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Operations

#CountDown: 11 Days to The New York Supply Chain Meetup #02

January 14, 2018 by Brian Laung Aoaeh

The New York #SupplyChain Meetup #01 – The Minimum Viable Launch
Photo Credit: Andrew Williams (@aswilliams73)

We’re now about two weeks from The New York Supply Chain Meetup’s second event. The purpose of this post is to outline our plans for that event, and preview what we expect to do over the course of the first six months of 2018 . . . We’re still in the early days of building this community, so much of this is subject to change,especially as we go through the process of recruiting sponsors.

Our Mission

To nurture and grow the world’s foremost multidisciplinary community of people devoted to building the supply chain networks of the future — starting in NYC.

Become a sponsor. Email me at: brian@tnyscm.com for more details about our vision, and the team that’s working behind the scenes to build this community.

Logistical Details: #TNYSCM #02

  • Date: Thursday, January 25, 2018.
  • Time: 17:30 – 20:30
  • Location: SAP America, 10 Hudson Yards, New York, NY.

This event will combine a Keynote Presentation, a Panel Discussion, and a Mini-Showcase. Our MC for this event is Lisa Morales-Hellebo (@lisahellebo), a member of our team of organizers.

Agenda

  • 17:30 – 17:55: Pre-event Networking
  • 17:55 – 18:00 Welcome Remarks
  • 18:00 – 18:40: Keynote Presentation, Q&A
  • 18:45 – 19:40: Panel Discussion, Q&A
  • 19:45 – 20:00: Mini-Showcase
  • 20:00 – 20:30: Post-event Community Announcements and Networking

Preview – Keynote: A Friendly Introduction to Decentralized Economic Systems, Blockchain and Other Distributed Ledgers, Cryptocurrencies, Networked Communities, and Supply Chains.

The keynote presentation will be delivered by Dr. Michael Zargham (@mZargham). Michael is the founder of BlockScience, a research consultancy that helps legacy business and industry learn about, understand, and interact with the emerging decentralized economic order. He holds a bachelor’s degree in Engineering Science from Dartmouth College, and a Ph.D in Electrical and Systems Engineering from the University of Pennsylvania. His research interests span decentralized optimization and control, network science, and operations research. BlockScience is an advisor to;

  • Sweetbridge, as it develops blockchain-based economic protocols to transform high-friction global supply chains into more liquid value networks.
  • ODEM.io, a blockchain platform that allows qualified and trusted members of the education industry to create customized curriculum and experiences and offer them directly to the market.
  • Fr8 Network, a set of decentralized applications designed to connect the freight trucking industry’s key stakeholders in order to reduce high costs and increase economic value.

The keynote presentation will last 30 minutes, with 10 minutes of audience Q&A to follow.

Preview – Panel Discussion: What Problems Are Big Companies Trying To Solve With Blockchain and Other Distributed Ledger Technologies?

Building on the keynote presentation, our panelists will explore the problems large supply chain management software vendors and large supply chain logistics providers are trying to solve, with blockchain and other distributed ledger technology, for themselves and for their customers.

Daniel James (@daniel_r_james), a member of The New York Supply Chain Meetup’s team of organizers, will moderate the panel which will last 45 minutes, with 10 minutes for Q&A from the audience.

Our panelists are;

  • Nataliya Stanetsky, manager, IT Application Security, L’Oreal. She is also a co-organizer of Women in Blockchain. Nataliya is passionate about blockchain technologies in various applications including supply chain management, identity management, and financial services. As co-organizer of Women in Blockchain she connects technologists and other professionals to share knowledge and experience about blockchain technology and its applications.
  • Kange Kaneene, director, business development, SAP Ariba, where she focuses on identifying merger and acquisition targets, establishing partnerships, and articulating SAP Ariba’s medium term strategy. During her tenure at SAP she has been in several strategic and operational roles including the office of the President for Global Customer Operations. Prior to SAP Kange was a supply chain consultant at Manhattan Associates. Kange holds a Bachelor of Science in Computer Science from the University of Michigan, and a Masters of Business Administration from New York University Stern School of Business. She loves international travel, cooking, dancing and spending time with friends and family.
  • Mahesh Sahasranaman, principal architect, UPS Supply Chain Solutions.
  • Rob Bailey, CEO & Co-founder, MState – a growth lab for enterprise blockchain companies. MState is backed by IBM, Comcast Ventures and Boldstart Ventures and invests in early stage blockchain companies that sell to the enterprise.
  • David Bergonzo, VP, Corporate Strategy for Blockchain/DLT, SAP.

Preview – Mini-Showcase

To wrap things up, we’ll hear from Ryan Robinson, a recent graduate of MIT who is trying to develop a cheaper, decentralized, cloud computing platform through his startup, Conduit.

The mini-showcase will last 7 – 10 minutes, with 3 – 5 minutes Q&A from the audience.

Testing – Community Announcements

People who attended the launch on November 16, 2017 say they’d like to hear from other people in the audience, so at this event we plan to test a “Community Announcements” segment before we wrap things up. This is an experiment, so . . . . We’ll see how it goes and iterate based on feedback from the audience.

Sponsor

This event is sponsored by SAP.io.

SAP.io helps innovators inside and outside of SAP build products, find customers, and change industries through;

  • The SAP.io Fund, a $35 million early stage fund that invests in startups that can leverage SAP’s data, APIs, and technologies to create value for their customers, and
  • SAP.io Foundries, in Berlin, New York, San Francisco, and Tel Aviv.

Preview – The Next 6 Months

Here is what the team of organizers is working on, between now and June.

  • February: A workshop focused on the tactics that non-sales business-to-business startup founders can use to go from zero to their first million dollars of sales.
  • March: A showcase of startups applying artificial intelligence to supply chain. Co-hosted with NYC Bots and Artificial Intelligence Meetup.
  • April: A panel discussion and showcase, focused on the issues that have kept blockchain and other distributed ledger technologies in the lab and out of the real world.
  • May: A showcase of startups in Fashion, Apparel, and Retail supply chain.
  • June: A Sourcing 101 workshop for startups building physical products.

Other Upcoming Supply Chain Events

  • TPM2018: TPM, part of IHS Markit is the world’s largest container shipping and logistics conference, 18 years old this year having attracted 2,300 in 2017 representing cargo owners, container carriers, forwarders/3PLs, railroads, ports, marine terminals, equipment lessors and various others. It is one of the three main annual regional container logistics organized by JOC including the Container Trade Europe event in Hamburg and TPM Asia in Shenzhen China. The programs are developed with editorial independence by the JOC team of veteran transportation journalists. I’m attending for the first time this year to moderate the Innovation Jam on Tuesday, March 6.
  • Maritime Global Technologies: Reverse Pitch on March 15, 2018 from 09:30 – 12:30. MGTIC is an initiative of SUNY Maritime College to build a global maritime technology innovation hub by bringing together all that the New York City metro-region has to offer entrepreneurs building software for the global shipping and maritime logistics market. I’m a member of the advisory board and have previously blogged about it here and here.
  • Transparency18: This is the flagship event series started by the founders of the Blockchain in Transport Alliance. It follows BiTA’s Spring Symposium, a members only event that occurs on May 21, 2018.

Update #01: January 15, 2018 at 13:21 EST to include Kange Kaneene’s bio, and preview of next 6 months.

Update #02: January 15, 2018 at 16:40 EST to include #TNYSCM Mission, and contact information for potential sponsors.

Update #03: January 18, 2018 at 22:50 EST to include SAP.io sponsorship of this event. Edit agenda to include welcome remarks.

Update #04: January 20, 2018 at 19:10 EST to include new panelists – Rob Bailey and David Bergonzo.

 

Filed Under: #TNYSCM, Business Models, Communities, Operations, Strategy, Supply Chain Tagged With: #TNYSCM, Blockchain, Business Models, Business Strategy, Community Building, Competitive Strategy, Cryptocurrencies, Decentralized Economic Systems, Distributed Ledger Technologies, Early Stage Startups, Logistics & Supply Chain, Logistics and Supply Chain, Meetups, The New York Supply Chain Meetup

White Paper | Towards A Supply Chain Operating System

August 26, 2017 by Brian Laung Aoaeh

Note: This article does not necessarily reflect the opinion of KEC Ventures, or of other members of the KEC Ventures team.

Supplying the world with nearly everything is an enormous and complex job: there are things to discuss. 

– Rose George (2013-08-13). Ninety Percent of Everything: Inside Shipping, the Invisible Industry That Puts Clothes on Your Back, Gas in Your Car, and Food on Your Plate (p. 142). Henry Holt and Co.. Kindle Edition.

In December 2014, I started monitoring a startup that I hoped KEC Ventures would invest in later, when they raise a round of financing. It was building and marketing compliance software for the freight trucking industry. I got to work learning about the trucking market. Ultimately, we failed to close that investment – despite our best efforts and the eagerness of our team to lead the round about a year after I first began to track their progress. I still feel let down by that founder . . . But, that’s a story for another time.

What I had learned about the trucking industry led me to ask myself; “If this is what’s happening in trucking, I wonder what the shipping industry is like?”

Some of what I have learned is chronicled here;

  1. Industry Study: Freight Trucking (#Startups)
  2. Updates – Industry Study: Freight Trucking (#Startups)
  3. Industry Study: Ocean Freight Shipping (#Startups)
  4. Updates – Industry Study: Ocean Freight Shipping (#Startups)

After I published the 4th article on that list, I got an email from a gentleman named Nahum Goldmann. I was intrigued by his email because even before I read his bio, I could tell that he knew A LOT about the topics I had been exploring – all the activities that have to be undertaken to get stuff from a supplier to the ultimate customer – supply chain.

So what exactly is supply chain? I will delve into that in another post more fully, but before then, perhaps this will help. A Supply Chain is;

A network of connected and interdependent organisations mutually and co-operatively working together to control, manage and improve the flow of materials and information from suppliers to end users.

– Martin Christopher, Logistics & Supply Chain Management: Creating Value-Adding Networks, 4th ed, Pearson Education Limited 2011, page 4.

Supply chain comprises;

  • Supply Chain Management (SCM),
  • Supply Chain Finance (SCF),
  • Supply Chain Logistics (SCL), and some people include
  • Supply Chain Execution (SCE).

The world is a supply chain.

I spoke with Nahum via skype on July 14, 2017. During the call we discussed a number of topics, among which was an observation I made in my update on the shipping industry; “One product that it appears the industry would gravitate towards is a system of record that connects all participants in the supply-chain, from end-to-end. This would be a platform into which various shipping industry data could be input, and other data can be obtained as outputs . . . Probably most input data would come from other platforms and data repositories, while output data would be fed to different counterparties based on their access rights and information requirements. It seems to me to be a problem suited for a cryptographically-secure, lightweight, multi-tenant, cloud-based ledger or database of some sort that can also provide anonymity for market participants who wish to maintain some level of secrecy from other counterparties with whom they interact through the platform. One can imagine that governments around the world, for example, would want special access rights in order to keep tabs on the movement of goods and people from one place to another.”

As luck would have it . . . I was describing an idea Nahum and other people with whom he has been collaborating have been working on.

Since then, I have helped him to distill their work into a white paper which you can read below. Also, there’s a link to Nahum’s bio.

A few days ago, on August 23 to be precise, I decided that I ought to start attending the supply chain meetup in New York City. To my utter shock, there was none. So I am fixing that. I have launched The New York Supply Chain Meetup (TNYSCM). Within 3 days, we had grown to 55 nodes. ((A member of TNYSCM is called a “node.”)) My vision is that TNYSCM will become a multidisciplinary community of practice that brings together the wide array of people and disciplines whose full participation it will take to build the global supply chain networks of the 21st century.

By Nahum’s estimates supply chain inefficiencies create a 15% – 20% drag on global GDP. The 2017 projection for global GDP is approximately $80 Trillion. This is a big problem. One of the things I will attempt to do in subsequent research is try to get gather more data on the economic and financial size of the problem.

But . . . Less I get distracted. Here’s the white paper. Also, here’s Nahum Goldmann’s bio. We want your input. My email is at the end of the whitepaper. Hopefully there will be more news to share soon.

For clarification; KEC Ventures is not yet an investor in Nahum’s startup – DLTArray. I am not a personal investor in DLTArray. My involvement is on a purely voluntary basis at this point and is based on my desire to see a large scale supply chain operating system that tightly integrates all the core components that make supply chain networks function come into existence. However, KEC Ventures is an investor in Gem, which is building an enterprise blockchain operating system, with supply chain applications.

Update #1: Sunday, August 27, 2017 at 06:38 EST.

  • Disclose investment relationships involving KEC Ventures, Gem, DLTArray.
  • Clarify my personal involvement

Filed Under: Business Models, Computer Science, Intellectual Explorations, Investment Themes, Investment Thesis, Lab Notes, Mathematics, Operations, Organizational Behavior, Startups, Technical Brief, Technology, Uncategorized, Venture Capital Tagged With: Early Stage Startups, Innovation, Logistics & Supply Chain, Technology, Venture Capital, White Paper

User Manual: The Early Stage Startups I Want To Hear About Most in 2017 and 2018

December 25, 2016 by Brian Laung Aoaeh

Source Unknown

About KEC Ventures

We are a team of early-stage investors based in New York City. We invest in information technology startups that are pursuing business models with the potential to transform the way business is done in their market. In such startups, we invest in the first institutional Seed Round. Often, but not always, we act as the lead investor. On rare occasions, we might invest earlier than this when we meet a founder pursuing a vision that we believe in. Currently, we focus on investing in startups based in the United States or Canada. Very rarely, we may invest in a startup based in Israel, but that is in the process of establishing a presence in the United States.

On our team at KEC Ventures, I have been largely focused on finding and meeting the founders that we can become most excited about. I will continue to maintain that focus over the course of 2017 and 2018.

Here are some notes for the founders of the startups I am most eager to meet.

Why I Love What I Do

My mom and dad have been running small businesses since 1981 when my mom quit her job as a teacher in Kano, Nigeria. She started a school in 1986 which they have been growing since under conditions of high uncertainty. I am intimately familiar with the pressures entrepreneurs face. I wake up every day trying to be the kind of investor my mom would have loved to have at her side.

I am most content when I am thinking about and trying to solve ill-defined problems – the types of problems other people may describe as being too difficult and not worth the trouble. I am abnormally enthusiastic about the research process that leads me to develop answers to such problems. I think of myself first and foremost as a research analyst. I embrace uncertainty. I am not afraid to be different.

Connecting With Me

If you know someone who knows me, an introduction would help. If you do not, never hesitate to communicate with me directly. I am easy to reach on the major social networking platforms. Also, I hold regular and frequent office hours at various co-working spaces in New York City. Some allow non-members to sign-up and attend.

The best time to start communicating with me is at least 6–9 months before you believe you will raise a round in which KEC Ventures might invest because I believe it is important to build trust before entering into the kind of working relationship that exists between startup founders and their early stage investors.

That also gives me sufficient time to understand the problem you are solving, so that if we invest, we are doing so with conviction. Time enables me to become a more effective advocate on the startup’s behalf when my colleagues and I have discussions about making an investment.

Communicating With Me

If we are not meeting through an introduction, I will respond quickest to founders who get straight to the point, and explain why we should meet in 250–400 words in their first email to me. Founders do not need a warm intro in order to communicate with me in order to start a dialogue.

I try my best to respond. However, depending on what else I have going on, I may not respond if I feel the startup is outside KEC Ventures’ areas of interest and that the founder could have easily found that out before emailing me. Please follow up with me once or twice if you believe I have made a mistake.

If you are not connecting with me or anyone else at KEC ventures through a warm intro, you can email me at: brian@kecventures.com. For your subject line use; Pitch: {insert name of your startup}. This way I can easily filter my inbox for these emails when I review them each week.

Characteristics I Look For in Founders, and Teams

I look for teams in which the founders have known one another for a considerable amount of time prior to launching their startup. I look for teams in which the level of trust and respect between the co-founders is high. I look for teams that will not have difficulty attracting other great people to join the startup. I look for founders who inspire confidence and loyalty from others because they are good at what they do, the kind of people I could picture myself working for.

I look for founders for whom solving the problem that their startup is solving has become their life’s mission and they plan to solve that problem with or without help from outside investors. I look for founders who have an unconventional opinion about the market opportunity they are pursuing, and can explain why their position is correct with evidence which investors can analyze independently.

At the outset I look for teams that can focus on building a simple product that their initial customers love, and who can focus on a niche within which to launch their product. I look for teams that are judicious and frugal in how they deploy the startup’s resources.

I look for founders who value teamwork, and who can become great leaders if they desire to do so. I value transparency, honesty, and openness. I value self-awareness. I like people who are determined and tenacious, who do not give up just because the going gets uncomfortable and things seem bleak.

I look for founders who have a hard time doing something simply because it is what someone else expects them to do. I look for founders who are not afraid to be different.

I like founders who marry a strong technical background with a deep understanding of  the important role marketing and sales will play in determining the success of their startup. I like founders who demonstrate a singular focus on creating value for their customers/users.

Characteristics I Look For In Markets

I look for large markets that could ultimately be served by the startup’s product, even though the initial target might be a small portion of the whole. I look for customers capable of and willing to pay for the product, and who are looking for and eager to find a solution to their problem.

I look for markets in which the pain is acute because the problem suppresses customers’ profits significantly, or because the problem makes users less happy than they could be.

If currently the addressable market is between $1B and $10B, I want to see evidence that it is growing quickly enough to support the startup’s future goals, and the competition that I assume will quickly follow if the team is successful.

In certain markets where I believe there are invisible barriers to innovation, I look for industry expertise on the founding team.

If your team is based outside one of the first- or second-tier cities for startups, it helps a lot if I can drive, take a train, or take a direct flight from NYC or Newark to come and meet you.

Characteristics I look For In Business Models

I look for products and business models that:

  • will benefit from network effects as time progresses,
  • can scale efficiently and quickly, and
  • can eventually benefit from an economic moat.

If you have the time you can read my work on economic moats here in order to understand what I will be thinking about as I conduct my independent analysis of your startup.

My Philosophy

I believe my primary responsibility as a seed stage investor is to discover founders solving problems in a manner that has the potential to positively transform industries and markets before other investors have heard of them.

We help founders focus on finding product-market fit by creating an environment in which they can focus on 4 things;

  1. Keep existing customers/users as happy as possible so that they stay and use the product more often over time,
  2. Improve product features that create and deliver additional value to existing customers/users,
  3. Hire new teammates in order to enable the team improve the product in order to deliver increasing value to existing customers/users, and finally,
  4. Attract new customers and users in order to grow the startup into a company.

I think if our founders do those 4 things well, at an increasing cadence, and with increasing efficiency and productivity, we greatly raise the odds of success of the startups in our portfolio. We strive to be good thought-partners as our founders make this journey.

The Themes I Am Focused On

Notes:

  1. My mental model of how our team functions is akin to how a soccer team functions, or how an athletic relay team functions. We take a team-first approach – it matters more that you communicate with one of us, and less on who specifically you communicate with. In turn, we will make sure that the right people on our team collaborate with a startup’s founders as we conduct our due diligence.
  2. These themes cut across different industries and sectors. That is a deliberate choice. Once you meet one of us, you’ll understand how we think about this.
  3. The technology sector evolves constantly. Accordingly, our team’s interests might ebb and flow in response. The themes I have described below should serve as a rough guide to how I think about the universe of startups in which we wish to invest.
  4. A startup raising its first institutional seed round should have raised less than $1.5M  or so prior to the round in which KEC Ventures would be investing. I personally prefer that the startup has raised $1.0M or less prior to the round in which we would invest.

I am currently interested in hearing about:

  • Marketplaces: Platforms that enable the participants in large, global markets to interact with one another in ways that reduce waste or create new, untapped opportunities.
  • Interconnectivity: Platforms that enable large numbers of different types of connected devices, machines, apps, and websites to communicate with one another seamlessly, and with the people managing or using them, within a secure environment.
  • Data & Analytics: Platforms or applications that help people or other machines to manage, analyze, interpret, make decisions, and take actions based on vast and growing troves of centralized or decentralized data.
  • Effectiveness & Happiness: Products that enable people to accomplish more at work, or to become happier outside work. Products that help large enterprises and other types of businesses and organizations to grow or function more effectively.
  • Distribution: Products that make it easier to create, manage, distribute, and consume existing and emerging forms of digital media and content.
  • Asset Management: Technologies for managing different forms of enterprise, business, or individual assets. Technologies for managing different forms of enterprise, business, or individual risk.
  • Other: New, and as-yet unknown technologies and innovations founders are building to solve problems that exist only because no one else has developed a solution.

Some, but not all, of the markets that fall within these themes include artificial intelligence – including all its existing and potential applications in different industries, software-as-a-service for enterprises – I am especially interested in products that help SMBs accomplish much more for a relatively small investment, virtual and augmented reality, distributed ledgers and other distributed computing systems, financial technology, insurance technology, educational technology and healthcare technology – where the founders discover a business model that addresses the concerns venture capitalists typically express about those markets.

Note: Starting in July 2017 I will function as the subject matter specialist on our team for investments in seed-stage startups building Internet Infrastructure, Supply Chain, and Transportation Services software.

Internet Infrastructure Software is; The software that connects computers, machines, devices, and people on the internet. Hardware is an important component of internet infrastructure, so I am willing to speak with founders who are developing a product that combines software and hardware.

Supply Chain and Transportation Software is; The software that enables networks of organizations, people, and information involved in moving products and services from one part of the world to another. This includes; Supply Chain Management, Supply Chain Logistics, and Supply Chain Finance. I have a particular interest in the application of artificial intelligence (e.g. computational stochastic optimization and learning), connected devices, and distributed ledger technologies, to the solution of problems in global supply chain networks.

Think of my focus as the union of Digital/Virtual Supply Chains and Physical Supply Chains. Virtual Supply Chains enable the movement of information within a network. Physical Supply Chains enable the movement of goods, services, and people within a network.

Things I am Not Interested In

  1. Exploding rounds: An exploding round comes with a caveat like “Seed round in ground-breaking tech startup closing in 1 week!” I do not like exploding rounds, not even exploding rounds that are being led by a name-brand VC. I need time to do my own homework.
  2. Meetings led by an advisor: I prefer my first few interactions with a startup to be with the team of co-founders, not with an advisor. It is okay for an introduction to come from an advisor, but I do not like to have advisors or mentors micro-manage my interactions with startup founders. That does not inspire confidence.
  3. Lack of control over core technologies: I try to avoid situations in which the startup has a product that has launched to the public, but the startup’s team has no primary responsibility for actually building the core product.
  4. Founders who will not share bad news: I only want to work with founders who will not hide bad news until it is too late for investors to do anything that might help the startup make a course-correction. I absolutely want to hear about difficulties, challenges, and problems. I expect the good news, but I think we have an obligation to try to fix the bad stuff before it becomes unfixable.
  5. Buzzwords: I do not believe in buzzword investing. I focus first on understanding the problem the startup has set out to solve. Only after I understand that do I concern myself with the specific technology or business model being employed to accomplish the founders’ goals.
  6. Obfuscation: “Trust me. Our algorithm is so complex and sophisticated that there’s no way you could possibly understand it.” Don’t say that. I’m willing to teach myself what I need to learn in order to understand what you do, and I need to understand the basics of how you will accomplish your vision before I can develop enough conviction to recommend an investment by our team.

My Commitment to Startup Founders

  1. I believe in Gil Dibner’s VC Code of Conduct, and will adhere to it in my interactions with founders.
  2. Given that we approach conversations with founders from the perspective of a potential lead investor, we always try to move as fast as we can to get to an answer without being sloppy about our due diligence. I wrote this guide so that founders can help us speed the due diligence process along.
  3. Other founders tell us they appreciate our team’s transparency about our due diligence process. We know founders’ time is invaluable, and we do not want to waste it if the probability that we’ll make an investment is nonexistent.

Update #1: Sunday, July 2, 2017 at 22:55 EST.

  • To reflect ongoing subject matter specialization on Internet Infrastructure and Supply Chain software.
  • To reflect institutional seed-stage focus.
  • To clarify approach to investments in Israeli startups.

Update #2: Thursday, August 17, 2017 at 08:47 EST.

  • To add Transportation.
  • To clarify that supply chain finance and supply chain management are part of our areas of interest.

Update #3: Thursday, October 26, 2017 at 09:30 EST.

  • Clarifications to themes I am focused on, and investment stage.
  • Add “Why I Love What I Do” section.

Filed Under: Deal Flow, Investment Themes, Investment Thesis, Operations, Pitching, Startups, Strategy, Venture Capital Tagged With: Dealflow, Due Diligence, Early Stage Startups, Entrepreneurship, Fundraising, Pitching, Venture Capital

#NotesOnTactics: Relationship Management Hacks For First-Time Early Stage Tech Startup Founders

July 23, 2016 by Brian Laung Aoaeh

View Over The Manhattan Bridge
View Over The Manhattan Bridge

Note: I published a post titled “Relationship Management for Your Startup” on January 13, 2014 at Tekedia.com. This post is inspired by that one, and portions of this post are exactly identical to the original. It appears the post at Tekedia is no longer online. This post updates that one, with lessons I have learned since that time and advice I share with first-time founders with whom I have the privilege of meeting as they embark on trying to build their startups.

How should an entrepreneur manage the relationship with investors who say “no” to that entrepreneur’s pitch for capital? As I have noted above, I first tried to tackle this question in a post in 2014.

Before I suggest an answer to that question, I will propose some assumptions.

  1. The interaction between the entrepreneur and the prospective investors has been one of respect, and professional courtesy. In other words, you have not been treated badly or insulted by any of the investors you have met.
  2. The investors you have met are honest people, who would tell you if there is absolutely no instance under which they would invest in your startup. They do not have to tell you why, although it would be great if they did.
  3. Irrespective of how things play out now, there is every possibility that you will speak with investors at a subsequent stage of the current project you are working on, or, Insha’Allah, you will become a serial entrepreneur who seeks funding for a new startup in the future.

If my assumptions hold true, then it does not work to your advantage to “cut-off” an investor just because that investor did not fund your startup during your current round of financing. This is especially the case if that same investor might be able to invest in your next round of financing – for example, a venture fund which makes institutional seed-stage and series A investments, but which passed on your seed-stage round of financing.

Every venture capital fund’s primary responsibility is to make money for its limited partners. Venture capitalists do not invest because they like an entrepreneur or an idea, or because they feel obligated to provide capital. No. Venture capitalists invest in entrepreneurs and startups that they believe will make them money, lots of money . . . enabling them to fulfil the obligations they have made to the LPs in their fund.

It is your responsibility as the entrepreneur to connect the dots, and to help the investor understand how they will achieve that aim by investing in your startup. That is a very difficult task. Dealing with the inevitable rejection that comes with fund-raising for an early stage startup is jarring, for anyone . . . and it is especially so for first-time founders.

Are there any hacks that a first-time startup founder can use to make the journey less fraught with frustration? I think there are. Below, I share some suggestions.

Preparation is key; It is better to be over-prepared than it is to be under-prepared.

It is easy to assume that one will be able to tell one’s story in a way that makes sense to one’s audience. That’s a fatal mistake. If fundraising is important for the startup’s survival then founders should practice the pitch . . . Fundraising is about narrative and storytelling. Founders must practice telling the story until it becomes second nature.

This involves both qualitative and quantitative aspects of the startup’s story. It is important to note that this kind of storytelling differs from others in the sense that a startup founder seeks to persuade the listening audience to take a specific action that will work to the startup’s benefit. Write a check. Become a user. Become a customer. Spread the news about the startup’s product. I do not know if there’s a recommended amount of time that one should devote to preparing for something of this sort. When founders ask me privately for help preparing for a do-or-die pitch that is a few months away in the future, I recommend 80 – 100 hours of preparation; something like 1 or 2 hours of daily preparation devoted to making sure they know the story inside-and-out and that telling it is as normal as breathing. I also recommend that they practice delivering the pitch to different types of audiences to get input on the delivery from different points of view.

When founders ask me privately for help preparing for a do-or-die pitch that is a few months away in the future, I recommend 80 – 100 hours of preparation; something like 1 or 2 hours of daily preparation devoted to making sure they know the story inside-and-out and that telling it is as normal as breathing. I also recommend that they practice delivering the pitch to different types of audiences to get input on the delivery from different points of view. Toastmasters International is a useful resource for this, but founders will need more than Toastmasters offers.

Research is key; Know who you should be talking to.

It is easy for a first-time founder to get suckered into thinking it’s imperative to speak with “every investor known to mankind” . . . Meeting lots and lots of investors can really give a founder’s ego the kind of massage that market realities aren’t willing to dish out without herculean effort from the startup. Also, an investor’s willingness to “meet for coffee to discuss your feedback on our model and your perspective on the opportunity” can seem like positive confirmation that the founder did not make a huge mistake by pursuing this goal of creating something from nothing.

Here’s the thing; That is not always true. Often an investor might just want to find out what’s happening in a given market, and coffee with a founder who has initiated the meeting is a low-cost way of getting educated by someone who’s currently and actively solving problems in that area.

Obviously, the opportunity cost of such a meeting is far higher for the startup founder than it is for the investor.

What is a founder to do? Think carefully about which investors have the highest propensity to invest in the startup; at this stage, given its current levels of traction . . . within the timeframe in which the startup must raise capital. Create a short-list and focus primarily on those investors who fit the bill. This is easier said than done since investors do not often state their investment parameters publicly.

That said, for founders in the United States there are a few tools one can use. Shai Goldman, currently a managing director at Silicon Valley Bank, has created an open-source GoogleSheet’s document that is a good starting point. Samir Kaji, currently a managing director at First Republic Bank, has also created a body of research on micro-vc that is another great starting point.

These two pieces of work complement one another quite well, and should be every first-time founder’s BFF every weekend after the decision to build a startup has been made. There are other pieces of information that a first-time founder should use. These two are especially key . . . but also most likely to be unknown to most first-time founders. I maintain an email I send the founders I encounter who evidently could benefit from having these resources at their fingertips. I will post links to those resources at Hack Your Startup: Pitch.

I spent some time explaining why this matters in The Path To Disaster: A Startup Is Not A Small Version of A Big Company – The Office Hours Remix.

It’s nothing personal, it’s just business; Manage your investor relations with email.

After every meeting with a potential investor, or quite frankly, with anyone who could be helpful to your startup in any way, I think it makes sense to ask if they would be willing to be added to a “Friends of Awesome Early Stage Technology Startup” email distribution list. The most common response will be “Yes. Please add me to your distribution list for updates.” These updates will be very general in nature and should be a stripped-down version of the email updates that investors in the startup get. No confidential information should be included in this email – only information you do not mind being in the public eye.

While the periodic updates are interesting on their own, to my mind they are not the point of this exercise. The primary purpose of this exercise is to split the universe of so-called “Friends of Awesome Early Stage Technology Startup” into three categories.

First; the people who unsubscribe from the updates. I do not know a more explicit signal that they have no interest in what the startup is doing but simply did not have the courage to tell the founder so directly. There’s no point devoting much more energy pursuing these people.

Second; the people who have not unsubscribed but have never engaged directly based on a prompt in any of the periodic updates. It is probably worth sending people in this group an email saying you are going out to raise a financing round for which they might have interest based on developments since the previous round . . . If they do not respond after two or three attempts . . . Move on.

Third; the people who have engaged with the founders after an update was sent. Perhaps the startup needed to hire an engineer and they responded with a recommendation or offered to share the job description with their network . . . They have demonstrated some interest in what you are doing. Even if they do not invest themselves, they are likely to be a positive reference to someone else for whom there’s a better fit. Focus on these folks.

These 3 suggestions are the big ones. I make other suggestions to founders I meet in person. Those are minor in comparison. For example, don’t let a friendly investor who passed on investing in a prior round for a specific reason find out about a new round in which they might still be able to invest with only a week left before your anticipated close. It’s unlikely they can conclude their due diligence that quickly.

It’s not personal Sonny. It’s strictly business.                                          – Michael Corleone, The Godfather

Financing a startup’s operations is a crucial part of every founder’s responsibilities . . . In fact, it might be the most important. If financing from external investors is part of the plan, then founders need to find ways to make it less of a hit-or-miss affair. I hope these suggestions provide some food for thought about how to do that effectively without spending an inordinate amount of time.

Source Unknown
Source Unknown

Further Reading

  1. When The VC Says “No” – a great discussion by Marc Andreessen. You must read this.
  2. Dear Dumb VC – a post by Andy Dunn, the founder of Bonobos and Red Swan Ventures.
  3. As Populist As it May Seem, 98% of VCs Aren’t Dumb – a rebuttal by Mark Suster of Upfront Ventures.
  4. How LinkedIn First Raised Money (and Endured Rejection) – a post by Lee Hower.

Filed Under: Entrepreneurship, Funding, How and Why, Innovation, Operations, Pitching, Startups, Venture Capital Tagged With: #NotesOnTactics, #Remix, Early Stage Startups, Investor meeting, Investor Relations, Persuasion, Pitching, Venture Capital

#NotesOnStrategy: Mental Models About Demand, Supply, and Markets For Early Stage Technology Startups

July 19, 2016 by Brian Laung Aoaeh

View Over The Manhattan Bridge
View Over The Manhattan Bridge

Alternate Title: An Exhaustive Introductory Guide To Demand, Supply, and Price Theory; For First-Time Tech Startup Founders.

To know that we know what we know, and that we do not know what we do not know, that is true knowledge.

– Henry David Thoreau

Introduction

I am always surprised when I am speaking with founders and come to the realization that they lack any understanding of the fundamentals of demand and supply. I do not think everyone should study economics – I avoided economics in college because I felt I could teach myself the basics outside school if I needed to. However, success as an entrepreneur is so dependent on those concepts that I expect founders to have made some effort to grasp the basics. This post is the outcome of what I have learned about economics since college, and how I apply that knowledge daily as I assess early stage startups.

Why do entrepreneurs need to understand the fundamentals of demand and supply?

How a startup’s customers/users think about a product affects how demand for that product might develop. Not understanding the fundamentals of demand puts founders at a disadvantage because it means that the way they talk about what they are doing to potential investors, potential customers/users, and the market, could be incongruent with the reality that is unfolding in front of them.

The target audience for this post is first time founders who have no prior exposure to introductory micro or macro economics. Ideally, they would be building a software-focused technology startup. Also, they should feel that a brief survey of some of the fundamental concepts of microeconomics will help them get a better grasp of the reality they are confronting as they try to raise capital or as they go about generating traction for their product/service. For these founders, this should serve as a comprehensive, but introductory survey of the relevant topics, and enkindle the desire to learn more about the topic.

Before I delve further into the discussion, an important caveat; I am not an economist. The majority of what I know about economics has been acquired through teaching myself. I am less focused on theory, and more focused on applications in the real world. Having said that I believe that practice without theory is the precise definition of bullshit. Also, this post will focus more on the qualitative aspects of the discussion . . . I think the quantitative aspects of these topics will be several levels of granularity too deep for this purpose.

I hope to raise more questions than I answer.

Motivation

Although I have been thinking about this topic for a while, the motivation to write this post did not crystallize until I read the July 14, 2016 issue of Dan Primack’s Term Sheet, a newsletter published by Fortune.

Instead of trying to paraphrase his words, I’ll let Dan speak for himself:

So far this year in the U.S. there have been over 500 children unintentionally injured or killed by a firearm. Last year, over 200 American adults were unintentionally shot by a child using a gun, with more than 80 fatalities. There also will be more than 10,000 suicides by firearm, often by teens or young adults who use a gun owned by their parents.

These are the sorts of tragedies that I know upset a lot of venture capitalists. Not only because VCs are human, but also because I see many of the social media posts whenever one of these horrors gets widespread public attention. Very often those posts include some sort of plea for gun control ― sometimes mild reform, sometimes outright repeal of the 2nd Amendment.

But here’s what I concluded yesterday, after our session on smart-gun technology during Fortune Brainstorm Tech: VCs are unintentionally complicit in this epidemic.

There currently are many entrepreneurs working on smart-gun technologies that could take a giant chunk out of teen suicide and unintentional firearm deaths. Some are working in fingerprint technologies, which would primarily be used by target shooters and the like. Some are working on RFID technologies, which would prevent a gun from being fired by anyone not carrying the proper token (such as in a watch or a bracelet or even inserted surgically just under the skin). Some are working on smart-grip technology, which can recognize the “proper” user.

The trouble, however, is that almost no venture capitalists have interest in funding these entrepreneurs. “It’s about investment,” said Margot Hirsch, president of The Smart Tech Challenges Foundation. “It’s very hard to create a real technology company on just grant funding.”

To be sure, the preferred VC metric of TAM (total available market) is not an issue here. There are going to be around 15 million firearms sold in the U.S. this year, and surveys have shown that many buyers would purchase a smart-gun, were it to be both available and reliable (to date, no smart gun has ever been commercially available in the U.S.). But smart gun entrepreneurs get a nearly-universal cold shoulder from VCs, some of whom cite regulatory risks that don’t seem to bother them when investing in Uber or Airbnb or a pharmaceutical company.

Legacy firearm manufacturers are not going to do the R&D here. Namely because they view the politics as too tricky, with many of their most loyal customers viewing smart guns as backdoor gun control (which it needn’t be). As always, real technological disruption will come from somewhere else, financed largely by venture capitalists.

Or it won’t. And more kids will die.

Before I explain why I think Dan and the founders he’s speaking about are mistaken in the way they have chosen to think about this specific issue, let’s dive headlong into Economics 101. We’ll come back to this at the end. However, Dan’s comments echo comments I have heard from numerous other founders who are struggling to understand why investors do not see “the opportunity” in the same way that the founders see it.

Economic Goods, Demand, Supply, Types of Economic Goods

What is an Economic Good? An economic good is any good or service that is scarce in supply and commands a price on the open market, satisfies a need or a desire, and provides utility to its purchaser. In the remainder of this discussion I am thinking of a specific good/service . . . not all goods/services in an economy or market. I will also typically speak in terms of an individual consumer, but the reader should interpret that as synonymous with any entity, individual person or business, which pays for a good or service.

What is Demand? Demand is the term economists use for the amount of a good that a market of buyers wishes to consume. When demand at a specific price is discussed, the term Quantity Demanded is used instead. Aggregate demand refers to the sum of demand for the good at every available price. Demand is often analyzed using a demand curve. The demand curve is usually depicted as a downward sloping line, which conforms to the law of demand; the quantity demanded of a good varies inversely as the price of the good. In other words, the quantity demanded decreases as the price of the good increases.

What is Supply? Supply is the term economists use for the amount of a good that a market of suppliers are willing to produce in order to satisfy demand for the product. At a specific price, the quantity supplied refers to the amount of the good that suppliers are willing to produce. Aggregate supply refers to the sum of supply for the good at every available price. Supply is often analyzed using a supply curve. The supply curve is usually depicted as an upward sloping line, which conforms to the law of supply; the quantity supplied of a good varies directly as the price of the good. In other words, the quantity supplied increases as the price of the good increases.

How is Price Determined? The price that the average consumer pays for a good is determined by the interaction of supply with demand. Analytically, we look for the point at which the demand curve and the supply curve intersect. That combination of price – plotted on the vertical axis, and quantity demanded – plotted on the horizontal axis, is the price at which every unit of demand is satisfied by a unit of supply.

What is Opportunity Cost? An opportunity cost is the potential loss in utility from an alternative action that a consumer might have derived, because of a decision to consume a specific good or service. Put another way, it is the potential benefit that a consumer forgoes because of an actual choice to consume one good good/service instead of another. We care about the opportunity cost of the best alternative that is available to the individual consumer because we assume that is the choice they would have made in the absence of the one they have actually settled on.

What is utility? Utility is a measure of the satisfaction or benefit that a consumer derives from consuming a good/service.

So far, so good. There’s nothing to this. Right? It all seems really straightforward.

Things get a little less straightforward when we start to categorize goods by their types. What does that mean? I will explain.

Remember my use of “. . . satisfies a need or a desire . . . ” when I was defining a good. Well that turns out to be quite important. Why that is the case will become clearer as we continue our exploration below . . .

Types of Economic Goods

  • Inferior Goods: An individual consumer demands less of an inferior good as that consumer’s income increases. In other words, they trade-up as they become wealthier.
  • Normal Goods: An individual consumer demands more of a normal good as that consumer’s income increases.
  • Luxury Goods: An individual consumer’s demand for a luxury good increases by a higher percentage than the percentage increase in the consumer’s income.
  • Complementary Goods: These are goods that yield the highest utility when they are consumed together.
  • Substitute Goods: These are goods that are normally not consumed simultaneously because they satisfy the same need or desire.
  • Veblen Goods: An increase in price induces consumers to consume more of a veblen good. Usually, this is an indication of strong brand power.
  • Public Goods: These are goods that are nonexcludable and nonrivalrous. They are nonexcludable because denying people who have not paid for the product from enjoying its benefits is prohibitively expensive. They are nonrivalrous because people who have not paid for them can consume them without any impact on the utility enjoyed by consumers who have paid for them. Public goods suffer from what economists term the free-rider problem.
  • Merit Goods: These are goods whose benefits are underestimated by consumers.
  • Demerit Goods: These are goods whose disadvantages are underestimated by consumers.
  • Free Goods: These are goods that can be consumed with no opportunity cost to the consumer.
  • Giffen Goods: An increase in price leads to an increase in the quantity demanded. Giffen goods are considered rare.

Elasticity of Demand, Substitution and Income Effects

Elasticity of Demand is a measure of the responsiveness of the quantity demanded to a change in some other variable on which quantity demanded is dependent, all other things held constant. This is equivalent to measuring the percentage change in the quantity demanded due to a one percent change in the other variable, assuming that everything else is held constant.

Price Elasticity of Demand is a measure of the responsiveness of the quantity demanded to a change in price of a good/service, all other things held constant. Equivalently, it’s a measure of the percentage change in quantity demanded due to a one percent change in the price of a good/service, all other things held constant. Generally, price elasticity of demand is negative, in conformity with the law of demand.

Income Elasticity of Demand is a measure of the responsiveness of the quantity demanded to a change in the income of the user/customer, all else held constant. Equivalently, it’s a measure of the percentage change in the quantity demanded due to a one percent change in the income of the user/customer, all else constant. Income elasticity of demand can be negative, positive, or zero.

Cross-Price Elasticity of Demand is a measure of the responsiveness of the quantity demanded of one good, X, to a change in the price of another good, Y, all other things held constant. Equivalently, it is a measure of the percentage change in quantity demanded of X due to a one percent change in the price of Y, all else equal. If X and Y are complements, this value will be negative. It is positive if X and Y are substitutes.

Comments about Elasticity of Demand: One can measure elasticity of demand in relation to changes in any variable that one chooses as long as one has the data required to perform such analysis. For example; suppose a startup is investing in paid SEO and SEM efforts, then it ought to be able to measure what may be called its “SEO/SEM Elasticity of Demand” which would be the percentage change in quantity demanded of its product/service per one percent change in its investment in SEO/SEM. Another example; A startup that is offering promotions as a means of generating traction and virality could measure a “Promotion Elasticity of Demand” which would measure the percentage change in quantity demanded of its product/service per one percent change in its investment in promotions. How this startup measures “quantity demanded” is a separate question that needs to be answered to perform the analysis. If you have a product in the market it might be a worthwhile exercise to think about what “quantity demanded” means for you specifically. Is it time spent engaging with the app? Is it number of in-app purchases? Is it something else? Is it the amount of advertising purchased by advertisers wishing to reach the audience/community that you have built?

Measuring Elasticity of Demand: The most accessible and convenient approach for most people will be to perform a regression analysis using a spreadsheet package like Microsoft Excel, or something more sophisticated. Unless the founders have enough training to do this themselves, it probably makes sense to get some help crunching the data. An extensive treatment of regression analysis is beyond the scope of what I feel is necessary right now . . . Founders can get a directionally accurate sense of what’s happening by using simple “back-of-the-envelope” calculations that require nothing more than a pencil, some paper, and perhaps a calculator.

Factors That Affect Elasticity of Demand: Quantity demanded and aggregate demand behave the way they do in response to numerous variables. The purpose of the kind of analysis I am describing is to isolate the handful of variables that affect quantity demanded disproportionately in order to reduce their impact – if it is negative, or increase their impact – if it is positive. The following factors are worth considering;

  • Do substitutes for your good or service exist? How do they compare to yours in terms of price and quality? Here the substitution effect might come into play; The substitution effect occurs when consumers shift consumption between substitute goods/services because of a price change for one good relative to its substitute, all else held equal.
  • How are you defining your good or service? If your definition is too narrow you’ll wind up with analysis that is meaningless . . . . . . This is often a concern when a startup founder says something like “No one else is doing this at all!” If your definition is too wide, you still may wind up with analysis that is meaningless.
  • What budgetary constraints do your users/customers face? This is particularly relevant if you want to measure price elasticity of demand. Here the income effect might come into play; The income effect occurs when consumers shift their consumption patterns due to a real change in income, all else held equal. Sometimes the income effect is similar to the substitution effect.
  • Is the price change permanent or temporary? If it is permanent, users/customers can seek an alternative if switching costs do not keep them locked in. If it is temporary, then they might forgo searching for a substitute, and so demand may hold steady or perhaps increase.
  • How strong is your brand? High brand affinity will cause users/customers to stay after an increase in prices. Low brand affinity will cause users/customers to leave.
  • How important is your product/service to your users/customers? I often smile when I am speaking with a founder who cannot understand why ” . . . no one else can see how important this app is . . . ” To that I often respond, your data refutes your assertion that this app is important to your users/customers. In one case the founder had stopped bothering to keep up with the daily, weekly, or even monthly numbers because they were so dismal, but was trying to convince investors that all he needed to solve the problem was a capital infusion of $500,000 or more. How potential users/customers react to a startup’s product is the ONLY VALIDATION THAT IS WORTH ANYTHING TO INVESTORS. Everything else is guesswork and hand-waving. One product might start out looking like a toy. Then users/customers extend the applications of the product, and it suddenly becomes integral to their day to day lives.  Another product starts out seeming like the most important thing in users/customers lives. Then it becomes clear that it is not robust enough to do more than one small thing among the multitude of things they want to get done using that product or one of its alternatives. All else equal, we should expect the latter product to experience more demand elasticity than the former. This is why investors usually will ask about a startup’s product roadmap as the founders think about what subsequent rounds of financing might look like.
  • Who is the startup’s customer? Who is paying? How are they paying? In the age of business models that are supported by advertising this can be a complex issue to untangle. Am I paying Facebook in units of privacy, personal data, and attention? If so, at what point do I become less willing to continue using Facebook? Am I Facebook’s customer? Should Facebook even think about that issue? Or, should it focus all its attention on the advertisers who pay it cash in order to direct advertising and marketing messages to me? Definition: A customer pays for a product/service by exchanging something of value for the right to use/own the product/service. For some consumer-facing startups every customer uses some form of the product – every customer is a user, but not every user of the product is a customer since not every user pays for the product with something that user considers valuable in conventional terms. For example; Facebook’s customers are businesses that want to sell advertisements to its 1.5 billion users. The product they are paying for is the attention of the users Facebook has amassed. The product its customers use to reach its users is a flexible advertising platform that serves large, medium, and small businesses alike.

Interpreting The Data for Own Price Elasticity of Demand

  • Absolute value of Elasticity > 1; Demand is elastic, and changes by a proportion that is greater than the percentage change in price. Demand is relatively responsive to changes in price.
  • Absolute value of Elasticity < 1; Demand is inelastic, and changes by a proportion that is less than the percentage change in price. Demand is relatively unresponsive to changes in price.

Paging Professor Clayton Christensen – The Jobs To Be Done Framework

Another way to think about your product/service is using Professor Clayton Christensen’s Jobs-To-Be-Done framework. Prof. Christensen is the management theorist responsible for popularizing the concept of disruptive innovation.

The keys to this framework are;

  • Understanding the “job” your users/customers are “hiring” your product to do for them, and
  • Understanding the alternatives your users/customers would consider hiring to do that job, and finally
  • Understanding what you need to improve in order to be the first product/service your potential customers think of when they need to hire a product/service to do that job for them.

The JTBD framework helps you understand why and how people hire your product.

For example, a founder I was chatting with once thought she was building a chat app. Yet it seemed to me that the handful of users she had used her app to organize informal groups of friends to do things. For example one use case was a group of friends who used the app to get together after work to play pickup basketball in Manhattan or Brooklyn. Another use-case was a hairdresser and makeup artist who needed to let her customers know where and when they could meet here during the weekend. As it turned out, the hairdresser was the most engaged, most active user of the app. The problem? The founder up to that point did not think of this hairdresser as her typical user, and had never spoken with the hairdresser to find out what features were important and needed improvement, and which ones could be cut.

Was she building a chat app? I don’t know . . . However, none of the use-cases that she described to me sounded like what I think of when I think of a chat app. Instead it sounded like people were using her app to organize groups to get together and do something. Chat seemed like a by-product. It did not seem like chat was the main thing. I suggested she go back and find out what it was about her app that the folks using it the most liked and why.

Wrapping Up and Connecting The Dots

Let’s think about Dan’s rant about venture capitalists’ disinterest in funding smart gun technology startups. We can flip that issue; should those founders even be pitching to venture capitalists, or would they be better off seeking alternative sources of capital?

How would you categorize smart gun technology? Is it a normal good? Is it a veblen good? Is it an inferior good? What is it?

Smart gun technology is a public good; it is non-excludable and non-rivalrous in nature . . . That places a cap on how much value the startups working on smart gun technology can extract from the market in exchange for the value that they create for that market. For an investor focused on financial returns that is a non-starter.

How public goods get financed can change based on changes in regulation, but usually such goods are brought to market with funding from sources that are not focused on financial returns.

Dan Primack’s rant was misguided. The founders he describes who are pitching venture capitalists are misguided too. Dan should know better. The founders working on smart gun technology should also know better than to be pitching venture capitalists. In this specific case, venture capitalists are not the problem. Ignorance is.

The startups I am thinking of build software-centric products/services. For such startups the supply side of the equation is a relatively simple issue to figure out. Startups building relatively complex hardware products have to worry more about the supply side of their business than their software-focused peers. Software startups have the advantage of building a product once, and being able to sell it many times over without incurring significant costs.

Understanding the basics of supply, demand, and price theory will not solve all the problems a startup founder faces. However, a firm grasp of the basics will help founders understand why consumers/customers behave in certain ways. Understanding that is priceless.

References

  • Managerial Economics And Business Strategy – Michael R. Baye, 5th Edition.
  • Price Elasticity of Demand, Wikipedia.
  • Public Goods, Library of Economics and Liberty.
  • Different Types of Goods, Economics Help.
  • Note: Price Theory and Applications by Steven Landsburg is my favorite introductory textbook on microeconomics.

Filed Under: Critical Thinking, Innovation, Management, Operations, Strategy, Technology Tagged With: Demand, Early Stage Startups, Markets, Micro Economics, Price Theory, Startups, Supply, Technology, Venture Capital

The Path To Disaster: A Startup Is Not A Small Version of A Big Company – The Office Hours Remix

November 14, 2015 by Brian Laung Aoaeh

Williamsburg Waterfront Piers
Williamsburg Waterfront Piers

Note: This is a remix of The Path To Disaster: A Startup Is Not A Small Version of A Big Company, a blog post I wrote for publication at Tekedia on August 20, 2012. This remix is based on my experience meeting early stage startup founders in NYC since then.

Each time I hold office hours in New York City, I encounter at least one individual who comes by to ask me a version of the question: “Where do I start?”

Some are first-time founders just getting started, others are in the midst of making a transition from being employed at a company to striking out to start something on their own, or with one or two other people. In every case so far I would not characterize any of the people who have asked me this question as completely clueless, in the sense that they have a network that includes many early stage investors – angels, and venture capitalists, and they know other people who are startup founders, they read numerous blogs etc.. They have asked this question of others . . . . . and yet when they encounter me at office hours they say they still feel confused.

I always promise that they will leave with a framework that they will always be able to use as a guide. This post outlines the conversation we have. ((Any errors in appropriately citing my sources are entirely mine. Let me know what you object to, and how I might fix the problem. Any data in this post is only as reliable as the sources from which I obtained it.))

I like to start with a few definitions, because that ensures that we are on the same page and thinking about things in the same way.

Definition #1: What is a Project? A Project is an undertaking by an individual or a group of individuals in order to accomplish a specific goal.

Definition #2: What is a Startup? A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model. ((I am paraphrasing Steve Blank and Bob Dorf, and the definition they provide in their book The Startup Owner’s Manual: The Step-by-Step Guide for Building a Great Company. I have modified their definition with an element from a discussion in which Paul Graham, founder of Y Combinator discusses the startups that Y Combinator supports.))

Definition #3: What is a Company? A company is a business organization that has been built for the specific purpose of scaling a repeatable, and scalable business model.

Given those definitions, let’s revisit the question I get asked by first-time founders; “Where do I start?”

Sources of Investment: Seed, Angels and VCs by Thomas Wisniewski, via SlideShare

Inflection Point 1: Idea -> Project

Initially, an individual, perhaps two or three individuals who know one another discuss an idea and feel that they may be onto something that could become big. At that point they have a project, and their goal is to determine if their idea is a big enough one to merit devoting more resources to transforming into a physical thing. This could happen while they are still in school, or perhaps while they are employed. So work on the project occurs at night, during weekends, and in whatever free time they can find. Importantly, the project is not yet a top priority. During this stage the founder or founders will be bootstrapping, spending their personal capital in order to conduct whatever research they feel they need to perform in order to make some progress.

If they eventually conclude that the idea has enough merit to become a business one day, and they would like to pursue building that business, then they begin the transition from working on a project to forming a startup. ((Sam Altman discusses the distinction between a project and a company in “Projects and Companies” which might be worth reading.))

Inflection Point 2: Project -> Startup

Once they make the choice to become a startup, it is most likely that the team will need to devote additional resources to their endeavor. For example; the team needs to start building a  product – a minimum viable product, someone has to start thinking about how to win early customers/users, and more time has to be devoted to sorting out a number of other issues like how everything that needs to get done at this stage will be paid for.

Friends & Family

If everything is going well so far, the founders might decide that they need some external capital. At this stage the easiest source of capital is the founders’ friends and family and the amount of capital raised will generally be less than $1,000,000. This round of capital should be devoted to building a minimum viable product (MVP) and confirming the hypotheses that the founders started to examine when  this undertaking was “merely” a project.

The key point here is that people in this group know the founders personally and are making an investment largely on the basis of their trust and belief in the founders. Often the investors in this category do not understand much about what the founders are building if the product involves a technological innovation. However, they likely believe “Brit is smart and hardworking. We know she will do great. We want to support her build her dream.” So while a financial return would be nice, it is not the primary motivation. Nonetheless, I advise founders to make it a habit to pitch the idea formally even to this group of potential investors because it is worth the effort to start learning to pitch other people even at that early stage.

This round will probably be a convertible debt round, with terms driven by the founders.

The minimum viable product is the smallest, least expensive product that can be built in order to test the most important hypothesis on which the startup’s business model will depend.

– Paraphrasing Teresa Torres

Angel Investors

If things go well enough, the founders decide that they need to raise even more capital, more than they can expect to raise from their immediate social circles. There are still important questions that remain to be answered. The business model has not yet been discovered. Although early customers/users have been identified there is not yet any meaningful revenue traction. It may be a few more months before the product is mature enough to generate meaningful revenues although potential customers/users are testing the product and so far the key performance indicators (KPIs) look promising. There is still substantial work to be done on product features, but there is enough for some early customers to consider paying for.

An angel round will generally be about $1,000,000 or slightly more, but generally less than $2,000,000 or so. With each angel investor typically investing an amount between $25,000 – $100,000 or so.

This round will probably be a convertible debt round, whose terms will be driven by a lead angel who will do some work on behalf of the group. If the round is raised from an organized angel investor network, then the process might unfold according to the framework within which the group operates.

Angels will generally have a much more sophisticated understanding of the product and the market than individuals who invested in the Friends & Family round.

Seed Stage Venture Capitalists

Two important differences between Angel Investors and Seed Stage Venture Capitalists is that Angel Investors typically do not invest on a full-time basis, and Angel Investors typically are making investments on their own behalf.

If things go well, it gets to a point where the team working on the startup has key members in place, the product has advanced beyond the MVP, there is meaningful customer/user traction, and revenue is early but indicative of a significant market opportunity. The team now decides that it makes sense to raise venture capital.

A seed stage venture fund will likely invest between $150,000 – $1,000,000 at a time, in financing rounds that range from $1,000,000 – $3,000,000 or so, but generally less than $5,000,000. Some funds might have requirements such as:

  1. Minimum investment size, of say $500,000.
  2. Ownership targets, of say 10%.
  3. Syndicate composition, preferring a syndicate that includes at least one or two other institutional seed-stage venture capital funds.

This round will likely be a priced round, and the venture fund leading the round will set the valuation, agree to a term sheet with the startup, and negotiate the final documents that will govern that round of financing.

Here are a few nuances about this segment of the startup and venture capital ecosystem.

  1. Founders should focus their efforts on finding and speaking with funds that have a current fund size that fits the size of the round the founders are trying to raise. What does that mean? A seed stage VC investing a $50,000,000 fund will likely set a minimum investment size of $500,000 or more as an internal rule of thumb. ((This is a general rule of thumb. Clearly, a fund like 500 Startups will have a different rule.)) I would not spend my time pursuing a meeting with this VC if I were a founder raising a $750,000 round, for example. Why? Minimum investment size and syndicate composition would likely pose stumbling blocks. On the other hand, a seed stage VC investing from a $10,000,000 fund might be worth the time and effort I put into getting a meeting because such a fund has likely set a minimum investment amount that is less than $500,000 – say, $350,000, and may also be willing to invest as part of a syndicate that is largely filled by angels. So my $750,000 round could be filled as follows: $350,000 from a lead investor (institutional VC #1), $200,000 from another VC (institutional VC #2), $100,000 from an angel investor (angel investor #1), $50,000 from another angel investor (angel investor #2) and the remainder in $25,000 increments (from angel investors #3 and #4)
  2. I do not advocate completely ignoring investment professionals at larger seed-stage funds. Let’s go back to the example of a founder raising $750,000. Assume that angel investor #4 is friends with a VC at a $120,000,000 seed stage fund and offers to make an introduction because ” . . . this is the sort of stuff they love to invest in . . . ” Then that meeting is very much worth taking because it enables the founder to start building a relationship with that VC and determine if there’s an investment and personality fit, and it enables the VC to observe the progress the startup is making over time and to get a more intimate sense of the founders’ management decision-making skills. This matters because this VC could be a potential investor in a subsequent “Institutional Seed Round” in which the startup is raising $2,500,000 for example.

Inflection Point 3: Startup -> Company

If things are going well, our startup gets to the point where it now wants to raise more than $5,000,000 because the founders believe they have:

  1. Confirmed their primary hypotheses,
  2. Understand how to win customers/users, and how to generate revenues and profits,
  3. Need more capital to pursue sales, and
  4. Hire more people.

This organization is still a startup, but it has started the slow transition from being a startup to becoming a company. This transition will depend to a large extent on how successful the startup is at creating and satisfying demand for its product. This transition will probably traverse several rounds. Generally I think of Series A, B, C and D as covering the period during which a startup is building out the internal and external structures that help it become a company. How do you know a startup has become a company. Well, it starts resembling organizations to which we are often accustomed. The existence of a full complement of c-suite executives is one good indicator.

Ultimately we get to a point where, the search and discovery stage has receded far into the past, and the structures of a company have been built. All that is then left is for the company to grow by executing and scaling the business model, and generating profits.

In Sam Altman’s article “Projects and Companies” he points out that the distinction is important mainly because of how it affects the way founders behave and think about what they are doing. The underlying feature of the transition from an idea to a company is that founders should be in a learning, experimentation, and discovery mode.

Distinctions matter. There is an important difference between a startup and a company.

In a company customers are already known, the product features that matter to these customers is already known, how much they will pay for the new product or service has already been established, and the market opportunity has already been sized and is well understood. In a company the business model is already known, and most activities are designed to execute a detailed business plan.

In contrast, a startup begins with no customers, no real understanding of the features customers need, no idea what customers will be willing to pay for the product, and no knowledge of the business model that will be most suited to creating, delivering and extracting value.

Steve Blank and Bob Dorf describe The 9 Deadly Sins of The New Product Introduction Model in their book The Startup Owner’s Manual. ((Steve Blank and Bob Dorf, The Startup Owner’s Manual Vol. 1: The Step –by-step Guide for Building a Great Company, Pub. March 2012 by K and S Ranch Publishing Division.)) These are the lessons they offer startup founders who are in the search and discover phase.

  1. Don’t assume you know what the customer wants – start with guesses and hypotheses. These become facts only after they have been validated with customers willing to pay for the product.
  2. Don’t assume you know what features to build – this follows directly from the preceding lesson, avoid building features no body cares about by first testing your assumptions about them with customers willing to pay for them.
  3. Don’t focus on a launch date – instead focus on building a product that customers want to pay to use. Focusing on a launch date can cause the team to place an emphasis on the wrong things, causing the startup to hurtle towards the launch date even if it does not yet know its customers, or how to educate them about its product. Also, this becomes a milestone by which the startup’s investors will judge the performance of their investment.
  4. Don’t emphasize execution. Rather emphasize developing and testing hypotheses, learning, and iteration – the emphasis on getting things done at a startup can lead employees to focus on execution rather than searching for answers to the guesses that the startup is operating under. Hypotheses have to be tested, and tested again. Executing on untested hypotheses is a “going-out-of-business strategy.”
  5. Don’t focus on a business plan, instead search for a business model – A business plan offers the great comfort of presumed certainty. The reality of a startup’s existence is one of acute uncertainty. That can be very unsettling. A startup’s founders, investors, employees, and board of directors must avoid the seduction that accompanies reliance on business plans, and the management tools that characterize the experience of large companies with known customers and well-established business models. Results of experimentation and validation tests should matter more than milestones.
  6. Don’t confuse traditional job titles with what a startup needs to accomplish – the traits that an individual needs in order to succeed in the environment of a startup differ significantly from those that lead to success in a large company with a known business model, a fixed business plan, known customers, and a known market. In contrast, to succeed in the startup environment an individual needs to be comfortable with chaos, flux, and “operating without a map”. The worst thing that could happen for a startup is for employees to default to behaving as they would if they were working in a large company.
  7. Do not execute a “Sales and Marketing” plan too early – sales and marketing can become too focused on executing to a seemingly great plan rather than learning the identity of a startup’s most profitable customers and gaining knowledge about what will spur those customers to engage in behavior that enables the startup generate revenues and profits. Consider a scenario in which a startup has gained hundreds of customers but only a tiny fraction of those customers actually make a purchase, and to make things worse a vast majority of completed purchases are made by a an even smaller number of repeat buyers. A focus on the “number of customers” might camouflage the startup’s dire need to determine what steps it needs to take in order to dramatically increase the number of paying customers.
  8. Don’t presume success prematurely – executing to a business plan often leads to premature scaling, even when the reality might call for the startup to hit the brakes. Expanding overhead costs before the revenue to support such costs materializes is the shortest path to disaster for a startup. Hiring, and infrastructure expansion should only happen after sales and marketing have become predictable, repeatable, and scalable processes. Moreover, startups need to be impatient for profits but patient for growth. A startup that know’s how to earn a profit can survive indefinitely. A startup that does not know how to earn a profit, but instead is focused on other measures of growth is playing a dangerous game of Russian roulette.
  9. Don’t manage by crises, that leads to a death spiral – the accumulation of all these mistakes leads to the inevitable demise of the startup that makes the mistake of operating as if it is merely a small version of a big company.

For those potential first-time founders who are grappling with the question: “Where do I start?” . . . I hope this helps.

Next? I think you should read: Paul Graham – Default Alive Or Default Dead?

 

Filed Under: Entrepreneurship, Management, Operations, Venture Capital Tagged With: Business Models, Venture Capital

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