Persuasion

#NotesOnTactics: Relationship Management Hacks For First-Time Early Stage Tech Startup Founders – Connecting The Dots

July 25, 2016 by Brian Laung Aoaeh

The post in which I offered some suggestions about how a first-time founder might make the fundraising process more efficient and less frustrating raised some follow-up questions that were sent to me via email by a handful of founders who read the post over the weekend.

We went back-and-forth over email, but I think it is worth sharing a paraphrased form of those conversations, as well as those I had back in 2014 which inspired the original post to begin with.

For appropriate context, read #NotesOnTactics: Relationship Management Hacks For First-Time Early Stage Tech Startup Founders before you read the rest of this article.

Founders Ask: My knee-jerk reaction is to permanently cut off investors who pass on our seed round. I may not completely cut off investors who pass on our seed round even though they have stated publicly that they are well-aligned with our mission and vision, and invest in our market. However, I do not think I will keep them updated, and I probably will not include them in my next round.

My Answer: The key is to stay focused on the long game, and not to lose sight of how things might change. An investor who passes on your seed round, but could lead your Series A is probably worth the effort to keep updated . . . if there’s mutual interest in doing so. Keeping an investor updated does not give you an obligation to let them into your next round. Founders will always retain the option to select which investors they let into their startup’s next round. That’s a source of power and control founders will always have, if things go well. In this context, I would try to avoid cutting off my nose just to spite my face.

Founders Ask: What of my instincts? What if my instincts say I should stop dealing with this investor?

My Answer: Always listen to your instincts. Our subconscious picks up information that our conscious mind can overlook, or miss entirely for any number of reasons. I am assuming that the parties involved are each acting in good faith; so investors are not taking meetings with founders for some ulterior motive, for example. To that end, I assume that founders would have done some due diligence on an investor before they meet for the first time.

Founders Ask: This does not work for founders who are; women, or under-represented minorities, or LGBTQ . . . or frankly, all of the above. Isn’t early-stage venture investing about investing in the team/founder(s) more so than in the idea/market/traction? If an investor whose primary function is to see the value in a team/founder(s) doesn’t see the value in me, frankly, I don’t think they’re that smart/wise. Why should I want them to ever profit from my endeavors ? We have to disrupt the status quo or nothing will change!

My Answer: I understand that sentiment. I won’t debate with founders who feel that way except to say that feeling that way risks leading them to sub-optimal decisions about how they engage with investors. This is especially true in situations where founders do not have a 360-degree view of the decision-making process as it unfolded. “Shooting the messenger” might be satisfying in the short-run, but is probably strategically unadvantageous in the long-run. If I were a cynical founder I might keep investors who passed in my previous round updated if only for the potential that they could function as a stalking horse in my next round. My comments about this probably do not apply for a fund that is run by one person, or that is run by two people.

Founders Ask: I’m sick and tired of hearing about other founders getting a term sheet signed same-day/same-meeting. If the EXACT same deal; same back story, same circumstances, same company, same traction, were presented….with a team made up of white/Asian men….the outcome is almost ALWAYS different.

My Response: I believe that life is fundamentally unfair, so I personally try not to let issues like this get to me emotionally. That said, I think I understand the frustrations you are expressing. I have faced such frustrations myself at various times in the past – most notably while I was growing up in Ghana and Nigeria. I believe that it is important to separate fact from myth. In the years since our team started investing in early stage startups, I have not seen a single startup get a term sheet “same-day/same-meeting” . . . I would question how committed an investor who commits that quickly is going to be when things get tough or even how engaged they will be in general as time progresses. I also wonder if there’s more of a back-story that is often left out of the breathless reports by the tech press. Hyperbole has a way of distorting reality. I have tracked a few startups for as long as 18 months before I was ready to recommend that we make an investment. It is more common for me to track a startup for between 3 and 6 months while I try to figure things out. I can’t dispute the reports that you allude to, but I would caution that they are the exception rather than the rule. In one extreme example, Tim Westergren pitched investors 347 times before he persuaded Walden Venture Capital to say “yes” at his 348th attempt. The team went without a salary for 2 years. Fundraising is a long, and arduous undertaking . . . for anyone. People who tell any founder the opposite are doing that founder an enormous disservice. That being said, I am not trying to imply that there’s no bias in the system. I just don’t think it’s what a founder of any background should focus on the most, assuming that founder decided to go down this path independently.

Founders Ask: Your suggestion about preparation beforehand seems disjointed from the reality founders encounter . . . Isn’t each investor different? For example; the conversation I had with you vs. Nnamdi Okike vs. Ben Horowitz vs. Hunter Walk vs. Mitch Kapor . . . Sure, there were a few commonalities; maybe 30 percent? But the other 70 percent of each conversation was so unique to each individual’s priorities, each person’s disposition the day we met, the individual personalities, their placement on the autism spectrum, etc. Isn’t that hard to prepare for?

My Response: I agree. It’s hard to prepare to raise capital from external investors. Now imagine if you do not absolutely nail your answers to the 30 percent of questions that are common to all the investors you will meet. Surely, your chances of success do not improve over time if you go in without thorough preparation for those questions. I assume those questions are ones you fully expect will get asked. As such, they are questions whose answers you can rehearse beforehand. Some of the best conversations I have had with founders have occurred when the founder has kept a running list of FAQs that is updated after each meeting with an investor. Over time, the probability that the founder will encounter a completely new question from an investor reduces to a minimum while the chances that the next pitch will lead to “yes” increases to a maximum. I’m hoping that is an appealing way to think about this. A practical advantage of this approach is that it frees you up mentally to focus on doing a great job answering the 70% of questions you did not expect . . . But, again, that proportion should decrease as you keep pitching investors.

Founders Ask: But keeping investors and other people updated takes so much time and effort. Why should I bother with investors who have passed on making an investment?

My Response: Absolutely. Focus on your current investors. My suggestion to use email as a way to keep other people in the loop is meant to cut down on the effort it takes to update people who are not current investors. Send a mass email to everyone who is not an investor in your startup but who you want to keep “in the loop” about your progress, use software to track engagement. Only meet one-on-one when it makes sense to do so. I tried to convey that idea in the article. The idea is to minimize the effort that is expended on keeping anyone who is not a current investor updated.

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

July 23, 2016 by Brian Laung Aoaeh

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.

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.
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.
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.

Further Reading

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

Revisiting What I Know About Intangibles & Startups

October 26, 2015 by Brian Laung Aoaeh

My notebook and pencil. a book I was reading, and my headphones.

This is the third post in my series of blog posts on economic moats. I have already written about Network Effects and Switching Costs. The remaining three sources of an economic moat are Cost Advantages, Efficient Scale, and Intangibles. ((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.))

In writing this post I am trying to consolidate what I have learned about intangibles & startups for myself.

I also hope that it is useful for first-time seed-stage technology startup founders who are trying to build a product, achieve product-market fit, and raise financing from venture capitalists. Often such founders are trying to accomplish all that while they also try to learn strategy, management and other subjects they perhaps had not been exposed to before they decided to build a startup. My goal in that sense is to provide one example of how an early stage venture capitalist might be thinking about these issues while assessing startups for a potential investment.

To ensure we are on the same page, I’ll start with some definitions. In the rest of this discussion I am primarily focused on early stage technology startups. If you by-chance have read the preceding posts in this series, you would have seen some of these definitions already.

Definition #1: 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.))

A company is what a startup becomes once it has successfully navigated the discovery phase of its lifecycle. As an early stage investor one of my responsibilities is to assist the startups in which I am an investor to successfully make the journey from being a startup to becoming a company.

Definition #2: What is an economic moat? An economic moat is a structural barrier that protects a company from competition.

That definition of a moat is the one provided by Heather Brilliant, Elizabeth Collins, and their co-authors in Why Moats Matter: The Morningstar Approach To Stock Investing.

I take things a step further in thinking about startups and companies with business models that rely on technology and innovation. I think of a good moat as performing at least two functions; first, it provides a structural barrier that protects a company from competition. Second, it is an inbuilt feature of a company’s business model that enhances and strengthens its competitive position over time.

As a result I have arrived at the following definition of an economic moat pertaining specifically to early stage technology startups;

An economic moat is a structural feature of a startup’s business model that protects it from competition in the present but enhances its competitive position in the future.

Definition #3: What are Intangible Assets? An asset is a resource that is owned by a startup with the expectation that it will provide an economic benefit to the startup in the future. Intangible Assets are assets that are not physical in nature; intellectual property, brands, skill in research and development, regulatory environment, culture and management.

Baruch Lev explains why intangibles matter:

Intangible assets—a skilled workforce, patents and know-how, software, strong customer relationships, brands, unique organizational designs and processes, and the like—generate most of corporate growth and shareholder value. They account for well over half the market capitalization of public companies. They absorb a trillion dollars of corporate investment funds every year. In fact, these “soft” assets are what give today’s companies their hard competitive edge.

– Baruch Lev, Sharpening The Intangibles Edge, Harvard Business Review June 2004 Issue ((Baruch Lev taught me accounting while I was an MBA student at NYU Stern, his constant emphasis on intangibles increased my interest in getting better at assessing the connection between intangibles and competitive advantage from an investment analyst’s perspective.))

In the remainder of this post I will discuss each broad category of intangibles from the perspective of an early stage startup and the issues such a startup’s founders ought to be aware of.

Intellectual Property

Bottom line: All things equal, a startup with a sophisticated understanding of the role that IP plays in creating value for customers and shareholders will be more attractive to shareholders than its peers.

According to the World Intellectual Property Organization: “Intellectual property (IP) refers to creations of the mind, such as inventions; literary and artistic works; designs; and symbols, names and images used in commerce.” As far as early stage technology startups are concerned I am mostly interested in copyrights, trademarks, patents, and trade secrets.

I am not an IP attorney, so please consult an IP attorney if you read this and have specific questions about how to protect your startups IP. The goal of this discussion is not to examine the intricate legal details and nuances of IP law, but rather to offer a broad view of the IP landscape with pointers about some of the issues to which first-time founders should pay attention.

Copyrights: This is a form of protection that is granted to the original author of any piece of work that can be stored in some form of fixed media. A copyright protects the original author’s work from indiscriminate copying by other people. Among other things, copyrights protect computer software, computer programs, blog posts, advertisements, marketing materials, videos, pictures etc etc. Merely creating the work in a form of fixed media establishes the copyright. In other words, an algorithm that exists in my mind is not protected by a copyright, but my copyright comes into existence the moment I commit it to software or document it some other tangible way – for example, in a notebook. While it is not necessary to register the copyright in order for the right to exist, there is a benefit to copyright registration with the appropriate legal jurisdiction. In the United States, a copyright holder can not file a lawsuit for infringement if the copyright is not registered with the United States Copyright Office.

It is important for early stage startup founders who rely on outside vendors and other contractors to understand the “work for hire doctrine” and its implications on copyright ownership. According to the United States Copyright Office: “If a work is made for hire, an employer is considered the author even if an employee actually created the work. The employer can be a firm, an organization, or an individual” The parameters for determining who is an employee is not very straightforward in an environment within which the early stage startup; exerts little or no control over the how the work is done, exerts little or no control over the employee’s work schedule over the duration of the contract, or does not provide the employee with benefits or withhold income taxes from the employee’s pay. Due to these ambiguities, I think that early stage startup founders should make it a practice to protect some of the work done by contractors and vendors with work for hire agreements. A good work for hire agreement will state unambiguously that the work product covered by the agreement between the startup and the contractor is a work for hire to the benefit of the startup.

For an individual, copyrights extend for the life of the original author and for an additional 70 years beyond the author’s death. For a startup, the copyright extends for 120 years from the date of creation or 95 years from the date of publication.

Trademarks: According to the US Patent and Trademark Office “A trademark is a brand name. A trademark or service mark includes any word, name, symbol, device, or any combination, used or intended to be used to identify and distinguish the goods/services of one seller or provider from those of others, and to indicate the source of the goods/services.”

Establishing a trademark is an important part of how an early stage startup begins to communicate its brand with its customers or users. Trademarks can take different forms, for example a distinctive sound can be used as a trademark.

Similar to copyright protection, merely using the mark in the course of doing business establishes the trademark right for the startup that owns the mark.

According to the International Trademark Association trademarks are:

Fanciful Marks – coined (made-up) words that have no relation to the goods being described (e.g., EXXON for petroleum products).
Arbitrary Marks – existing words that contribute no meaning to the goods being described (e.g., APPLE for computers).
Suggestive Marks – words that suggest meaning or relation but that do not describe the goods themselves (e.g., COPPERTONE for suntan lotion).
Descriptive Marks – marks that describe either the goods or a characteristic of the goods. Often it is very difficult to enforce trademark rights in a descriptive mark unless the mark has acquired a secondary meaning (e.g., SHOELAND for a shoe store).
Generic Terms – words that are the accepted and recognized description of a class of goods or services (e.g., computer software, facial tissue).

A fanciful mark has the strongest trademark protection. A generic mark has the weakest protection. Over time, the protection afforded a fanciful mark can wane if that term becomes a generic term that is used to describe a category.

A startup founder seeking trademark protection should seek the advice of an IP attorney since this is a more complicated topic than copyright protection.

Patents: According to the World Intellectual Property Organization “A patent is an exclusive right granted for an invention. In other words, a patent is an exclusive right to a product or a process that generally provides a new way of doing something, or offers a new technical solution to a problem. To get a patent, technical information about the invention must be disclosed to the public in a patent application. The patent owner may give permission to, or license, other parties to use the invention on mutually agreed terms. The owner may also sell the right to the invention to someone else, who will then become the new owner of the patent. Once a patent expires, the protection ends, and an invention enters the public domain; that is, anyone can commercially exploit the invention without infringing the patent. A patent owner has the right to decide who may – or may not – use the patented invention for the period in which the invention is protected. In other words, patent protection means that the invention cannot be commercially made, used, distributed, imported, or sold by others without the patent owner’s consent.”

A utility patent is used to protect the functional features of an invention. Most of the patent applications made to the US Patent and Trademark Office are for utility patents. A design patent is used to protect the appearance of an invention. Utility patents generally provide broader protection than design patents, also it is easier to avoid infringing on a design patent. Utility patents are more expensive to obtain and take longer to obtain.

To receive patent protection an invention must be:

Patentable,
New, or novel,
Useful,
Non-obvious, and
Adequately described.

Additionally, software and business process patent applications will likely be subjected to a “machine or transformation test.” The machine test means that software or business processes can not be patented unless they are combined with a machine of some sort – a computer. The transformation test means that software or business processes cannot be patented unless they transform one thing into another, different thing, or into a different state.

An invention is “adequately described” in a patent application if “someone of ordinary skill in the arts” can replicate the invention using nothing but prior background in that technical field along with the inventor’s description in the patent application.

An invention is non-obvious if someone of ordinary skill in the arts would not necessarily have reached the deductions made by the inventor on the basis of prior art in that technical field.

A theory will not receive patent protection, in and of itself it is not useful in a practical application.

There are two main patent award systems; first to invent, or first to file. In first to invent jurisdictions, the first person or group of people to conceive of an invention will be awarded patent protection if they go through the application process successfully and can demonstrate that they indeed conceived of the invention first. In a first to file jurisdiction the first person or group of people to file an application for patent protection will be awarded the patent irrespective of when they conceived of the invention relative to other inventors pursuing the same invention. The United States is a first to invent jurisdiction.

In the US, the clock starts ticking when an inventor first discloses the invention to the public – such disclosure could happen during a presentation to investors, a sales pitch to potential customers, or a presentation at an industry conference. Once public disclosure of the invention has occurred, the inventor has one year within which to file a patent application. If a year elapses without the inventor filing for patent application, that inventor then forfeits patent protection for that embodiment of the invention.

To avoid this, a provisional patent application can be filed with the USPTO to preserve a filing date. A final, or utility application has to be filed within 12 months of the provisional application. The utility application is what the USPTO examines in order to determine the merit of the inventors appeal for patent protection.

Outside the United States, inventors do not have the benefit of a grace period. As a result any international patent applications must be made as soon as possible, in order to preclude public disclosure by the inventor.

Public disclosure causes the invention to become part of the “prior art” in the field of the invention.

In 2009 I worked on an intellectual property audit with the management team at David Burke Group, that process culminated in the issuance of a patent, US 20100310736 A1 which describes a process for aging meat. The dry-aged steaks served at DBG restaurants are prepared using this process. That was my first experience securing intellectual property rights on behalf of a company.

In 2011 our team at KEC Holdings ((KEC Holdings is the parent company of KEC Ventures.)) invented a family of financial derivatives. I assumed responsibility for (1) ensuring that our valuation methodology was justifiable on the basis of widely accepted financial and economic principles, and (2) working with an IP attorney to attempt to obtain patent protection for the idea. Our electronic documentation of the idea came to 50+ pages of background, mathematical derivations and proofs, problems and worked solutions to demonstrate how the invention might be used in practice, valuation tables etc etc.

In 2012, I worked with a team of founders in Ghana who wanted to seek a patent for their idea. I was a volunteer mentor/advisor to the team. They worked with a patent agent in India. The working relationship was ineffective for reasons that were entirely preventable if the team had embraced some simple suggestions about how to work with a patent agent/attorney working on their behalf.

What have I learned about how to work with a patent attorney or patent agent?

Generally, a patent attorney or patent agent is unlikely to be an expert in the technical field of an invention even if they specialize in the legalities of obtaining a patent in that field; a software patent attorney is unlikely to understand the nuances of a software product as well as a software engineer. For that reason, it is the inventor’s responsibility to transfer as much background knowledge as possible about the technical field of the invention and specific nuances of the invention itself to the patent agent/attorney. First, this will help the attorney perform a more complete and comprehensive patentability search. Second. it will ensure that the patent application is drafted correctly from the outset. That has the benefit of minimizing rework. Third, it will also help the attorney answer questions and respond to objections during the period when the patent is being examined by patent examiners.

Here are some additional suggestions:

Maintain “excruciatingly detailed” notes about the invention. You should describe the invention such that someone of considerably less expertise than you can understand the description. Also, keep pictures, drawings, figures, and any data that you create as you go through the invention process. It is a good idea to maintain a “lab-book” with numbered pages, dates, and handwritten notes about how you have tested your invention using theory, as well as the steps you have taken to test the output of what you have created. These can be supplemented by electronic notes created with MS Word, and also saved as PDF files as well as spreadsheets you have developed to test the idea further.
Describe of prior attempts to do what your invention does, and keep notes about why those prior attempts did not work.
Keep notes about the alternatives to your invention, and descriptions about how your invention is unique. You should describe the advantages of your invention over the prior art and alternative approaches.
Keep records about any discussions you have had about the invention with people outside of the immediate team working on your startup’s product.

Assuming it makes sense, you should discuss the possibility of obtaining international patent protection with your IP attorney. In certain instances it is possible to speed up a patent application in the founders’ home jurisdiction by first obtaining a patent abroad using the Patent Cooperation Treaty (PCT) between different jurisdictions. You should ask your attorney about this, and come up with a strategy that works given your specific circumstances.

Here’s one illustrative example:

A startup founder in the United States must decide how to protect her idea with a patent. If she files in the US it will likely take 5 years or more before the patent is granted. If she files in the UK the wait is much shorter, 2 years or less before she may expect to be granted the UK patent. What should she do? She would like to obtain patent protection in the US and the UK since she believes these are her startup’s two most important markets. She should ask her patent attorney about using the PCT and Fast Track Examination under the Patent Prosecution Highway (PPH) to speed up the process.

What is the PPH? According to the USPTO: “The Patent Prosecution Highway (PPH) speeds up the examination process for corresponding applications filed in participating intellectual property offices. Under PPH, participating patent offices have agreed that when an applicant receives a final ruling from a first patent office that at least one claim is allowed, the applicant may request fast track examination of corresponding claim(s) in a corresponding patent application that is pending in a second patent office. PPH leverages fast-track examination procedures already in place among participating patent offices to allow applicants to reach final disposition of a patent application more quickly and efficiently than standard examination processing.”

In the scenario I painted above, our founder should apply for the UK patent and then use that as the basis for requesting fast track examination of her US patent application at the appropriate time. In which case she might obtain her UK patent as well as her US patent within 24 months of filing her patent application in the UK; 18 months to get her patent granted in the UK and 6 months under PPH to get her patent granted in the US. Remember, I am not a patent attorney. Discuss this with you lawyer.

Trade Secrets: A trade secret is any confidential and non-public information that confers a competitive advantage on the owner of that information because of it is not known to the public, and especially because it is not known to competitors in that market. The owner of the information must make demonstrable effort to keep the information secret.

Trade secrecy can be lost by legitimate means, such as reverse-engineering by a competitor. Also, trade secret protection lasts for as long as the information remains confidential and undisclosed to the public. Any kind of information can be designated as a trade secret by its owner.

The key to maintaining trade secrecy is the creation of internal practices and procedures that are designed to protect the information designated as “trade secrets” from being divulged to the public.

The mystique behind the formula for Coca Cola is one famous example of a trade secret.

Trade secrets have the following advantages, among others:

It is cheaper to obtain IP protection through trade secrecy than by going through the process of obtaining a patent.
A trade secret can cover subject matter that would not qualify for patent protection, for example; mathematical formulae, algorithms etc.
Protection of IP through trade secrecy comes into effect almost instantaneously, and that protection can last indefinitely if appropriate processes, procedures and practices are put in place.

Trade secrets have the following disadvantages, among others:

As previously stated, trade secrets can be reverse engineered by others.
Information protected by one party (A) could legitimately be “independently invented” by another party (B) which then proceeds to seek and obtain patent protection for the invention. In that case A would be in violation of B’s rights as the patent holder. I do not understand how this works in “first-to-invent” jurisdictions, so it is worth speaking with an attorney if a choice has to be made between trade secrecy and patent protection.
Once trade secrecy is lost, it is lost forever.
Trade secrecy provides a significantly lower degree of protection than protection obtained from holding a patent.

https://www.youtube.com/watch?t=216&v=AQpaKJjEQR8

Brand

Bottom line: To build a strong brand early stage startup founders must start by building a product that wins wide and sustained adoption by the market because the startup has intimate knowledge of its customers/users.

A startup’s brand develops primarily as its users and customers build an accumulation of experiences with its product or service over time. Ideally, these accumulated experiences should lead to customers and users having a positive affinity towards the product or service. The positive feelings that users or customers feel towards the startup and its product should be amplified through public relations, media and press commentary about the startup, community outreach, marketing, and advertising. Trademarks, copyrights, design, and iconography should all reinforce the positive emotions that the startup is accumulating within its users/customers towards itself. Lastly, knowledge that a startup has developed “trade secrets” which contribute to the pleasant experiences customers/users have each time they use the product/service can serve as a powerful source of implicit brand affinity and loyalty.

Austin McGhie puts things succinctly in his book Brand is A Four Letter Word when he defines a brand as:

“A brand is emotional shorthand for a wealth of accumulated or assumed information.” or
“A brand is present when the value of what a product, service, or personality means to its audience is greater than the value of what it does for that audience.”

According to Heather Brilliant, Elizabeth Collins, and their co-authors in Why Moats Matter: “A brand creates an economic moat around a company’s profits if it increases the customer’s willingness to pay or increases customer captivity. A moatworthy brand manifests itself as pricing power or repeat business that translates into sustainable economic profits.”

Austin McGhie emphasizes throughout his book that a company’s brand embodies the market’s response to:

The company’s product,
The customer/user’s experience when they use the product, and
The company’s marketing strategy, which should lead to a differentiated and valuable positioning of the company and its products relative to its competitors.

Early stage technology startup founders commonly treat marketing as an afterthought. That is a mistake. The excuse I have encountered when we discuss this topic is that there is insufficient capital for the startup to devote to marketing. The problem with that line of thinking is that it exposes a lack of imagination; marketing is not a one-size-fits-all proposition, nor does it always have to be expensive in order to be effective. Moreover, a startup’s founders are its most effective marketers in the very early days of its existence.

What should marketing look like during those early days when capital is scarce and the startup appears to lurch from one near-death experience to another? It should be a simple, uncomplicated strategy to:

Communicate to customers;

What – What problem does the startup’s product solve for them?
How – How is this better than the current alternative?
Why – Why should they accept the risk that comes with trying a product from an early-stage startup? Why will they gain more than they stand to lose?

One complexity that early stage technology startup founders must contend with is that marketing in technology is multifaceted in the sense that there are numerous constituencies engaging with the startup’s marketing at any given time. Prospective customers want to know if they should switch to the new product/service. Investors want to know if they should make an investment. Potential distribution partners want to determine if there is a benefit for them in forming a partnership. Employees want to get a sense of how much job-security they can expect. Technology press and bloggers want to be first to scoop the next big thing. Regulators want to make sure that consumers are protected. Oh, and don’t forget competitors too. They’ll be paying rapt attention.

Research and Development

Bottom line: Research and development should purposely seek to strengthen the startup’s ability to win and retain customers, and increase profitability.

To understand why an early stage startup founder’s attitude towards research and development (R&D) matters, we first need to understand what it is.

Paraphrasing Investopedia, R&D is:

The set of systematic, investigative, and exploratory activities that a business chooses to conduct with the intention of making a discovery that can either lead to the development of new products or procedures, or that can lead to an improvement of existing products or procedures, and in the process create better ways of solving customers’ problems, creating new profit opportunities for the business.

Notice the key elements of R&D:

It is systematic, investigative, and exploratory – it seeks to expand the boundaries of organizational knowhow and organizational capacity.
It seeks to solve customers’ problems in a better way than the status quo.
It seeks to create new opportunities for the startup to make profits.

For those reasons, R&D is one important means by which any organization that operates in a competitive market can create an enduring competitive advantage for itself.

There is only one valid definition of business purpose: to create a customer.

– Peter Drucker

If you agree with that definition, then it follows that activities that make a startup more likely to create and hold onto new customers must be pursued. Those activities are what we call R&D.

Research demonstrates the important role that R&D can play in investment returns:

In this paper, we examined the future excess returns of R&D intensive firms. Firms with R&D intensity measure greater than (lesser than or equal to) that of the industry are classified as Leaders (Followers). We show that Leaders have sustained future profitability. However, the future risk-adjusted excess returns are higher for Leaders than Followers, suggesting that the stock price does not incorporate the R&D relevant information in a timely fashion. We then directly examine the difference across Leaders and Followers of two risk measures: stock return volatility and future earnings variability. We find that Leaders have lower stock return volatility and earnings variability, ceteris paribus. We then examine whether the financial analysts’ help mitigate the apparent lack of information with respect to R&D, and find that even though the longterm earnings growth estimates for Leaders is high, they revise these estimates downwards perhaps as a reaction to short-term earnings. Overall, it appears that the stock market does not incorporate the Leaders’ potential for sustained future profits as argued in the strategy and economics literatures.

– Baruch Lev, Suresh Radhakrishnan, and Mustafa Ciftci. The Stock Market Valuation of R&D Leaders ((Lev, Baruch and Radhakrishnan , Suresh and Ciftci, Mustafa, The Stock Market Valuation of R&D Leaders (March 2006). NYU Working Paper No. BARUCH LEV-15. Available at SSRN:http://ssrn.com/abstract=1280696))

So what does this mean for early stage investors? All else equal, invest in startup founders who show indications of being capable of building organizations that will become R&D leaders in the markets in which they have to compete.

How might one go about assessing this? How often in the past have the founders’ started with the same information as everyone one else, but examined it in a way that led to unexpected results that proved to be correct and so enabled them to exploit an opportunity others ignored or did not know existed?

Culture and Management

Bottom line: The early stage startup founders who excite me the most have convinced me that they know how to build an organization that will become exceedingly more valuable than the sum of its parts. They must inspire excellence from their co-founders, from other early team members they recruit to join the startup, and they must inspire devotion from their early customers.

Does the startup’s culture, and the assumptions that its founders make about the core assets it should acquire and how it should be structured as an organization lead to an overwhelmingly positive reaction from the market and from its customers?

One aspect of seed stage investing that I feel is not sufficiently discussed explicitly is how much of a bet seed-stage investors are taking on the founders’ decision-making skill as managers of entrepreneurial risk, and the assumptions that drive those decisions.

What are the kinds of decisions seed-stage investors are betting founders will make, and make correctly on a consistent enough basis to yield a return on the investors’ capital?

Below, I paraphrase some definitions of an entrepreneur to help highlight this idea.

Jean-Baptiste Say: An entrepreneur shifts resources out of an area of lower productivity and into another area of higher productivity and return. (1800)

Frank H. Knight: An entrepreneur is someone who confronts a business challenge and is confident enough to risk financial loss in order to overcome that challenge. (1921)

Joseph Schumpeter: An entrepreneur is someone who exploits market opportunities through technical and organizational innovation. (1965)

Peter Drucker: An entrepreneur is someone who always searches for change, responds to it and exploits it as a business opportunity. (1970)

Robert Hisrich: An entrepreneur is someone who takes the initiative to organize social and economic factors of production in order to create something unique that is of value to society, and accepts financial and social risk in the process. (1990)

In some cases, including the entrepreneurial context, uncertainty includes not only uncertainty about others’ actions, but also uncertainty regarding the courage and willingness of others to act.

– Ross B. Emmet, Frank H. Knight on the “Entrepreneur Function” in Modern Enterprise (PDF)

What are some of the decision-making pitfalls that can cause the failure of an otherwise promising seed-stage startup? I’ll list some examples I have encountered since 2010.

Insufficient focus on the customer, too much focus on the technological innovation.
Sub-par outcomes regarding recruiting great people, and empowering them to bring the founders’ vision into reality.
Inability to think creatively about new organizational designs and structures that will yield better insights about shifts in the expectations of existing customers, the potential pockets of potential new customers, and opportunities that might be going unrecognized by competitors.
Incongruities between what the startup needs to accomplish in order to satisfy its customers and achieve product-market fit, and the choices that the founders make. For example, relocating the startup and its team to a geographic region that makes it difficult to reach its most promising potential early customers and makes it difficult to recruit the people it needs.

There are many others.

One problem seed-stage investors face in trying to sort founders who go on to build successful companies from founders who fail to get past the startup phase is that it is very hard to differentiate between skill and luck at that stage because the financial ratios and metrics that one could use to make that determination do not yet exist. Managerial decision making skill only reveals itself over time.

So what is a seed-stage investor to do? Study the founders’ past accomplishments and try to determine which aspects of that track record result from decision-making skill. Isolate them from the other aspects of the founders’ past accomplishments that could be attributed to luck. Weigh those two things during the assessment of what that means for the startup. I try to provide sufficient time to observe founders’ decision-making skills and abilities before I have to make a final decision – individual skill matters just as much as collective skill. As a result I am interested in the role that each co-founder plays in the final outcome. For example, did the CTO fail to prevent the team from making an incorrect choice of the technology on which to build the product? If so, does the CTO take personal responsibility for that failing, or does the CTO attempt to pass blame and make excuses?

Culture is the way in which a group of people solves problems.

– Geert Hofstede

It is also important to remember that the culture of a startup is determined predominantly by the attitude, behavior, and personality of the founders. In trying to understand the kind of culture that will develop as an early stage startup evolves I am interested in trying to understand if the following things are true.

The founders are self-aware, and understand how their behavior affects the startup through the response it elicits from members of their team, from their early customers/users, and from their early investors. Example: They hire strong performers who have complementary skills, and they empower those people to excel.
The way the founders talk about themselves and the organization they are building is distinctive, it illuminates the founders’ beliefs about the world, and about the reality they will create as a result of those beliefs. Example: No one could confuse this startup with another startup because the distinction between the two is unambiguous.
The founders understand what they need to do to build a winning team. They also know why they need to do those things if they want their team to succeed. Example: They communicate clearly. They hold themselves accountable. They are adept at reducing harmful internal conflict. They promote and moderate the types of internal debate and disagreements that will help their team make better decisions. They motivate people to work hard, and in exchange offer fair reward and recognition for the hard work it takes to build the startup. They encourage experimentation, and learning from failure. They are great teachers, and great students. They bring out the best in others by inspiring great performance.
The founders understand that culture is not something they can ignore until things are falling apart, rather it has to be tended continually. Culture matters just as much as engineering, sales, and other organizational functions that are much easier to measure and manage. Example: They understand that an organization with a strong culture is easier to manage, and often will have a longer period of sustained excellence than an organization with a weak culture.

Culture is the collective programming of the mind which distinguishes the members of one group from another.

– Geert Hofstede

Regulatory Environment

Bottom line: If it is appropriate I want to see some evidence that founders have an understanding of the role that regulations might play; will they be a catalyst or an impediment? What can the startup do to make regulations work in favor of the business model that the startup has set out to create?

I have to admit that this is the most difficult intangible for me to discuss for a number of reasons. First, I have relatively less experience on this subject than on the preceding ones. Second, it is such a specialized subject that it is most likely a function that will largely be outsourced to a lobbyist, at least in the United States. Last, this is unlikely to be something a startup needs to worry about until it has grown considerably, which is likely to happen well beyond the seed stage.

The regulatory environment is the framework of rules, laws, and regulations that the startup and its competitors have to adhere as they go about their operations.

Startup founders who can play a role in shaping the regulatory environment that is developed to govern their activities have a better chance of influencing events in their favor than founders who demonstrate an inability to influence legislation.

In the United States there are many examples of regulators requesting comment from participants in an industry during the period when rules, laws, regulations are being crafted to govern the activities of organizations within a given market.

It’s worth observing that the benefits of this asset accrue to every entity that decides to enter that market after rules have been established by regulatory bodies. As a result, first-movers who bear the cost of creating a favorable regulatory environment might be at a relative disadvantage to other organizations that decide to enter the market after a regulatory framework has been established since the first-mover would have borne all the social, political, and financial risks of putting the regulatory environment in place. In comparison to the first-mover, fast-followers get a free-ride.

Concluding Thoughts

Assessing intangibles and their potential impact on the future of an early stage startup is hard work that can seem to rely on information that is even more qualitative and less data driven than other aspects of early-stage startup analysis. Nonetheless, it is important to think through the issues carefully since that work can lead to important conclusions that highlight potential risks, point to future areas of opportunity, and yield better decisions about when and where the investor should deploy scarce capital.

Collectively, intangibles are important because once a startup establishes them as an asset, it is impossible for that asset to be replicated in exactly the same way by a competitor.

Additional Reading

Blog Posts & Articles

Books

How Studying Bankruptcy And Working On Two Turnaround Assignments Prepared Me To Become An Early Stage Venture Capitalist

August 1, 2015 by Brian Laung Aoaeh

The Chinese Character for Crisis; Danger + Opportunity (From The Ten Strategies For Leading At The Edge)

When I started business school at NYU Stern in the fall of 2005 my plan centered on taking every class in Bankruptcy & Reorganization, and Distressed Investing that I could. I took 3 elective classes in that area; Bankruptcy & Reorganization with Prof. Ed Altman, Case Studies in Bankruptcy & Reorganization with Prof. Max Holmes, and Investment Strategies: Distressed Investing with Prof. Allan Brown.

By my logic, if I learned how to assess and invest in dying companies, and then nurse them back to health, analysing, valuing and investing in healthy companies would seem easy by comparison. I was so sure of this that I also tried to turn my Equity Valuation elective into a pseudo Bankruptcy & Reorganization course too, by opting to value a bankrupt company for my final group-project. I do not recommend trying that.

I was still in business school when the economy began to falter. I moved from UBS to Lehman Brothers in late March 2007. A few days later New Century Financial Corp. filed for Bankruptcy. I was let go from Lehman Brothers a year later, on March 12, 2008. Bear Stearns collapsed and was acquired by JP Morgan Chase on March 16, 2008. I graduated from Stern in May, 2008. On September 7, 2008 Fannie Mae and Freddie Mac were taken over by the federal government. Lehman Brothers collapsed on September 15, 2008. On September 16, 2008 the Fed bailed out AIG.

The rest of 2008 was a bloodbath.

It was in that environment that I joined KEC Holdings, KEC Ventures parent company, in December 2008. I was employee #2. I had been hired into a new role that had not existed before at the company. My responsibilities encompassed any direct and indirect investments the company had made, or might make in the future.

Most notably, the company had already made 2 private equity investments; one in a private jet charter company and another in a fine-dining restaurant group – they were struggling to stay afloat given the economic environment. My first order of duty was to “make sure they don’t die” and “help them come out of this mess stronger than they were going into it.” There would be no financial engineering gimmickry. No tried and true business school textbook “indiscriminate” cost-cutting shortcuts. I had to roll up my sleeves and work with each company as intimately as necessary to achieve the objectives.

This post is about how we navigated that period. It is also about what that period between December 2008 and August 2013 has taught me about the challenges startups face, and my role as a venture capitalist.

Every day is a journey, and the journey itself is home. - Matsuo Basho — Every day is a journey, and the journey itself is home.
– Matsuo Basho

Further Background

Both companies were generating top-line revenues in the range of $20,000,000 – $30,000,000 per year. Both had fallen short of budgetary expectations in 2008, but the aviation company had a more prolonged string of losses than the fine-dining restaurant, partly because the restaurant was a more recent investment at that point. I functioned as an “external management consultant”; I was not a full-time employee of either company, but I worked with employees across the hierarchy of both companies. The restaurant company employed between 400 and 500 people while the aviation company had between 30 and 40 employees after several previous rounds of downsizing.

Both companies had watched as some of their competitors ran into strong headwinds, and subsequently shut down operations because the economic environment was so bleak.

Lesson #1: Understand The Business

Once a company is in financial distress investors have to decide if it is worth saving, and they also have to answer the accompanying question; can it be saved given current known constraints? The only way to do this is to develop a deep understanding of the business, and the context within which it is operating.

Between 2008 and 2012, confidence in the economy was very low. People simply were not splurging on expensive meals or luxury jets. An economist would say that private jet charter and fine-dining both have a high elasticity of demand.

I had no prior experience working at, let alone helping to run a restaurant or a private jet charter company. So I decided to spend the first six months in learning mode. I studied everything I could about both markets while I helped the executives and managers at both companies deal with day-to-day nuts-and-bolts issues.

This was important if I was going to build personal credibility, and if I wanted to win buy-in for my ideas from the executives and managers later on. I had to be able to influence them into doing things they probably did not believe in at the outset, and I had to do this with little real influence.

How this applies to early-stage startups: Today, I look for founders who embrace their expertise, and demonstrate a knowledge of their business that surpasses mine. However, the founder also has to demonstrate an ability to assist me learn enough about their industry to make a decision, and act as a useful sounding board for decisions that have to be made in the future.

Lesson #2: Understand The People

During those six months, I also tried to understand the protagonists in each situation. I relied on a technique I had learned in my Literature in English classes during secondary school in Ghana; character analyses.

A character analyses involves performing an in-depth study of the key characters in a drama, and trying to figure out each character’s story; What motivates that person? Why is that person who they are? What is the person afraid of? What drives that person? How does that person communicate? How does that person respond to pressure and stress. What does that person gain the most satisfaction from? What’s the state of that person’s family life? How does that person perceive me? How do I perceive that person? Does that person buy into the need for a turnaround? Is that person willing to commit to the turnaround? What biases does the person exhibit that I can identify? How does that affect things?

I had to be honest, and to contend with the pleasant and the unpleasant, especially around the perceptions other people had of me at the outset.

I took copious notes, and added to them until I felt I had a decent understanding of each of the people with decision-making authority that I would be dealing with most often; executives, managers, and front-line employees.

Perhaps an important, but often overlooked insight is that an investor should strive to understand the people within the context of the business. For example, is this person a leader or a manager? The distinction matters because it can spell the difference between beating about the bush with no results to show, or getting to the heart of the matter and fixing the problems that need to be solved at a tactical and granular level. Fred Wilson writes about this problem in: Leaders and Executives.

How this applies to early-stage startups: We make seed stage and series A investments. That early in a startup’s life, the people make all the difference. The market is important, so is the product. However, at this stage the future is still so nebulous and difficult to envision that the team that has decided to embark on that journey matters more than anything else. So, I have learned to focus on questions like; How did this team come together? Do the founders take responsibility for outcomes, or do they have a habit of passing blame? Do they have the intestinal fortitude to withstand the difficulties they are bound to face as individuals, and as a team on this difficult path they have chosen or will they wilt under pressure? What evidence do I have to support my answer to this question. What is their approach to learning, as individuals and as a team? Have they faced crises together? How did they fare when the going got tough? I will not ask most of these questions directly, but I will be processing every interaction, every bit of information I get, to determine answers to questions along this line of reasoning.

Lesson #3: Create A Sense of Urgency, But Provide Hope

Unlike a startup, a company in financial distress already has a product that it has sold successfully in the past, it also has a sense of who its customers are and where to find them. It is easy for the people within the company to succumb to status quo bias. This is identifiable by statements such as;

“Everything will be fine, we just need to close this one sale.”
“I feel confident it will happen, we have this sale in the bag.”
“They are not our competitor, they do not do what we do!”

In the face of incontrovertible evidence that “they are up shit’s creek without a paddle” people will still choose to do what feels comfortable.

It was my responsibility to shake them out of that rut. As John P. Kotter says in Leading Change: Why Transformation Efforts Fail; 75% or more of a company’s management has to buy into the need for change, otherwise the chance that the change effort will fail is unacceptably high.

How did I do this? In both cases I did not shy away from asking questions that I expected to generate conflict. Indeed, on several occasions I had to have unpleasant and difficult conversations with the top managers and executives in both companies. I did this even if it appeared that I was “meddling” in areas where I had no business poking around. Of course, the idea that there was a part of either company’s operations that I “had no business” exploring was a fallacy only someone keen on maintaining the status quo would believe.

The message, delivered by the investors and the board, and reiterated by me during my frequent field trips, was simple; “The status quo is unacceptable, and failure for lack of effort is out of the question.” We had one chance to get it right, and we had to make the most of that chance even if it meant discomfort some of the time. We could get there with or without conflict. It was entirely up to us to make that choice.

How this applies to early-stage startups: The time for the whole team to start thinking about the Series A Round of Financing is the night before the Seed Round closes. Some one on the team should always be thinking about what it will take to raise the next round.

The time to start thinking about revenues is yesterday, even if you do not implement those plans immediately. Always have a plan. Always test your plan.

Lesson #4: Investors Have Ideas, But Management Runs The Business

Investors will always have ideas about how a business should be run. Sometimes investors know more about a certain topic than management. It is okay for investors to make suggestions, and to offer ideas to management. However, responsibility for choosing which ideas to accept and which to reject has to rest on the shoulders of management, and management has to accept accountability for the outcomes.

There are a number of ways this aspect of the relationship between investors and management might unfold;

Investors can dictate to management what investors think management should do, or
Investors can teach management how and why things should be done a certain way.

I chose the latter. That approach takes more time, but it is also more likely to lead to permanent change in behavior than the former. Also, once the lessons had taken root that approach allowed me to gradually pull back my involvement without jeopardizing the progress that management was making in improving results. It is an approach that builds self-sufficiency.

As part of the process, we cultivated the practice of communicating:

Why a certain goal or strategic initiative was important for the company’s near term goals and long term vision.
What had to get done in order for that goal or strategic initiative to be successfully executed.
Who specifically was primarily responsible for seeing that it got done, and which executive they could go to as often as necessary in order to navigate what ever obstacles they might encounter.
How it would get done, not in excruciating detail, but in broad terms. For example; Which teams needed to collaborate with one another in order to make it happen?
When the team expected to be able to report back periodically on their progress, and importantly, when the project needed to be complete.

To do this successfully, I had to focus on asking questions and encouraging deeper levels of inquiry than was the custom beforehand. Asking probing questions helped us cut out the “bullshit” of conventional wisdom that is seductively easy to accept.

Each time I heard; “You do not understand, that is not how it is done in our industry.” I would ask; “Why?” That would lead to an examination of the assumptions behind the choices that had been made in the past. Often there was no good reason to refuse to try something different even if it seemed out of step with accepted industry convention.

How this applies to early-stage startups: I am looking for founders at the seed or series A stage whose judgement I can trust enough to feel they do not need me to opine on every decision they ever have to make. That does not mean I am passive. It means I need to trust their decision-making skill and maturity enough to feel confident they will consistently make the right choices for all the startup’s constituents without the need to run everything by investors.

From the investors’ perspective, a policy of “show, don’t tell” goes a long way. To paraphrase the oft quoted saying; “Give a founder a fish and . . . . ” If I feel there’s something a founder ought to learn, I’d rather provide a guide to enable that founder learn the applicable frameworks and how to apply them in day-to-day decision-making situations.

Lesson #5: Create Internal Value By Increasing Organizational Capacity

The way we defined it; Organizational capacity is the harnessing of a company’s human, physical and material, financial, informational, and intellectual property resources in order to enable the company to continually perform above expectations and strengthen its competitive position.

In difficult times especially, it is important that companies do not lose sight of the need to continue to find ways to increase organizational capacity.

One way we did this, in both cases, was to shift both companies off MS Exchange Server and onto Google Docs for Work. This was not easy because of cultural attachments to MS Exchange and fear of having to learn something new. Both companies made the shift, eventually. The immediate benefit they experienced was a dramatic reduction in the costs they incurred for IT assistance. A more important, though less tangible benefit was that both businesses could then afford to give every full-time employee a corporate email address and access to a corporate intranet portal. The benefits were enormous; easier collaboration, easier information transfer and sharing, and increased security of corporate information and trade secrets. Quicker turnaround on tactical decisions because people could now communicate by chat.

Given the improvements in tools for collaboration, we encouraged the formation of cross-disciplinary teams to tackle some of the problems that each company was dealing with. This allowed people from one area of each business to interact more closely with their colleagues from another area of the business. They developed a better understanding of one another, and of the challenges and constraints that they each faced in trying to execute their day-to-day responsibilities. In turn this fostered a more collaborative relationship across the entire organization. It also enhanced the learning environment for all employees.

How this applies to early-stage startups: It does not take a lot by way of resources to create an environment that is rich in opportunities for cross-functional collaboration and learning. This comes in handy during due diligence because every member of the team will be able to speak knowledgeably about the startup’s immediate and long term plans.

Lesson #6: Direction Must Be Set From The Top, But Engagement Must Begin at The Bottom

We started working on trying to develop a strategic plan for both companies in summer 2009. Before this time, neither company had previously had a coherent strategy.

In consultation with the executives in each company, the board of directors set out the broad areas that the strategic plans ought to cover; Finance, Operations, People, Demand Creation, and Expansion.

Once those had been agreed on, it was my job to meet with front-line employees as well as managers in the field in order to obtain data and insight about how the strategic plan would have to be set up in order to function effectively for them given what each company was trying to accomplish.

That sounds easy. It is not. It took multiple meetings, of several hours each. The restaurant had multiple locations in NYC, one location in NJ and another in CT. I did not visit the location in Chicago, the CFO held discussions with them during his quarterly visits. I had to sift through everything I heard during those meetings, and I had to extract broad themes. Then I had to reconcile that with the strategic framework established by the board. Finally, I had to interpret that information from the perspective of the competitive landscape for each of the two companies. Finally, I had to synthesize it all into digestible chunks for the board, the executives, the managers and rank-and-file employees.

The goal of spending so much time on having these meetings with people across all ranks in each company was to ensure that once the strategy was developed and implemented, there would be complete alignment behind the vision embodied in the strategy, and just as important that every employee would be engaged in and committed to executing the tactical initiatives required to make the strategy succeed.

How this applies to early-stage startups: The founder creates the vision that investors and the startup’s team buys into. The team executes to turn that vision into a living, breathing, growing reality. Investors hopefully act as a positive catalyst to help the process unfold more quickly.

Lesson #7: Do Not Ignore The Soft Issues, Emphasize Both Hard and Soft Issues Simultaneously

My experience might as well be called The Tale of Two Turnarounds. In one company leadership admitted things were awful. They also admitted that they could use whatever help I could offer. They readily admitted their limitations as a team. We had many instances of conflict, but starting from a position of optimism and a willingness to try, the process moved along slowly, but steadily. We created a survey that we administered twice a year to get a sense of how employees were feeling, data that might not be captured in the key performance metrics we monitored weekly, monthly, quarterly, and annually.

We launched the strategic plan in January 2010 after 9 months of work specifically focused on that task. A year later the company made its first ever payments from a new profit-sharing plan that we had created as part of the new strategy. The payments were not huge, but they were evidence that the team’s hard work was paying off. It also created a feedback loop about how actions by employees affect the bottom-line performance of the company.

In the other company the founder, who was also the ceo, was grumpy and relatively uncooperative with investors. To cut a long story short, we launched the strategic plan in April 2010, after about 9 months of work specifically focused on that assignment. Within 6 months 75% of the managers with whom we had worked to develop and launch the strategic plan had left the company or had been fired. It was a classic case in which we would take two steps forward only to take four steps backward.

Morale dipped ever lower. The founders incessant talk about “a vision” and “a mission” became the butt of jokes among rank-and-file employees. It became clear that employees were becoming disillusioned with what the company stood for. While the company fared better than it would have if there had been no attempt at executing a turnaround and developing a strategy, it continued to perform well below its potential.

At a board meeting one day, the founder/ceo went into a vituperous rant about all the areas where the company was falling short. This was in early to mid 2012. I had to burst out in laughter. He might as well have been reciting problems whose solution formed the core of the strategic plan we created in 2010. Implementing that plan would have started the process of solving those problems he was so exercised about that day. We had lost two years for no good reason.

No amount of emphasis on key performance metrics made a difference. Without the founder’s full embrace of the strategic plan, nothing else mattered. I should point out that he had been intimately involved in crafting the strategic plan. This was not a plan that was forced down on him “from on high.” It became clear how badly things had deteriorated when a long time employee quit, this individual was the only employee at the company who had been there as long as the founder.

How this applies to early-stage startups: I am of a firm belief that the team is really important at the seed and series A stage, or at least until uncertainty around product market fit has been largely eliminated. So, I need to develop a sense that a founder is someone I can work with over the long haul . . . Actually, the kind of founder I am happy backing has to be someone I could envision myself working for if circumstances were different. Age, race, gender, religion . . . That is all irrelevant. Early in my process for assessing a startup I focus almost entirely on soft issues.

In one example, I sensed something amiss about the body language between 2 Spanish co-founders pitching a startup to my partner and I in 2013. I decided to tune out what they were saying in order to better observe their body language. There was something about their body language towards one another that did not align with what they wanted us to believe, in my opinion. We passed on their seed round, and decided to watch them till we could get more data about the relationship between the co-founders. That was nearly 3 years ago. I have heard no reports to suggest we made an error in that case.

Let chaos reign, then reign in chaos.

– Andy Grove, Only The Paranoid Survive

Lesson #8: Be Prepared For Chaos; Harness, Focus And Direct It, Empower People

Once employees understood the strategic plan as well as the tactical initiatives that accompanied it, they began developing ideas related to the various functional areas in each company and making suggestions to managers and excutives.

At first this was overwhelming . . . Managers had to do their own work, manage the work of the groups of people that they managed, and now . . . . They also had all these ideas being thrown at them from “left, right, and center.” The initial knee-jerk reaction was to try to “make it stop.”

That would have been a mistake. Among the deluge of ideas were some real gems.

For example, a maintenance department team member at the aviation company noticed that the company could cut down on its electricity usage by changing all the bulbs in its main hangar . . . No one had thought about that over the years, but our discussion about the strategic initiative around improving the product while reducing costs prompted him to take another look at the company’s hangars in search of opportunities to reduce operating costs. Thanks to improvements in technology over the years this was now a measure that could be implemented relatively easily.

In another instance, the team at our restaurant in CT had observed that on certain days of the week large groups of Chinese tourists visited the casino resort in which they are located. They had been thinking of a way to capture some of that business, but had assumed the corporate office would object to the menu changes they thought they had to make in order to execute that plan. As part of our implementation of the strategic initiative around increasing revenues, I suggested they conduct an experiment, analyze the outcome, and then seek assistance from the corporate office if the results looked promising. They did that, and saw a jump in revenues on two days of the week when business would otherwise have been slow. The corporate office gave its blessing, and assisted in making that practice more entrenched by using corporate resources to give it the polish required for company-supported initiatives.

How this applies to early-stage startups: A startup stops being a startup once its search for a repeatable, scalable, and profitable business model is complete. While that search is in process it is important that every member of the team feels empowered to contribute to the discovery of that business model. It can’t be the job of only some members of the team, it has to be part of everyone’s job. The faster a startup gets through the discovery process the better.

Lesson #9: The Turnaround Should Be Its Own Reward; Incentives Should Reinforce Change Not Drive It

It was nice to be able to make payments from the profit-sharing plan that we instituted. The payments were relatively small, yet they were tangible evidence to the employees, managers, and executives that they were collectively well equipped to make it through the ongoing turbulence and correct the mistakes of the past.

The sense of accomplishment employees felt translated into a number of things, among them;

Newfound and increasing pride in being associated with a company that was succeeding where many of its rivals had failed.
High levels of morale and optimism about the future of the company, and their place at the company. Less stress about employment security.
A greater willingness to take the initiative in situations where the possibility of generating business for the company exists.

Basically, every employee was empowered to function as a salesperson on the company’s behalf. We arranged training sessions to equip every employee with the vocabulary they needed to understand in order to do that effectively. We also developed simple tools that they could use. They did not replace the company’s professional salespeople . . . They became an auxiliary sales force.

How this applies to early-stage startups: As startups grow, founders and early team members need to get better at the art and science of “managerial leverage” . . . What is managerial leverage? It is the process by which a manager creates output that far supersedes that manager’s input by using all the resources at the manager’s disposal to influence the work that is done by the group of people whose on-the-job effectiveness and work-output is affected by interactions with the manager.

What is a manager’s output? According to Andy Grove, co-founder and former CEO of Intel “The output of a manager is a result achieved by a group either under his supervision or under his influence.” Great managers create positive output that far exceeds expectations. Below average managers create output that fails to meet expectations given superior resources. Average managers? The team’s output would not be any different if the manager were absent.

The art of managerial leverage is in determining; how to apportion time, where to pay more attention, where to pay less attention, who to pay more attention to, who to pay less attention . . . . etc etc. The science of managerial leverage is in determining; what to measure, when to measure it, how often to monitor what is being measured, where bottlenecks are most likely to occur and why, and how to eliminate them . . . . etc etc.

Managerial leverage drives output. Output drives results. Results are measured and reflected in the KPI’s that founders and investors measure. Getting that order right is critical to a startup’s success.

Lesson #10: Learn To Listen, And Communicate Effectively

It is amazing how many problems can be solved relatively quickly if people would communicate more effectively internally and externally. Communication involves two actions; first listening actively in order to understand what is driving the actions of other people. Second, responding to what other people have said in a way that gets to the root cause of the problem being discussed.

During one of my field visits, I spent 8 hours on my first day listening to the executives talk about all the problems they each perceived, and how they felt the issues ought to be tackled. I spent that day with the CEO/President, the CFO, the Head of HR, and the Head of Sales. I encouraged open disagreement and debate.

On my second day I spent about the same amount of time speaking with the middle managers; again we discussed the problems they each perceived, and how they each felt the issues ought to be tackled.

On the third day I brought both groups together, and moderated an all day discussion about the problems the company was facing. Once again, I encouraged open disagreement and debate. Also, I put the inter-personal issues and conflicts that I had uncovered on the table. Things often got heated. It was my job to function as a pressure-release valve during those episodes. It was not pretty.

For example, I explained to the entire group how the CFO who was disliked by a large number of people within the company had made payroll on too many occasions by dipping into his personal 401(K) savings for example. The irony, the folks who disliked him routinely failed to provide the finance team with the data they needed in order to collect on accounts receivable from the company’s customers.

The outcome of this exercise was that;

Everyone felt they had been given a chance to speak and be heard by the rest of the leadership team, and
We discussed expectations in a fair amount of detail, enough so that more work could be done laying them out in adequate specificity rather than vaguely wondering what people could expect from one another, and finally
Created an environment in which each member of the leadership team contributed in creating a communication framework against which they agreed to be held accountable

Our goals for the communication framework were that;

Every employee should know what is expected of them, as individual team members,
Every employee should know what to expect from every other member of the team,
Employees should know what to expect from executives and managers, and lastly
Accountability should be about improving team and company performance, not punishing individuals.

As Rosabeth Moss Kanter says in Four Tips for Building Accountability; “The tools of accountability — data, details, metrics, measurement, analyses, charts, tests, assessments, performance evaluations — are neutral. What matters is their interpretation, the manner of their use, and the culture that surrounds them. In declining organizations, use of these tools signals that people are watched too closely, not trusted, about to be punished. In successful organizations, they are vital tools that high achievers use to understand and improve performance regularly and rapidly.”

How this applies to early-stage startups: Startups typically have to move quickly, especially if they have taken in capital from institutional venture capitalists. A culture of blame, lack of cohesive teamwork, and a lack of organization-wide accountability is an insidious tumor that will eventually lead to failure. The founders who are most successful in the long run are those who do not shift responsibility when things are difficult, but instead serve as a model that other team members can emulate.

Closing Thoughts

Executing a turnaround and getting a startup through the phase of discovering a business model are really just two sides of the same coin. That experience has led me to the belief that it is when things seem bleak that great early stage investors prove their worth.

Further Reading

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A Note on Startup Business Model Hypotheses

March 29, 2015 by Brian Laung Aoaeh

One of the observations I have arrived at over the course of meeting founders of early stage startups is that often it is not clear during our conversations if they have spent time examining the hypotheses that underlie the business model for the startup they are building.

This post ((Any mistakes in quoting from my sources are entirely mine. This post is an updated and adapted version of my posts The Startup Customer Development Model and Customer Discovery Phase I: State Your Business Model Hypotheses? which were published at Tekedia.com on September 3rd, 2012 and January 21, 2013 respectively. Large portions of this update are identical to the originals.)) is my attempt to outline some of the areas that I consider as I try to understand an early stage startup’s business model and the hypotheses that are the foundation on which its success must rest. ((I have adapted portions of: Chapter 2 and Chapter 4 of The Startup Owner’s Manual Vol. 1: The Step –by-step Guide for Building a Great Company, Steve Blank and Bob Dorf, Pub. March 2012 by K and S Ranch Publishing Division.))

To ensure we are on the same page, first some definitions;

Definition #1: 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 #2: What is a business model? A business model is the description of how a startup will create, deliver and capture value. Alex Osterwalder’s Business Model Canvas is one framework for describing and documenting the elements of a startup’s business model.

Definition #3: What is Customer Development? Customer Development is a 4-step process by which a startup answers the questions it needs to answer in order to find a business model that is repeatable, scalable, and profitable. Step 1 and step 2 of Customer Development cover the “search” phase of a startup’s life-cycle. Step 1 is Customer Discovery. Step 2 is Customer Validation. More on those a little later.

Definition #4 What is a hypothesis? A hypothesis is a statement, or a group of statements, that proposes an answer to a question, or a solution to a problem, in a manner that is testable through experimentation. The goal of experimentation and testing is to determine if the hypothesis is correct, and to inform the subsequent actions that the startup should take on the basis of that evidence.

Step 1 in the Customer Development Process: Customer Discovery – this involves translating the initial vision behind the startup into a set of hypotheses about each component of the business model. This allows experiments to be performed that either validate or invalidate each proposed hypothesis. In my experience the exercise of testing hypotheses about the business model with prospective customers accomplishes at least two things. First the startup entrepreneur gets to hear directly from customers about the elements of the business model’s value proposition that are most critical from the point of view of the startup’s customers or partners. Second it jump-starts the sales process even before the startup has invested much time or money into building a product. The founders of a hardware startup discussed their idea for an innovative new product with a potential partner. The partner’s input proved crucial in determining the direction they followed with regard to product design – it evolved from a product with one offering to one with three distinct but complementary offerings.

The revenue model also changed based on those discussions. Even better, the partner agreed to work with this startup to bring the product to market when it is ready. Obviously, there’s still a lot to be done – product design, product development and manufacturing for example. Yet those initial discussions have been critical in conferring the kind of credibility that has made it possible for the startup to seek an audience with other potential partners. Customer discovery for this startup also involved market research to determine the priority of features from the perspective of individual end-use customers – the men and women who might actually decide to purchase the startup’s offering once it becomes available to consumers.

Step 2 in the Customer Development Process: Customer Validation – this step proves that the work done in step 1 is easily repeatable, scalable, and capable of delivering the customer volume required to build a profitable company. The startup I described above is now building prototypes based on all the information it gathered during the Customer Discovery process. Eventually we will test our ability to deploy the product in the field – a few hundred first, then a few thousand, and barring any major setbacks, tens-of-thousands, then hundreds of thousands.

During that process we will test how well the back-end software works with the hardware that we have designed and manufactured once people are actually using the device. At each step I expect we will go back to the drawing board on several aspects of the product and the business model. For example, our pricing model may not reflect reality since our market research confirmed the hypothesis that our potential customers have never encountered a device like the one we are developing. We may discover that customers will gladly pay more for the value proposition we offer than we currently plan to charge. It is important to note that we have gone through a number of product pivots during Customer Discovery. For one, we made an incorrect hypothesis about the amount of space our partners would be willing to devote to this new device, never mind all the assurances they gave us during early conversations.

We also made a number of pivots in terms of the user experience and the interface through which users will interact with the device because we realized that a number of hypotheses we had made about certain design, engineering, and manufacturing issues related to the product were just flat out wrong. The product we will soon show to our partners satisfies the desires individual end-use customers told us they seek in a product like ours ((Market research involved nothing more than a description of the device. In other words, we relied on potential customers’ ability to imagine a future in which they could use the device we were setting out to develop.)), in a manner that accounts for the constraints our partners expressed they would eventually have to contend with in deploying the devices when they come to market. Moreover, this exchange of information led us to develop a product with performance characteristics far superior to what we would have achieved within the parameters of our previous vision. We expect to make a few more pivots before all is said and done.

Developing Hypotheses During Customer Discovery

The first step in customer discovery is developing a rough estimate of market size and sketching an initial business model for your startup using the business model canvas, which I have discussed in some detail in What is Your Business Model? Using the business model as a guide, develop a hypothesis brief for each component of the business model canvas. A hypothesis brief should contain a succinct statement of the hypothesis itself as well as a sufficiently detailed but brief outline of the information that makes the hypothesis a reasonable and valid one for that business model component.

The market size hypothesis is probably the most critical, even though it does not correspond directly to any of the business model canvas components. Investors like to back companies that target potentially large markets. At the same time, be careful to differentiate the total addressable market opportunity, the serviced addressable market, and your target market. Needless to say, your initial target market will be the smallest of these three. In most cases a bottom-up estimate is better than a top-down estimate because it is relatively easy for an investor who wishes to do so to replicate a bottom-up estimate. Whereas, a top-down estimate could be viewed as “hand-waving” with no basis in reality.

The value proposition hypothesis should discuss the problem your startup solves for its customers. A segment of this brief should capture product features, and a minimum set of initial product features that early customers would be willing to pay for. This is the minimum viable product, a bare-bones version of your product that solves the “core” problem your customers face. Put another way, your minimum viable product is the least developed product that you can create in order to validate your most important hypotheses about the problem you are solving and what your customers or users will accept.

The customer segments hypothesis forces you to answer the questions “Who are my customers?” and “What problems do my customers face?” The hypothesis brief should discuss customer problems, types, and archetypes respectively. Understanding “a day in the life” of your typical customer is a powerful way to understand your startup’s customers. Finally, Steve and Bob suggest you develop a customer influence map. There is an important aspect finding customers that can be overlooked. What is the smallest group of customers that is experiencing the pain or problem you are solving most acutely? Perhaps they do not have enough money to be attractive to incumbents. Or, perhaps they are a niche that is considered weird and unprofitable by your competitors. Start your experiments there. Why? If your product indeed solves their problem, they will adopt it quickly. On the basis of broad adoption within that niche, you can plot a path to other communities of customers who are facing the same problem. In other words, find the groups of people who will be your “Innovators” and “Early Adopters” and focus your early efforts on those groups.

The channels hypothesis should differentiate between physical, web, and mobile channels. An important consideration during the development of this brief is whether your product fits the channel. At this stage it is important to pick the channel with the most potential and to focus on gaining customers and cultivating sales through that channel to the near exclusion of every other alternative. With very few exceptions, since you are still testing your hypotheses, developing your business model, and determining what product is best positioned to solve your customers problems avoid the temptation to launch via multiple channels.

I was having lunch with the founder of an early-stage startup on Thursday, last week. She was giving me an update – the struggle to raise seed capital from investors, what she’s learning about building a team, and so on. We got to talking about how she would distribute her startup’s MVP. Her initial plan would have cost her a lot of money – capital she can’t afford to spend and a significant portion of the round she’s trying to raise, because she was thinking about traditional channels – the most obvious route to the customers she thinks she needs to get to. I pointed out that without further testing, she was taking a very risky gamble whose most likely outcomes do not favor her startup. Instead I suggested she spend the least amount of money she can to test non-traditional channels, and maximize the yield from those avenues before she does anything big and splashy through traditional channels. In this example, her hypothesis was poorly formed because it failed to take her startup’s capital constraints into full consideration.

The market-type and competitive hypothesis discusses the nature of the market into which your startup is entering and tries to anticipate the competitive landscape of the market that you will be attacking. You might consider it the second half of the value proposition hypothesis – your product solves a product for a group of customers, or a market. In broad terms a market already exists, or your startup is creating a completely new market where none existed previously. Your market entry strategy will depend on the market type you identify, as will your cost of entry into that market. In an existing market, your startup will have to position itself against the competition in a manner that ensures it can win given the basis upon which you have chosen to compete.

The customer relationships hypothesis describes how you get, keep and grow your customers. It is similar to the LBGUPS model, which I discussed in What Is Your Business Model? There’s no need to emphasize that this is an important hypothesis brief – without customers or users your startup will die a not premature death. How you get, grow and keep customers is very channel dependent. Your analysis should take that into account, and should also factor in related costs.

The key resources hypothesis discusses how you’ll obtain resources that are critical to your startup’s operations but that you do not have within the startup. These resources might be physical resources, financial capital, human capital, or intellectual property. In each case it is important to list the resource and an outline of how it will be secured to enable the startup run its operations. For example, servers can be rented in the cloud at a cost that is lower than managing your own server. Another example, a first-time founder who does not yet have a technical co-founder might partner with an outsourced software development shop to build and MVP with which to run some experiments. Often the devshop will remain as a service provider till the startup becomes self-sufficient enough to bring that work in-house. I have a bias for startups that control their intellectual property.

The key-partners hypothesis describes the partners that are essential to enabling your startup to succeed. It also describes the value-exchange that keeps the partnership alive. For example, a startup might have all its development and design work done by a software engineering consulting firm established for that specific purpose. In this case the startup pays the software engineer money in exchange for software engineering related to its product. Key-partner relationships might take the form of a strategic alliance, a joint new business development effort, a key supplier relationship, or co-opetition. Certain of these are more common early in the startup lifecycle, and others are more common late in the startup lifecycle. It is important to realize that a partner should not have control over anything that is critical to your startup’s ability to exist and do business.

The key activities hypothesis summarizes your startup team’s understanding and assumptions about where its energies should be most focused in order to create the most value for its customers. These are those activities that you feel cannot be left to one of your startup’s key partners. For example, a hardware startup might view design as a key activity, while assembly is left to a manufacturing partner in a low-cost manufacturing jurisdiction.

The revenue and pricing hypothesis brief is important because it ensures that the startup can extract value for itself and its investors. It asks a number of simple questions all related to revenue. The nature of the specific questions asked depends on the channel, but the essence of those questions remains the same. Together they should enable you determine if there’s a business worth pursuing along the path you have chosen for your startup.

The cost structure hypothesis brief forms the second half of the value extraction hypotheses – the first being the revenue and pricing hypothesis. Your startup’s cost structure must ensure that it can effectively deliver on the value proposition it has promised customers, and keep a portion of the revenues that the startup cultivates in the form of profits. Here too the questions asked will be relatively simple, and will reflect the channel and the market type. For example, a startup whose only channel is the web will have a lower cost structure than one with a physical channel.

Once your hypothesis briefs are complete, your entire startup team should discuss the output. Seek contradictions, conflicts and inconsistencies. The most important reason for developing these hypotheses is to ensure that the actions that your startup is taking have the highest probability of yielding success that is possible.

During my conversations with founders I listen carefully to determine if the startup has thought about these issues, or is thinking about them – it depends on the stage. I become concerned when I get the sense that important questions have been left unasked and unanswered.

Question Everything; My Remarks At FOCUS100 2014

October 4, 2014 by Brian Laung Aoaeh

Background: I gave these remarks at Digital Undivided’s FOCUS100 2014 Conference which was held between October 3rd and October 4th in New York City. A number of investors were invited to explain to the audience how they ought to pitch venture capitalists in order to win funding. Digital Undivided is a social enterprise that develops programs that increase the active participation of urban communities in technology. It has a particular focus on women. ((I have edited it by adding comments based on questions people at the conference asked me after I had spoken, mainly adding a little more context.))

I am not very good at listening to what other people tell me to do, so rather than outline what I think you should do in order to get funded by a venture capitalist, I thought I should instead share with you some of my beliefs about founders, and startups, and how I think about my responsibilities as an early stage investor. I hope in doing so you will question some of the assumptions you hold about how you should go about raising capital.

The kind of founder that really excites me does not need a venture capitalist. She simply needs some capital to enable her build her vision and transform the world. My job is to give that founder sufficient reason to decide that she wants to undertake that journey with KEC Ventures as a companion.
To get past the first meeting, a founder has to inspire confidence. She has to make me want to follow her over the edge of a cliff, or into a burning building. She has to make me feel I could trust her with my life because come hell or high water, she’s going to figure things out. She’s smart, hard working, can process an enormous amount of unfamiliar information and take action based on what she’s learned, she knows or can learn how to build and lead a team that’s going to do something ambitious. She might be an introvert, or an extrovert. She gets me to buy into her vision of how things should be, and how she will use technology to accomplish that. She wants to win, and she knows how to win. I do not believe in “pattern matching” in the way some well known investors have described it. I don’t pattern match people. That’s an intellectually lazy approach to picking investments. Instead I pay attention to ideas, problems, and the characteristics of successful businesses. Meeting and investing in startups led by founders with a vision to make the world a better place is what makes me eager to wake up each morning and endure the cognitive dissonance that is a daily and ever present aspect of my job as an early stage investor.
I do not believe in founders who lack the intellectual and emotional fortitude to debate and argue honestly about what is best for the startup with their investors and with others who might have opinions about what they should do. I believe that the best decisions are made when one can debate issues with one’s self, and when founders and investors can engage in healthy, critical and honest debates with one another and subsequently reflect and contemplate on everything they have learned through that process. I get frightened by founders who cheerily agree with everything investors say. If the founder is indeed creating something new, or solving a widely-overlooked problem, there’s no way the average investor has considerable experience and expertise in that area – by definition the founder is “the expert”. I expect the entrepreneur to know far more than the average investor about what will work, what will not work, and why. Cheery agreement with everything an “ignorant” investor suggests acts as a red flag to me that perhaps this founder does not understand the problem she is solving, or her market, as well as is required to do what she says she wants to accomplish.
My primary responsibility to investors in KEC Ventures is to be skeptical; Skeptical about myself, and what I think I know, and skeptical about the founders I meet and the claims they make. This is the only way I can minimize the chance that I pass on an idea that seems inconsequential at the outset, but goes on to form the basis for a transformative business. I hope another consequence of my skepticism is that I also minimize the probability that I am too eager to invest in startups that fail because they are built on ideas that are obvious. (Note: I also need to be optimistic.)
Most startups fail. Let me rephrase that, the overwhelming majority of startups fail. My only task is to find those that will succeed before they become well known by other people. Further, we should not invest in a startup unless we believe that our investment in that startup can return our entire fund. One founder at the conference suggested he could “guarantee” a 10x return if KEC Ventures would invest $250,000 in his seed round. That would be great, if we were investing from a $2,500,000 fund.
The type of startup I want to invest in is a very specific thing; it is a temporary organization that has been created to search for a profitable, repeatable, and scalable business model while it solves a problem that has been overlooked in a certain market. It is designed for fast growth once that solution is developed and the business model has been found, and if it succeeds it completely transforms and overwhelmingly dominates the market in which it operates before it moves into adjacent markets. ((This definition is a composite that combines elements from definitions other investors have used. It is primarily derived from a definition that Steve Blank and Bob Dorf use in The Startup Owner’s Manual.))
Accepting the definition of a startup that I use as my guide, there are certain things that I listen for when I am speaking with a founder. Collectively, they are described as “Economic Moats” . . . Intellectual Property, Network Effects, Efficient Scale, Switching Costs and Branding. Even if these do not exist at the very outset, it has to be clear that they can be designed into the startup’s business model as it matures and that the founder has already been thinking about them. Also, I am not interested in situations where only 1 of those sources of an economic moat is present. I prefer 3 at a minimum, all 5 ideally. The durability of a moat is a something I worry about. Also, how wide or narrow that moat can be made is something I think about constantly. Essentially, I want to avoid the detrimental effects of competition.
A venture capitalist does not provide capital to people who need it. A venture capitalist has a fiduciary responsibility to make the best effort possible to generate a positive return for investors in the fund.