Thursday, October 28, 2010

The Benefits Of Thinking Small

In previous posts I wrote about visionary entrepreneurs, and how to constantly ask how you can 10X your business.  However, many startups fail because the founding team thinks *too big* from day one, and doesn't take the time to really define the short term, immediate value their product or business provides.

In this post, I write about the opposite of thinking big - thinking small.  I point out why thinking small may be one of the most powerful things you can do as an entrepreneur.

The Biggest Companies Today Started By "Thinking Small"
Think of the top internet services you use - I am guessing all of them started as "niche" products:
  • Facebook
    • Then: An invitation-only social network for college students during a time when MySpace, Friendster, Multiply, Orkut, etc. all existed. 
    • Now: identity management on the web.
    • Twitter
      • Then: Group SMS. 
      • Now: Primary information network on the web.
    • Zynga
      • Then: Poker app when everyone knew that RockYou/Slide style apps were the future of the FB platform. 
      • Now: Massive, highly profitable social gaming company.
    • Google
      • Then: a search engine when 10 other search engines existed and companies like Yahoo! were actively outsourcing search since it did not have a good monetization model (brand ads were the key).  However, they always wanted to "Organize all the world's information and make it universally accessible and useful".  So they thought big from day 1.
      • Now: The primary search switchboard for the internet with multiple indices (search, local/maps, books, video (YouTube), email, Android phone O/S, etc.)
      • With Google in particular, they are executing on the original "big vision" they had.  However, they had the discipline to start with one core product (web search) and expanded from there.

      Starting Small Keeps You Focused On What Is Important
      Too many entrepreneurs start with a grand premise that is impossible to execute from day one, and distracts from building a useful product.

      Imagine if Facebook had said from day 1 "we are identity management for the web".  What would have been a potential outcome of this mindset?
      • Facebook would have started as an open social network which anyone could join (vs the exclusive, school by school network everyone wanted to join.).  I am guessing no one would have joined it.
      • They would have immediately built Facebook connect.  After all, they are identity management on the web...  But no one would use it as they had no members.  This would have been a big waste of engineering time and a distraction for the company.
      • They would have hired big company VPs of Eng, HR, Product, and BD to be ready to "scale" to the massive opportunity at hand.  These people would have promptly destroyed any cultural components the company had and screwed up its roadmap.

      It Is OK To Build Something That Does Not Scale From Day 1
      A common VC question is "how does this scale?".  Ultimately, to build a large, long-term business you need to be able to take an approach and scale it.  However, it is OK to start with something that is manual and hands on.  The key is to have something that can be systematized and replicated over and over eventually.

      Examples: Yelp needed to crack the code on getting a small group of people contributing reviews in SF before they could roll out the Yelp model to new cities.  Ditto with GroupOn and local sales.  Facebook with schools.  Zynga learning game mechanics within individual games and then rolling them out across multiple games.

      If You Want To Build Something Big, You Should Have A Path To Greatness
      Now, while it is crucial to think small and to build something that does not scale, you should always keep in mind the long term path for your business or product.   This path (and the end goal the path itself leads too) may continuously change as you learn more and as circumstances dictate.  However, you should constantly be thinking how to make what you have even bigger than what it is.

      A great example of this is Facebook transitioning from schools, to .coms, to an open social network.  They needed to keep opening up to more users as they saturated their smaller markets.  This forced them to keep moving towards a bigger and bigger objective - online identity management - even if this was not the original goal of the service.

      By thinking small, they eventually were able to think very big indeed.

      Implications: Why The YC Model Works
      This post was originally inspired by a question on Quora about whether the YC model can generate big successes, despite its emphasis on "small markets" and "low risk" products.  As I point out above, thinking small if often the key to building something truly huge.

      Any other benefits or drawbacks to "thinking small"?  Let me know in the comments section.

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      Wednesday, October 20, 2010

      Breaking Apart the Startup in the Cloud - A Dramatic Shift in Company Building

      Sequoia Made 15 PC Investments Early On
      Don Valentine, legendary Sequoia  founder and investor (Apple, EA, Cisco, etc.) mentioned that when PCs came to the forefront Sequoia made 15 investments in all the other subsystems, components, and peripherals that needed to exist for the PC to be a success.  In other words, due to the new market, lots and lots of great companies were created in parallel.

      A Huge Shift - Startups Who Will Break Up a Business Into Hosted Services
      A similar shift is now happening as multiple services move to the cloud, and in parallel every major company has a set of web services they need to provide their customers.  Things that many websites do not consider core are being outsourced to a new breed of startup.  These startups take one main service that most companies don't want to build themselves, and provides it to any company that needs it.

      SaaSification of Your Startup
      This is accelerating as more and more components that businesses used to run themselves are being broken into SaaS services.  Startups can benefit from it as now not only can you use open source software to build your stack quickly, but you can also outsource many of the components needed to actually run your business, customer service (e.g. Zendesk), and even IT ops (e.g. PagerDuty) day to day.  

      You can call this the "SaaSification of the startup", and I am sure this will increasingly hit large entreprises as well.

      We are still early days for these sorts of services, and this is a very big opportunity area for entrepreneurs (as both inventors and users of this new type of software).

      Example Services:
      These services make it easier and faster for a startup to get up and running, and in parallel are potentially great businesses for an entrepreneur to found in their own right.

      Any other services you think will be especially promising?  Add them in the comments section!

      You can follow me on Twitter here.

      Monday, October 18, 2010

      Are You A Visionary Entrepreneur?

      I think of all the entrepreneurs I have been helping out over the last year or so, 3 stand out as what I would characterize as "Visionary Entrepreneurs".  These are people with a singular vision for what they want to accomplish.  They view their product or company as the vehicle by which they can fulfill a messianic mission to change the world.

      Impact of a visionary founder
      Many startups can and will succeed without a visionary founder, but the likelihood of either a very big success (or huge flameout) goes up dramatically with a visionary founder.  Visionary founders want to accomplish a big vision, so will keep doubling down on their business despite obstacles, buy out offers, and internal team issues.  Visionary founders are on a mission to change the world via their product or business, and they will do whatever it takes to accomplish that vision.

      Characteristics of a visionary entrepreneur
      • Want to change the world.  The goal of a visionary founder is not to make money, impress girls (Facebook movie notwithstanding), or to shmooze with famous people.  What they do want to do is either scratch a big itch they have, or to dramatically change the world (or both).  
        • There is a singular vision the entrepreneur is following, and they will get other people on board to focus on this singular vision.
        • This means the visionary founder won't go for an early (or late) exit.  It is not about money, it is about impact.
        • This means they may be maniacal about the product or service, and unwilling to relent in their pursuit of a vision.  This means not everyone will like them.
        • Examples: Larry and Sergei from Google always talked about wanting to index all the world's info.  Mark Zuckerberg (I am guessing potentially with influence from Sean Parker) from Facebook wanted to connect the world.
      • Willingness to take big risks.  Given their focus on a singular vision, visionary founders will take risks other people won't take in order to make their business work.  They will max out their credit cards and sleep on their friends living room floor in order to keep working on their business.  This is one reason younger people are often more likely to be visionary entrepreneurs (they have less to lose, so it is easier to risk what you don't have - see below :)
        • Example.  Fred Smith, the founder of FedEx not only put his inheritance into FedEx, but also famously took the last cash the company had and went and gambled it in Las Vegas in order to meet payroll.
      • Question the basics, an experimental attitude towards everything.  Visionary entrepreneurs often question the basics.  They ask why things are done a certain way and often try to blaze new paths not only for their product or service, but also in the fundamental ways their business run.  They will experiment with things that more experienced people will take as a standard that should not be mucked with.  This experimental attitude helps drive the creativity and innovation in the organization, although also carries the risk of distracting the organization inappropriately.
        • Examples.  Facebook making an engineer head of HR (Chris Cox) rather then hiring an HR person for this role.  Google building its own computers and networking equipment.  Richard Branson starting an airline (a notoriously bad business) with the Virgin music brand.  Fred Smith from FedEx having pilots help unload FedEx delivery planes.
      • Fast learners.  Given that they question the basics of everything, visionary entrepreneurs can often be perceived as naive or inexperienced.  In many cases they are.  But they ramp quickly and gather information from a lot of sources to drive their success.
      • Youthful.  Most visionary entrepreneurs start businesses when they are very young.  They have a vision and they go for it.  They do not talk about getting a job at Google to "learn how to build products".  They go and build a product in their college dorm.  They are also able to live on close to nothing and the relative opportunity cost of starting a company is small.  They don't have as much experience and the baggage that comes with it, so are willing to experiment aggressively.
        • Examples:  Founders of Facebook, Google, Dell, Virgin, Apple, Microsoft all dropped out of school.
      • Good storytellers and recruiters.  Visionary founders constantly are roping people in to their vision and their company.  They set a big goal people can rally around and attract great talent due to the strength of their personality and vision.  This does *not* mean they have to be the smoothest, most charming people alive.  Rather, the magnetism of their commitment and the enormity of their goal often serves as a way to get people excited enough to join up with them.  They don't talk about getting to "1 million users", they talk about reaching 5 billion.
        • Examples.  When Larry Page of Google was hiring Eric Schmidt as CEO (when Google was just 100 or so people), he told Eric he wanted to build a $100 billion company.  Eric asked "$100 billion market cap?" and Larry replied "No, $100 billion revenue".  At the time Google was still focused on enterprise search as its (in hindsight tiny) revenue source.  Steve Jobs famously recruited John Sculley from Pepsi to be CEO of Apple by asking him "Do you want to sell sugar water for the rest of your life or do you want to change the world?"
      Any other traits visionary founders have?  Any examples or anecdotes I missed?  Please leave them in the comments section.

      You can follow me on Twitter here.

      Tuesday, October 12, 2010

      Investor - Want an Equity Seed Round? Pay For The Legal Fees

      I know a number of investors who would prefer investing in an equity round over a capped convertible note for a seed round. (note, this post largely refers to seed financings)

      Reasons investors prefer equity rounds include:
      1. Protective provisions and shareholder rights.  There are a set of terms that protect the investor that are negotiated into equity rounds that frequently don't exist in notes.
      2. Taxation.  If the company sells, there is different tax treatment to this investment if the note converts into equity upon acquisition then if the investor held equity the whole time.
      3. Sets the tone for the next round.  Often, some of the terms in an equity seed round will set the terms for follow on equity rounds.  This is often good for both entrepreneur and investor if the terms are set properly up front, decreasing the potential negotiation for future rounds.
      The reasons entrepreneurs like convertible notes:
      1. Time - they are faster.  A convertible note ends up being 10 pages total between the note + purchase agreement, vs a thick stack of equity financing docs.
      2. Expense - they cost less.  (a) The entrepreneurs legal fees cost 2-3X more for an equity finaning then a convertible note, due to the increase complexity of an equity financing (and the legal time it takes to negotiate).  (b) For some reason the entrepreneur is asked to pay the legal fees for the investors in an equity financing.  Not sure if this strikes anyone else as ridiculous.  This means an equity financing can end up costing $35-$50K.  If you are raising $500K in seed, this means up to 10% of the cash raised for the business goes to pay legal fees.
      3. Terms.  See protective provisions above.
      I find the fact that the company is asked to pay for the investor's legal fees in a seed equity financing to be kind of ridiculous.  This should be treated as a cost of business on both sides, and each should pay their own legal fees.

      Thoughts?  Leave a comment in the comment section below.

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      Friday, October 8, 2010

      Your Lawyer and 3 Other People You Should *Not* Give Equity To

      The Hidden Costs of Handing Out Equity
      Giving people equity has a number of hidden costs which may include everything from having to get them to sign off on an acquisition (depending on how it is structured, you may need 100% shareholder approval) to them having a variety of shareholder rights which may allow them to become a pain in the butt.

      As an entrepreneur, I would suggest giving options/equity only to people that will be working full time at the company, and to your investors.  

      4 People To *Not* Give Equity
      Here are 4 people founders often give equity to, even though they shouldn't.
      1. Your lawyer.  Many lawyers will ask you to give them equity in exchange for deferring fees.  You should say no.  They will still defer fees.  If you really want the lawyer and they are unwilling to relent, give them the option to invest e.g. $25K in your next round of financing.  If they still say no, find another lawyer.  There are plenty of good ones out there.
      2. Your landlord.  Some co-working spaces are willing to allow you to defer rent with the deferred cash going into your financing round.  Space is cheap.  Equity is precious.  If you really need an early space to work besides your living room, ask a friend with a startup to crash there.  Or, look for a super cheap sublease on Craig's List.  Or meet at a coffee house and work from there.
      3. Contractors.  Unless the person will make or break your company, I typically advise against giving a contractor equity.  There are alternative ways to structure contracting work.  This one is less set in stone, but the basic question is - do you really want someone who spent 2 months with your company to own a piece of it?  There is a reason companies have vesting cliffs.
      4. Your accountant.  Not sure why anyone would do this.
      People You May Want To Give Equity To
      1. Your family.  It is most tax efficient to grant stock to loved ones early, or to set up a trust in their name.
      What do you think?  Let me know in the comments section.

      You can follow me on Twitter here.

      Monday, October 4, 2010

      10X Your Business

      Often when I meet with a startup I will ask them to put aside their existing product/distribution roadmap for a minute and brainstorm around a simple question -

      Question 1: "What circumstances would lead to a 10X increase in the value of your product or business?"

      Most product and distribution roadmaps are incremental.  Do x, then y, then z, each of which has a linear increase in the value of the product or company.  I think it is good to periodically get out of that way of thinking and ask what sorts of deals, adoptions, or customers would completely change the game for the company.   These things should be at least borderline realistic - i.e. if you devoted a small set of resources, the stars aligned perfectly, and luck went the right way, it might, just might, work out.  But you will never know if you can make something amazing happen if you don't think audaciously and actually devote some small subset of resources to just go for it.

      As an entrepreneur or business manager, you should periodically ask yourself, what can create a big step function in company or user value?  And then you need to figure out, how can I execute that 10X step?

      Question 2: "What can you realistically *do* to accomplish the circumstances that will 10X your company?"
      • Can you dedicate a person to fly out and camp out for the next 6 months until you close that company-making deal?
      • Can you spend all your funding on acquiring users and manufacture a network effect?
      • Can you lobby for a partnership in a company's home headquarter's newspaper or turn their users into a lobby for you on Twitter and Facebook in order to make an impossible deal possible?
      Examples of things that 10X'd Companies:
      • AOL/Apple deal in the 1980s.  In the 1980s, Steve Case was on the marketing team at Quantum Computer Services (later renamed AOL).  The QCS management sent Case to stake out Apple offices and asked him to not come back until they had an Apple deal.  It took many months of living out of a hotel room, but Case eventually sealed the deal.
      • PayPal paying $10 a user.  PayPal raised tens of millions of dollars of funding but its users base was not growing as quickly as they would have liked.  Rather then sitting on the money and waiting for something organic to happen, PayPal's leadership decided to make a bold bet - spend a large portion of the funds they raised ($10s of millions) buying users in order to bootstrap a network effect.  The company went on to go public before being acquired by eBay.
      • Microsoft/IBM deal.  Microsoft famously told IBM they had an operating system when they didn't in order to win IBM's business.  They then scrambled to find an OS they could quickly license from another software developer.  A number of lessor entrepreneurs would have said "sorry, we can't help you".  Of course, within a few years the OS franchise became the foundation of Microsoft's meteoric rise.
      • Google/Yahoo! deal.  Yahoo! outsourced search to Google and allowed Google branding on the Yahoo! homepage.  This lead to two outcomes: (a) Google had a massive spike in both traffic and data that is could use for analytics and to refine its search engine (b) The Google branding on the Yahoo! site caused non-early adopters to become aware of Google as a brand and drove significant traffic directly to the Google site.  Since Yahoo! paid Google for the service, it also partially funded Google as a business.
      • Zynga raising a crapload of cash for media buying and "overpaying" for social gaming startups.  When Zynga got started there were dozens of other social gaming startups.  Zynga changed the game for itself by realizing scale is what would cause it to win.  Zynga raised large amounts of money to buy scale - both via media buying (ads) as well as via buying lots of small startups for more then its competitors would pay (by projecting the future value of the assets, vs current value).  One of these acquisitions turned into Farmville, their core franchise.  All the other startups that could as easily have been Zynga?   99% of them are acquired for small change or are dead.
      What are other examples of companies making unexpected 10X moves?  Let me know in the comments.

      Related post you might find interesting: Is your startup a cash or equity business?

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