Thursday, January 2, 2014

Running A Business

I have recently seen two tech businesses run into the ground despite their products having thriving user bases.  I was not formally involved with either company, but got a close up look from time to time as the founders called for advice.  In both cases, the founders confused building a product with running a business.

As the CEO, you need to keep your eye on the underlying product and business fundamentals of what you are doing.  If you can not keep focused on the business side you must hire someone who will.  Otherwise there is a reasonable chance your company will die.  The two most common ways for a startup to die are founder conflicts and running out of cash.  Running out of cash is often avoidable.

Cash Management Mistakes:
1. Not raising enough money.
One founder who recently shuttered his company had a top tier investor invest $550K of what was supposed to be a $1MM round.  The product had good user growth so the founder thought a big series A would be easy and decided to wait instead of raising the rest of the money.  He hired too many people and and ran out of money when no one would fund him.  Instead, the founder should have raised the $1MM seed to its completion when he had a chance.  The easiest time to raise money is when you already have momentum on a round.  Don't wait for the perfect moment to raise.  Just get it done.

2. Overspending.
This includes hiring a team larger then your cash can support, hiring an expensive PR team, or paying early people too much salary relative to the stage of the company.  The faster you spend your funding, the less time you have to survive.

Another entrepreneur I know had 3 months of runway left and decided to do a PR blitz for $25,000 to get investor interest up for a bridge round.  This blitz evaporated 2 weeks of runway and made investors even less likely to fund the company.  The less runway you have, the less likely people are to fund you.

At 4-6 months of runway left, you should raise a round (these can take 3 months).  Your other options include laying off members of the team to extend your runway, or to increase how much you charge for your product.

At 1-2 months of runway, raising money from smaller angels becomes dramatically harder as they worry you are about to become a black hole for their money.  Only people who can write larger checks can fund you at this point, reducing your options and momentum.[3]

3. Sticking to "free" when you should be making money.
There is a Silicon Valley mantra of offering things for free to get scale, and then monetizing later.  This works for some products (e.g. social media) where locking in a network effect by focusing all resources on growth early on makes sense.  During a social site's hypergrowth, any engineer used to build monetization is wasted relative to growing the product.

However, many products have monetization built directly into them and work just as well as a free product.  Would AirBnB have grown any faster if they did not charge a transaction fee?  Would Dropbox not reached 200 million users if it did not charge for more storage[1]?

Silicon Valley is too wed to the concept of making things free to go for share.  I have worked at two companies where this early approach worked (Google[2] and Twitter) but the lesson I learned from observing other companies is that "free product going for scale" model needs to be applied thoughtfully and usually only makes sense if you have someone other then your user pay eventually (i.e. ads supported businesses).  As an aside, most companies focused on "getting big fast and then selling aggregate data" tend to fail.

4. Bad pricing.
One way to extend your runway is to price your product well.  Many founders make arbitrary pricing decisions that they can not back up with any logic.  E.g. why did you charge $4.99 / month instead of $9.99?  Double the revenue per user can be incredibly meaningful to your runway if it does not impact user adoption.

One way to make more money through pricing is to segment your users.  When VMWare first launched it had a "hobbyist" price and a "business" user price.  They did not even enforce who went into which tier, but had both tiers available for people to sign up for.  You can also discriminate pricing based on features provided in the product, amount of usage etc.

Pricing can give you enormous returns on effort.  You can just run a spreadsheet and make assumptions about how to segment your users into different pricing buckets, or how changing pricing may impact user growth and revenue.  If you only have a few months of cash left, you may want to buckle down and focus on making money even if growth stalls.  In some cases, you just need to price things properly to buy yourself runway to survive.

5. Inventory turns and cash flow.
Jeff Bezos talks a lot about free cash flow.  Even if a company is "profitable" it can constantly be squeezed for cash.  If you have a supply chain, if at all possible you need to bargain to get the float on transactions relative to the chain of suppliers->you->customers.    You can read more about this here.

Other Business Issues
Besides cash management, there are a number of business issues that can royally screw up your business.  These include: agreeing to bad financing terms (too many entrepreneurs don't try to understand what their funding round actually mean), bad partnership deals (beware of exclusivity or equity commitments), acquisitions (lots of distractions and screw ups here even if an acquisition doesn't go through), and on and on...

Ultimately, poor cash management is still the quickest way for startups to die young.  Watching your runway, and figuring out how to turn your product into a self-sustaining business, is crucial for your success as a company.

Notes
[1] Don't confuse "freemium" with free.  Dropbox has a free tier that allows users to get addicted to the product and then upsells them at a well defined conversion rate.  Similarly, Optimizely has a 30-day free trial period, but then charges for the product from that point on.

[2] Google actually tried a few ways to monetize before AdWords including selling enterprise search as well as syndicating search (without ads).  In both cases, these markets proved to be too small.  So, Google was actually trying to monetize as a much younger company then most people seem to recall in hindsight.

[3] The reason rational small investors drop out sooner is that their check doesn't buy you enough runway for you to escape shutting down the company.  E.g. say you are burning $50K a month.  A $25K investment from a small angel just covers two weeks of burn - hardly enough time to change momentum or raise more money.

Related Posts
4 Ways Startups Fail
How Funding Rounds Differ
How To Raise Series A / VC Funding
The Long Road To $5 Billion