category has grown from ~5% to 13% of retail sales since 2007. While not all commerce will move online, there is still massive tailwinds to the Internet.

The last 2 decades have seen the shift of behavior online + commerce online. The next 2 decades will see a further shift in buying behavior and expansion of the Internet as the motive source for startup expansion. In other words, startup companies will continue to grow in scale, and get there even faster. Markets are bigger and faster than ever before.

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Monday, April 1, 2019

Founder Investors & Scout Programs

A major trend of the last few years has been the rise of first time founders (or ones early in their startup career) investing their own, or scout fund money, into other startups. In the past, many founders would not become angels until they had either a prior exit under their belt (and therefore cash to invest) or the company was many years into its journey and they were far enough along to have a large salary or some secondary-stock-sale-based liquidity. Many early founders are now being given their own micro venture funds, or money from other funds to invest.

For founders starting to invest, there are a few key things to consider:

A. Being A Good Angel Investor Takes Time
Part of being a founder CEO is spending time with other entrepreneurs. Founders often exchange tips on hiring, distribution and other areas, gossip about which investors are good or bad, or provide each other with moral support or cross-coaching [1]. The nice thing about founder to founder time is it is optional. If you get really busy, you can more or less drop these activities.

If you are an angel, you are pledging time and help to the people you back. While not all angels are able to help all the founders they fund, you should generally pick up the phone if they call or reply to emails and asks.

When you have 1 or 2 or 4 companies you are involved with as an investor, it does not feel like a big load. You can manage the interactions with a limited set of investments. Once this number gets to 10 or more companies, it really starts to add up. While 1-2 companies is a hobby, >10-20 companies starts to feel like a part time or even full time job (depending on how involved you are).

Companies you back will need help with fundraising, people issues, hiring, M&A offers, and other events. Angel investing can start eating into your time in a deep way. The extra hour you should be spending on your own company to work on the strategy roadmap you keep procrastinating on will suddenly go to help a founder instead. The default path may become to pick up the phone to help a founder, which is easier to do than focusing on your own startup work.

The best way to counter this time sink and mode switching is a few fold:

1. Is now the time to start investing? What do you hope to get out of it?
Is it worth waiting on your company hitting some moment of momentum before starting to give others advice and capital? Is now the right time for you to invest your own money or that of a scout program (or raise a fund)?

In my case I took a small number of advisory roles while starting my first company (MixerLabs, acquired by Twitter) but did not do much real investing (in part for focus, and in part because I didn't have much money). I am not sure if scout programs had been more extensive then if I would have participated, it is quite possible I would have - however I am happy I had time to focus on my first company. Startups are always hard, and first time startups are extra hard. By the time of my second company I had been investing for a few years and continued to actively do so.

The positives of investing include giving back to others, broadening your network, information access (for example, what new distribution approaches are working for others), and the potential for financial return (although you should plan to lose any personal money you invest - so do not invest if you can not afford to lose the money)[2]. The cons include investing can become a big distraction, can irritate your cofounders or employees if a lot of your time goes to it (and your startup is not working), and the potential to lose money.

2. Time box investing.
If you do decide to invest, carve out the time you are going to spend on investing and stick to it. Is it every Tuesday and Thursday night? Your Saturdays? Treat it like a hobby. If you would not drop out of work mid day regularly to go do yoga teacher training or collect model trains[3], maybe you should not spend that same time on other people's startups. Your own startup should come first.

3. Set expectations up front.
Give founders you back realistic expectations - how fast can you reply to calls/text/emails? Are you only available to meet live certain nights and weekends? Or just breakfasts? You can write a guide to working with you as one approach.

4. Don't spray and pray.
The more investments you make the harder it will be to manage time. Make sure each incremental investment is better than the average of all investments you have made so far. If you are not moving the average up with each investment you are probably investing badly (or your first two investments were Stripe and Airbnb).

5. Focus on investments that will come to you, versus hunting.
If you have just left a key network (Stripe, Facebook, etc.) to start a company, you are part of a unique cohort. Lots of your friends are probably also starting companies and you know who is good. Similarly, if you work in Fintech or another market, you will know who the best companies and founders are in your market. Invest in people or products you already know, do not need to diligence as deeply, and who you planned to help or informally advise anyhow. This will be differentiated access and also will prevent investing from becoming a massive time suck.

6. If you get extra busy, stop investing.
If your startup goes through an especially intense period, you will need to put investing (and all hobbies) on hold. If you are investing your own money, it is easy to ramp things up and down. If you are in a scout program or have raised your own angel fund, make sure expectations are set that there may be long periods of time (even years) when you may go dormant. One way to avoid pressure to invest is not take a management fee, or only take fees on capital you have deployed. No matter how you do it, make sure you can pull the breaks if needed.

B. Scout Programs and Your Personal Track Record: It is not free money!
In the last 5 years, a large number of venture funds have started scout programs, in which they give a set of founders or executives money to invest on their behalf. For example, a VP engineering at a company may be given $100,000 by a venture fund to invest, with the VP and the venture fund splitting the upside. Some scout programs have gotten quite large, with one notable one including 30+ of people.

I have heard a number of people in scout programs say that they treat scout money as pure optionality - they have no personal skin in the game - so they do not diligence or really care where the money is going. One person told me "I like to learn new things, so the scout money allows me to pay to learn something - its not my money so its OK." Another told me "I am investing in my friend's company which isn't great, but its scout money so it doesn't matter".

While not all scouts think this way, some do. So it is important to consider a few things when investing other people's money:

1. You are building an investor track record. Don't ruin it early.
While you might not realize it now, if you ever want to become a professional investor (raise a fund or SPV, or join a venture firm), people will want to see your track record. If you invest badly as a scout it may be hard for you to do either of these things. Effectively you are destroying your reputation as a good picker of companies by thinking the scout money is free. Reputation is the highest value thing you own. Is it worth trading future reputation and opportunities for a $10K check in a bad company?

Similarly, other investors look to your portfolio as a quality signal of referrals you make. If you angel invest in a lot of bad companies early, VCs will be less likely to react quickly to companies you refer for series A or B. Effectively, people will view your past taste as a guide to your future referrals.

This means you should not treat scout money as free money. Rather you should view it as a way to generate returns for yourself and for the fund that is backing you. You should also view it as the track record you are laying down that create optionality for you to some day join a venture fund or start your own fund.

2. You are a fiduciary of someone else's money.
If someone gives you money to invest, the goal is to make them money. The venture capital funds themselves raise their money from large institutional endowments, family offices, and other sources. For example, the dollars you are investing may ultimately belong to a teacher's pension fund, or an anti-cancer philanthropy. Your goal should be to make these institutions money to keep them funded.

Some scout programs are nuanced in that venture funds are using scout programs to build information access and network. However, if you make people money they tend to like you more than if you don't. If you want to eventually work at a venture fund, the VC partners will look at your scout track record.

Thanks to Naval RavikantGarry Tan and Suhail Doshi for feedback on this post.

[1] In general I have found founder to founder coaching to be dramatically better than most self styled executive coaches. A few are actually good, but I would make sure to define what you plan to get out of the hiring of one.

[2] Most founders I know eventually end up with a tight circle of other founders they are quite close to and speak to each other very regularly (in some cases more or less daily or weekly). So informal founder to founder networks are quite strong and can provide the network and information access without the investment. That said, some founders have made more money from a friends startup as an advisor or investor than from their own.

[3] I do not know anyone who collects trains, so it is a hypothetical.

[4] You can also see this Twitter thread started by @suhail.

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Raising Money

Managing Investors

Wednesday, March 6, 2019

For YC Companies Raising Seed Rounds

In the weeks before demo day, a number of YC founders will reach out to me for advice on fundraising or early customer acquisition. In general, the same set of questions come up from the founders. Below are a set of links and takeaways that I hope will be of help to founders.

1. Fundraising.

Some takeaways (usually items discussed live with founders):

  • Every company is unique and edge cases may emerge for you. When in doubt talk to a trusted angel or advisor. If you are in YC, talk to your YC partner (they see a ton of parallel fundraises!) to get another view.
  • If your company does well, you will be working with your investors for the next 5-10 years. As such, you should optimize for (i) who can help your company and (ii) who you have good personal chemistry with. It is a long road.
  • Over optimizing for valuation and brand tends to be a common first time founder thing. The specific partner at a fund, or set of angels you work with is more important than a bit more dilution or a brand name firm with a partner you don't really gel with.
  • In reality, there is not that big a difference between SAFE notes and equity raises. SAFEs tend to be easier and faster and most (probably 70-80%) of seed companies do those. But an equity raise is OK too.
  • Ask your investors to commit time to help as part of their investment. Even the busiest people are more likely to carve out time to help you if you ask as part of them investing.
  • You usually do not give up a board seat for a seed round, and almost always do for a series A. If you add a board member, make sure to vet them with other founders. In particular focus on how they help, and also how they act if things go badly.

2. What to do once you have investors.
You spend all this time raising money, how should you make use of your investors?

Hope this is useful!

Thanks to Avichal Garg for a quick sanity check look at this post.

You can order the High Growth Handbook here.

Raising Money

Managing Investors