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.

You can order High Growth Handbook here.


Startup life:

Raising Money

Managing Investors

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.

You can order the High Growth Handbook here.

Raising Money

Managing Investors