Seems to me, a key attribute of a successful VC is also to have learned the right lessons from failure. Often we tell ourselves it's OK to make mistakes, just don't make the same mistake twice. But people often do make the same mistake, over and over again. And it's often because they didn't learn the RIGHT lesson.
Once, I came in late to a HW development cycle. It was in serious shape and the others didn't even want to listen anymore. Eventually it failed, miserably, but not before I was able to take away part of the failure and something better from it. The lesson everyone else seemed to learn from it, though, was that you should never try to develop a new product. None of the same players would ever listen again to new product ideas the pain was so intense. Eventually the company failed altogether, because it had no new products and couldn't even integrate well.
So, learn the right lesson, then get up and go again.
Michael
· 2 years ago
Fred, thanks for sharing those experiences. I've been digging into exactly those issues with a few other folks, mostly from the social venture community. Where I'm looking now is into that area of exploring 'the dark alleys' quickly and effectively and how can investors get better at supporting entreprenuers/investees in doing that - e.g. what does that mean for board roles, practices, deal structures, tools etc.? Would love any ideas you have and will share what I come out with in my other conversations. Thanks again for sharing...
Thomas Purves
· 2 years ago
Thanks for this post Fred.
It seems to be there is an interesting contradiction between "Most venture backed investments fail because venture capital is used to scale the business before the correct business plan is discovered. " and the fact that 2/3rd of your successful businesses changed direction *after* being funded.
So how does this affect your investment decision. Do you go with the entrepreneur who has total confidence in a specific direction for the company, or do you do you go with the entrepreneur say with a great idea but who admits to not knowing yet the best direction (at the risk they might never find it, or just aren't ready for VC yet).
Or how else does this apparent dilemma affect your thinking when considering a deal?
fred wilson
· 2 years ago
Thomas,
"scale" is the key word. if you use your VC money carefully and keep your burn low until you've found the right model, then you can change direction after being funded and things work ok.
it's the situations where the VC money is used to step on the gas before you really know where you are driving to that causes the problems.
Fred
Crawford
· 2 years ago
Fred, the speed-to-failure truth is key. One of the great joys of the digital age is rapid prototyping. Embrace the failure! I recall an ad headline I wrote years ago for an early solid modeler: "Hire us and fail in half the time." Fun stuff. Now, get out there and fail.
Shafqat
· 2 years ago
Great post Fred. I've always believe that sometimes not being around VCs and not having access to funding at an early stage may be a blessing in disguise. Bootstrapping, putting in that extra blood/sweat/tears, and making that last dollar go that extra bit further could be worth it. Necessity is the mother of invention, so it also could drive innovation. Of course, at some point we all need funding to take on the world, but in the meantime, we can always keep our head down and focus on the product, on being disciplined, and doing it because you still believe.
Vijay Goel, M.D.
· 2 years ago
Fred,
I'm curious as to how your conclusion on finding the right market fit corresponds to VCs getting bigger and wanting to do bigger rounds. It would seem that model would be fundamentally flawed in locking entrepreneurs into larger investments with larger minimum expected return-- even Pee Wee needs to try to swing for the fences (and his stroke may not be ready).
I would think that your conclusions would lead VCs to stagegate investments at a lower level (almost like a farm team or something) where you help the promising companies gain enhanced access to the equivalent of table stakes, without getting the big infusion of cash that causes people to jack up burn rates before they're ready.
I'm on the other side of the equation bootstrapping the development of Health Shoppr (we help consumers differentiate and buy/book services from healthcare and wellness providers).
Given that I'm creating a marketplace, I probably have a 2 year marination period to build up the right consumer/provider networks to critical mass-- and I'm finding that there are few sources of patient capital looking to put in small amounts of capital to fund and test different milestones as we find out which pieces are early-adopter targets.
With my McK skillset, I can pull together cashflow from consulting work to pay for development myself, but how many others could afford to do this?
I'm seeing some movement in the model with Y Combinator and programs like Charles River's Quickstart, but I'm curious as to why investors think companies can just flip the switch to scale before the market's ready and expect these deals to succeed.
Tobias
· 2 years ago
Very interesting, thanks for posting this.
But :)
Can you shed a bit more light on what "keeping burn low" means for you? As I see it, every investment that I take as entrepreneur is to step on the gas (go to market faster, increase sales faster, etc). The question is just how much pressure to put on the pedal. Enough to survive with the current investment and projected burn for a year? Six months? 2 years?
Joe Hunkins
· 2 years ago
venture capital is used to scale the business before the correct business plan is discovered. That scale/burn rate becomes the cancer
Fred thanks for the really interesting insights into this. On the one hand they seem to make a lot of sense. However - and I hope this does not offend you - my working hypothesis is turning into this:
Winning VC firms are like winning stock pickers - they for the most part the ones that were at the right place at the right time and in some ways the lucky ones, but the win is NOT the product of conscious, clever, consistent application of any sets of rules.
(for what it's worth I also apply this rule to my own successes and failures in biz and life in general)
The interesting thing is that as with stocks when you use a performance record and then analyze things *after the fact*, as you are doing here, you don't find relationships between the past and the future. Many people think they *do* understand those past to future issues, but in the stock world this does not hold up to scrutiny. If it did, staggeringly huge returns await anybody with even very modest level of long term predictive power and a modest initial stake.
I'm open to disproving this, but note that there will *always* be a top tier of winners. What supports the hypothesis is that those winners change over time and past does not predict future (in Stocks - I'm not up on VC stats). I think VC may have more of a schmoozing human component than stock picking so that may play a role here. I've noticed from the few VCs I know how they are generally very bright and personable. Yet even this is somewhaat conspicuous given that average VC return is negative yet the average bright personable person is doing well.
jon
· 2 years ago
Found about it on TechCrunch. I am now officially a fan of your blog. Great post. This what I said about it on TC:
“Most venture backed investments fail because the venture capital is used to scale the business before the correct business plan is discovered. That scale/burn rate becomes the cancer that kills the business.”
Agree. That and bad cash flow planning, which in a way, is the other side of the same coin.
andre taliercio
· 2 years ago
Fred,
To me it just shows that you are investing in a team first. Then they can reinvent a business plan when required.
Scott Lawton (Blogcosm)
· 2 years ago
Wow Fred, you're on a roll. Great insight (which I blogged). One point I raise: while many investors may know about burn rate, they don't seem to follow this advice. A key problem: the "hit driven" and "portfolio" nature of the VC business gives investors a different set of incentives than entrepreneurs. (Paul Graham and others have written about this.)
Charlie Crystle
· 2 years ago
So Fred, what constitutes a reasonable net burn, and for how long? Or better, what is a reasonable net burn ratio
net burn=expense - revenue;
net burn ratio= net burn/revenue (want it to get to zero ultimately)
Jay Virdy
· 2 years ago
I also like Steve Blank's take that more startups fail from a lack of customers than from a failure of product development. According to Blank, we have processes to manage product development, but no process to manage customer development. Emphasis should be on learning & discovery before execution or putting the pedal to the metal as you've mentioned.
Delving into dark alleys is all about learning & discovering from failures--quickly. Keeping the burn rate in check during the early customer discovery & validation phase is key to survival. I know this first hand having dealt with a runaway burn rate from my first startup in the late 90s. Once I had the burn rate under control, I was able to transform and adapt to successfully "bring the nose back up."
I am now in the trenches with my second startup. My #1 focus is to keep the burn rate in check while we get to product fit as quickly as possible.
Greg Hogan
· 2 years ago
Fred,
This is fantastic stuff. I worked for a company before which suffered from the problems you describe above. Excellent article.
Alan Wilensky
· 2 years ago
Some good ideas never get to the VC stage! I have made quite a tour of the dilution system before finally realizing that my tried and tested, blue collar mobile messaging plan for automotive trades will have to be bootstrapped through working partnerships and equity sharing with developers.
A hard lesson learned. A lot of abuse taken at the hands of Junior partners.
Some good ideas never get to the VC stage! I have made quite a tour of the dilution system before finally realizing that my tried and tested, blue collar mobile messaging plan for automotive trades will have to be bootstrapped through working partnerships and equity sharing with developers.
A hard lesson learned. A lot of abuse taken at the hands of Junior partners.
Fred is the best. The key in my experience is giving up fast when the going gets tough; what does it generally mean when your product is tough to sell, it means your product is not superior, maybe even sucks. It's the exact opposite of "don't give up". My philosophy is to give up readily...I look for reasons to give up. The times when I have made money as an entrepreneur is when it was easy to sell my product to advertisers. The times when I lost money and wasted time was when I worked my hardest to sell product, canvassing prospect after prospect with my salesguys and our wares, but people weren't buying or not at the right CPMs or quantities (in my case advertising as I'm in the media business). The problem stems from this: The smarter to you are, the more difficult it is to admit your thinking was flawed and you were dead wrong initially. But the longer you wait, the more money/time you lose. My advice is to believe in your product less and desire money more. If something is validated by the market, there is no question of "belief" or reason to "believe", it simply is. All entrepreneurs should substitute the term "belief" with "speculate"; this will help you get away from a bad read on the market. When you "believe" your product or service will be a hit, you "speculate" that your product or servide will be a hit. It's easier to walk away from one's speculations than it is from one's beliefs. Business is not religion, it's a means to make money and show people how smart you are. Most people I know treat their product vision as a lottery ticket with a lot of hopes and wishful thinking behind it. It often seems most entrepreneurs value their product vision more than they value the money; this is what leads to faulty resource optimization. Would you rather have $8 million and have your vision realized fully or $10 million without realizing a single part of it, most would take 8 and that type of thinking usually results in 0 except for the very few. I am far more sentimental about my money (my money represents sweat, blood, and tears) than I am about any business I have been involved in (and ironically the brands I have founded are enthusiast media brands in the most fun categories). This is a good way to keep your emotions in check and hang on to your oxygen supply. Cut your losses, fire when necessary, and go as slow as you can, you'll know when to speed up. Be conservative, the act of starting a business is the riskiest thing you can do. Offset your initial risk assumption with total conservation.
Gregg Smith
· 2 years ago
We had a great product, great customers (Big 4 accounting, national consulting firms, millions in revenue) a great core group of developers and a great board. We took the first $25 million, hit the gas and burned a lot of it on worthless ventures that weren't related to the core business (EMEA and a West Coast acquisition). The second $25 million was to survive. We sold it too early and too cheaply because we, in a couple of our investors cases, were their only opportunity near-term liquidity event.
Anthony Kuhn
· 2 years ago
Fred:
I think it's great you started a dialogue regarding who's to blame for the failure of a startup venture. Share, and share alike, seems to be a reasonable place to .
Thanks for your insights on how best to view VC funding investments in light of failure, and success.
Happy Friday,
Anthony Kuhn
Shanti Braford
· 2 years ago
This is a great post, Fred.
What I'm curious about are cases like Friendster or some of the other VC horror stories where the venture capitalists were pushing the founders to spend the money at such a high rate.
Does this happen often?
i.e. I'm a founder; you just gave me $3million. But I tell you, I want to keep a slow burn rate until we have gone down a few of those dark alleys and finally found a sensible model. Maybe make a few key hires, but not the kind where VPs of X are just sitting around twiddling their thumbs & building powerpoints, because the product/service isn't ready or fully flushed out yet. (seen this first hand several times)
And if you don't do this (pressure to burn), have you seen it among other VCs much? =)
francine hardaway
· 2 years ago
Thank you, Fred. In Arizona, where I work, there is very little capital and we (Stealthmode Partners) help our companies bootstrap. They hate it. They beg to go for funding. I flat out tell them they can't get it most of the time, because they can't.
However,every once in a while, I send a guy who needs $1m to a VC in Silicon Valley. Always in the meeting, the guy comes out thinking he needs $5m because the vision has grown/changed when the VC inserts his own idea o where the market is.
The blame goes equally: entrepreneurs who think money makes success, and VCs who want to give them too much money too soon.
Aruni Gunasegaram
· 2 years ago
Really great post and great comments! It is so true about having to go down several dark alleys, figuring out the dead-ends, and moving on fast. It's much harder to do when bootstrapping.
I liked Alan's points about 'the reasons to give up' and give up quickly. It is hard to do because as entrepreneurs we become really enamored of our company and its products. However, having observed the success of several companies many do not sell now (or have the same strategies) as when they first started. It's important also, to get out there with something and start testing the waters to see what works and doesn't...bootstrappers just don't have the financial wherewithal to keep doing that for long!
To Anthony's point...having been a founding CEO back in the late 90's I saw a push by VCs to burn money. They didn't want you to be conservative even if you felt you should be. Several discussions arose among my founding peers that this was a tactic by some VCs to push through the money fast that the Company would have to go ask them for more thereby giving up more of the company. It's kind of a jaded view but isn't it funny how different people view the same situation?
wallbang
· 2 years ago
Fred, thanks for sharing your perspective! The 2 hour bike ride(s) help a crunch, er, bunch.
Re: "...going down lots of dark alleys..."
In 1987 (eighty seven!), I visited San Francisco promoting a software app I developed. So many smiles with completely blank stares. The worldwide market I passionately spoke of wasn't born until 1997-99. Ten years...
I remember visiting with one known VC in his home. He watched me demo my product. His eyes lit up and he stopped me. He excitedly asked me if the feature he was looking at was done? He wanted to know if I could strip it out as a stand alone product? I foggily remember him saying he'd fund me immediately if I answered yes.
I answered no. No doubt I could do what he wanted, but it didn't make sense to me based on my business plan, the plan never funded. The VC continued on to develop his app. I continued on making a business succeed in a tiny ski town, selling my app to a niche national market, cashing out in 1996. This app was re-acquired a few times, continuing on to this day selling to a larger niche market.
Today, in my ninth year of developing a new app, I learned quickly to describe it as organic - one mistake layering another upon another - watching the growing humus with humor. I don't have a business plan. I don't have an income model. I don't have a single customer. I don't know when I'll cash out. I live simply and ride my bike a lot. The market I need has arrived, and this time society is passionately speaking up, demanding, hmmm, change. Perhaps I'll know the model in 2009 - ten years again...
Michael ;)
ps: The VC's app? A networked contact /calendar. He cashed out but the app failed. Enter web 2.0, and we still have the idea cashing out, but failing. wuwt?
Mark
· 2 years ago
Great post Fred, thanks for sharing. The idea of numerous dark alleys points to the other key to success and that is in any venture investment you are betting on the quality and ability of management. They must be able to not only have the vision to conceptualize the intial product but execute the plan to realize it and if necessary - all those dark alleys - shift that plan into a new vision. The bet is as much on management as on product.
Victor
· 2 years ago
In most cases, having too much money in any business, startup or not, will lead to bloat.
If you are bootstrapped you will ultra-prioritize your goals. One thing I have noticed time after time is that having a long engineering queue due to limited engineering capacity in a bootstrapped company can actually save you. When the 3-6 months roll by and you look back at the jobs in the queue, half of them don't make any sense anymore, yet if you had the capacity, you likely would've pushed them all out- much of it garbage.
Secondly - And I think it was Lucille Ball who once said never ask anyone who is not busy to do a job for you. Well, guess what. More cash, means everyone has assistants, longer lunch hours, and shorter working days. Most company's could probably lop off 1/3 of their staff and get more done if they could only bite that bullet and take the leap of faith. People often work better under tighter conditions, they collaborate better, they don't have to go through 3 layers of management, and generally feel they can personally move the needle, which is rewarding to most.
Stay lean, be a boot-strapper. Once you build up a value, then go sell equity at a premium.
wallbang
· 2 years ago
re: " ... having a long engineering queue due to limited engineering capacity in a bootstrapped company can actually save you"
I'd like to highlight Victor's post above - the funded web 2.0 community should take heed of that paragraph.
Bryce
· 2 years ago
Fred,
Thank you very much for the thoughts. I am left with the question, if business practices that extol the virtues of capital allocation, efficiency and a focus on the realities of the business model are hallmarks of success what value do pure financiers, without operational backgrounds, bring to an early stage entity other than capital?
Bryce
Mike
· 2 years ago
Let me comment on your quote
"I should also say that for businesses that don’t have the benefit of venture capital backing, the reverse is probably true. Almost certainly non-venture backed businesses will not have the ability to get too big too fast. They will mostly fail because they have the wrong business plan and they don’t have the wherewithal to survive for the period of time it takes to figure out the correct one."
I think this statement is a bit ignorant (and I mean it respectfully) of the process of bootstrapping. I've been bootstrapping for two years now and when you're a bootstrapper, you rarely have a business plan (as business plans are for getting money).
Generally, I think most bootstrappers start out with a fuzzy idea of where they want their product or service to go but end up taking it towards market segments where there is real, yet unexpected demand.
Mike
· 2 years ago
Let me comment on your quote
"I should also say that for businesses that don’t have the benefit of venture capital backing, the reverse is probably true. Almost certainly non-venture backed businesses will not have the ability to get too big too fast. They will mostly fail because they have the wrong business plan and they don’t have the wherewithal to survive for the period of time it takes to figure out the correct one."
I think this statement is a bit ignorant (and I mean it respectfully) of the process of bootstrapping. I've been bootstrapping for two years now and when you're a bootstrapper, you rarely have a business plan (as business plans are for getting money).
Generally, I think most bootstrappers start out with a fuzzy idea of where they want their product or service to go but end up taking it towards market segments where there is real, yet unexpected demand.
Allan Isfan
· 2 years ago
Fred,
What another great post! Cuts through the typical bull and over analyzed scenarios ... the value of knowing what actually matters. Reminds me of the "thin-slicing" concept discussed by Malcom Gladwell in Blink. It would be great if you could elaborate on this with some more specifics and examples. Of course, your loyal readers read this your blog to get some real advice but many of us are also trying to figure out how you think so that we can one day get funded by you. No surprise I'm sure.
The company I co-founded is presently bootstrapping in the media personalization space and launching an app in FB imminently. We have many features and tech development in the pipeline and they are popping slowly due to minimal resources. At the same time, we have the opportunity to white label our service (ASP) to a couple of media companies .... pretty darn proud of that for such a young company. White labeling brings its own development requirements. I know I could sign on more white label partners but am holding off because we won't be able to support more customers without growing beyond our boots. I struggle with this all the time. I've dreamed of signing on customers and now have to hold back. This is probably a good thing but somehow it doesn't feel that way.
Allan Isfan
· 2 years ago
I've been thinking a lot about this since the post came out. Being the CEO and co-founder of a young startup looking to raise money, this question is so crucial.
We've already gone down some dead-end alleys and am glad we were not funded at the time ... would have pulled the trigger in the wrong direction and would have been pressured to deliver the wrong thing. In my last start-up, we also re-vectored, and it paid off hugely.I totally get this ...
But something has been bothering me with the comments around failing fast. Things like "I look for reasons to give up" are really disturbing to me. Anything really disruptive and major requires people with balls that are willing to go against the grain and persevere. It isn't about the romantic aspects ... it just takes perseverance to do something hard. That's how I was brought up in the eastern block ... fight for what you believe in. Would google have ever existed? The list is long of companies that went against the grain and did something incredible.
I think the point of your blog was not give up or fail fast ... it is that it is important to run lean and hungry and keep looking until you get it right then go like stink. The trick is to really figure out when you have it right.
Michael Rivers
· 2 years ago
"So it’s pretty clear to me that most venture backed investments don’t fail because the business plan was flawed. In my experience at least 2/3 of all business plans we back are flawed."
Further to Shafqat's post I imagine that this may be the reason why microfinancers such as Y Combinator and Charles Rivers (and Y Europe and Seedcamp over here) have set up - to thrash the dust out of the business model, plan and product in a short, intensive period, with the benefit of hands-on experienced support. If done well, should reduce the risk of the above ...
Michael Rivers
· 2 years ago
For early-stage companies gaining market traction is often difficult, resulting in slower growth that disappoints.
Why does this happen? Not because the product or service is not ready or has no value....
From experience of working in, with and for technology-based businesses, one main reason is because the company's response (product, service) is a mismatch with one or several of: the nature of the need, the size of the pain, the value of the solution and the timing of its offering. But that is all relatively motherhood...
The second principal and often unadressed reason for failure is the lack of a sound approach to marketing (and no, I don't mean wasting money on PR and advertising...).
This starts with inaccurate understanding of the size, value and life of the market opportunity continues through indistinct positioning, undercooked market strategy and the lack of actionable plans to underappreciation of the strength of the competition, failure to understand why rates of adoption are slow and persuasion harder and, of course, unprofitable pricing.
So why does this happen? Well, in early stage companies there are those that build and those that sell - anyone else is generally considered an irrelevant and unacceptable overhead, right
(imho) Including an experienced strategic marketer (and the "VP of Sales and Marketing" is not this person) in the early-stage team will help the business to side-step some of these common mistakes. (Selling too early is a mistake - see scale/burn discussion).
Chris Blake
· 2 years ago
We all like to believe that backing past winners is a successful strategy. Unfortunately the evidence points in the opposite direction. One study by Carhart looked at every managed fund from 1962 to 1993. They top decile performers were tracked for the following years - to see if yesterday's winners are tomorrows' winners. In the second year more of the past years' top performers were in the top quartile again than the 10% that chance would suggest (but also 20% of them were in the last decile the following year!) But after this mild one year winners' effect there was no correlation at all. There are differences between picking stocks in mutual funds and backing start-ups with VC money. And yet we all believe in winners. The interesting question is why do we believe it when it isn't true. For a neat explanation you need to read Shefrin's coins thought experiment (Beyond Fear and Greed) for the interplay between luck and skill. There is always a lucky winner and we always assume its down to skill. Competence does play a part but you can't tell if the winner is skilful or lucky!
Rob McNealy
· 2 years ago
I cannot relate more to what you said about businesses so often having to "transform" or reinvent themselves. I also agree that investors need to be able to fail from time to in order for them to be real veterans.
Thanks for the great insight.
psychic readings
· 2 years ago
I dont have much experience in this field, but this was a great article to read.
Thanks :)
Case interview practice
· 2 years ago
Excellent article. Great reminder to start up entrepreneurs to keep burn rate low and be flexible to changes in the business model!
Difficult when you have a model that requires critical mass to prove itself! Good luck trying to solve the chicken and the egg problem?
Jeff Chavez
· 2 years ago
I really appreciated this post. I wanted my readers to see this also so I've provided a link to it from one of my recent posts:
having helped to start a number of successful VC backed companies, the concept of having a healthy skepticism regarding the market really resonates. Painfully, I have seen companies spend $50-70Mil on development based upon flimsy "customer interest" and a good set of PPT. Focusing on the marketing / sales element is something I believe too many founders just don't get.
For the next time around, I want a P.O. before any major investment!
Blake
· 1 year ago
All this time I have been a bootstrapper without knowing it?!
Starting without a traditional business plan is tough, but success can be had if you can stay afloat long enough (and pay attention to that which drives your market).
Zoorroyathy
· 1 year ago
Tahnks for posting
Jean-Claude Goldenstein
· 1 year ago
Thanks for the trip down memory lane yesterday Fred, I enjoyed your talk.
I agree with you that New York's tech community is "more connected to media and business." New York also is the capital of banking and real estate. I know you didn't have time to discuss yesterday but you and many others could on CREOPoint.com, a global community for professionals in that space.
I founded that company in April with former executives from E&Y, Citibank, Morgan Stanley, NAI, CNET and WPP as I believed that hundreds of thousands of people would need a place to reinvent themselves and the industry.
If you are intrigued by my story and plans, I'd love to get your views on how to best scale the business with a low burn rate.
All Comments
Seems to me, a key attribute of a successful VC is also to have learned the right lessons from failure. Often we tell ourselves it's OK to make mistakes, just don't make the same mistake twice. But people often do make the same mistake, over and over again. And it's often because they didn't learn the RIGHT lesson.
Once, I came in late to a HW development cycle. It was in serious shape and the others didn't even want to listen anymore. Eventually it failed, miserably, but not before I was able to take away part of the failure and something better from it. The lesson everyone else seemed to learn from it, though, was that you should never try to develop a new product. None of the same players would ever listen again to new product ideas the pain was so intense. Eventually the company failed altogether, because it had no new products and couldn't even integrate well.
So, learn the right lesson, then get up and go again.
Fred, thanks for sharing those experiences. I've been digging into exactly those issues with a few other folks, mostly from the social venture community. Where I'm looking now is into that area of exploring 'the dark alleys' quickly and effectively and how can investors get better at supporting entreprenuers/investees in doing that - e.g. what does that mean for board roles, practices, deal structures, tools etc.? Would love any ideas you have and will share what I come out with in my other conversations. Thanks again for sharing...
Thanks for this post Fred.
It seems to be there is an interesting contradiction between "Most venture backed investments fail because venture capital is used to scale the business before the correct business plan is discovered. " and the fact that 2/3rd of your successful businesses changed direction *after* being funded.
So how does this affect your investment decision. Do you go with the entrepreneur who has total confidence in a specific direction for the company, or do you do you go with the entrepreneur say with a great idea but who admits to not knowing yet the best direction (at the risk they might never find it, or just aren't ready for VC yet).
Or how else does this apparent dilemma affect your thinking when considering a deal?
Thomas,
"scale" is the key word. if you use your VC money carefully and keep your burn low until you've found the right model, then you can change direction after being funded and things work ok.
it's the situations where the VC money is used to step on the gas before you really know where you are driving to that causes the problems.
Fred
Fred, the speed-to-failure truth is key. One of the great joys of the digital age is rapid prototyping. Embrace the failure! I recall an ad headline I wrote years ago for an early solid modeler: "Hire us and fail in half the time." Fun stuff. Now, get out there and fail.
Great post Fred. I've always believe that sometimes not being around VCs and not having access to funding at an early stage may be a blessing in disguise. Bootstrapping, putting in that extra blood/sweat/tears, and making that last dollar go that extra bit further could be worth it. Necessity is the mother of invention, so it also could drive innovation. Of course, at some point we all need funding to take on the world, but in the meantime, we can always keep our head down and focus on the product, on being disciplined, and doing it because you still believe.
Fred,
I'm curious as to how your conclusion on finding the right market fit corresponds to VCs getting bigger and wanting to do bigger rounds. It would seem that model would be fundamentally flawed in locking entrepreneurs into larger investments with larger minimum expected return-- even Pee Wee needs to try to swing for the fences (and his stroke may not be ready).
I would think that your conclusions would lead VCs to stagegate investments at a lower level (almost like a farm team or something) where you help the promising companies gain enhanced access to the equivalent of table stakes, without getting the big infusion of cash that causes people to jack up burn rates before they're ready.
I'm on the other side of the equation bootstrapping the development of Health Shoppr (we help consumers differentiate and buy/book services from healthcare and wellness providers).
Given that I'm creating a marketplace, I probably have a 2 year marination period to build up the right consumer/provider networks to critical mass-- and I'm finding that there are few sources of patient capital looking to put in small amounts of capital to fund and test different milestones as we find out which pieces are early-adopter targets.
With my McK skillset, I can pull together cashflow from consulting work to pay for development myself, but how many others could afford to do this?
I'm seeing some movement in the model with Y Combinator and programs like Charles River's Quickstart, but I'm curious as to why investors think companies can just flip the switch to scale before the market's ready and expect these deals to succeed.
Very interesting, thanks for posting this.
But :)
Can you shed a bit more light on what "keeping burn low" means for you? As I see it, every investment that I take as entrepreneur is to step on the gas (go to market faster, increase sales faster, etc). The question is just how much pressure to put on the pedal. Enough to survive with the current investment and projected burn for a year? Six months? 2 years?
venture capital is used to scale the business before the correct business plan is discovered. That scale/burn rate becomes the cancer
Fred thanks for the really interesting insights into this. On the one hand they seem to make a lot of sense. However - and I hope this does not offend you - my working hypothesis is turning into this:
Winning VC firms are like winning stock pickers - they for the most part the ones that were at the right place at the right time and in some ways the lucky ones, but the win is NOT the product of conscious, clever, consistent application of any sets of rules.
(for what it's worth I also apply this rule to my own successes and failures in biz and life in general)
The interesting thing is that as with stocks when you use a performance record and then analyze things *after the fact*, as you are doing here, you don't find relationships between the past and the future. Many people think they *do* understand those past to future issues, but in the stock world this does not hold up to scrutiny. If it did, staggeringly huge returns await anybody with even very modest level of long term predictive power and a modest initial stake.
I'm open to disproving this, but note that there will *always* be a top tier of winners. What supports the hypothesis is that those winners change over time and past does not predict future (in Stocks - I'm not up on VC stats). I think VC may have more of a schmoozing human component than stock picking so that may play a role here. I've noticed from the few VCs I know how they are generally very bright and personable. Yet even this is somewhaat conspicuous given that average VC return is negative yet the average bright personable person is doing well.
Found about it on TechCrunch. I am now officially a fan of your blog. Great post. This what I said about it on TC:
“Most venture backed investments fail because the venture capital is used to scale the business before the correct business plan is discovered. That scale/burn rate becomes the cancer that kills the business.”
Agree. That and bad cash flow planning, which in a way, is the other side of the same coin.
Fred,
To me it just shows that you are investing in a team first. Then they can reinvent a business plan when required.
Wow Fred, you're on a roll. Great insight (which I blogged). One point I raise: while many investors may know about burn rate, they don't seem to follow this advice. A key problem: the "hit driven" and "portfolio" nature of the VC business gives investors a different set of incentives than entrepreneurs. (Paul Graham and others have written about this.)
So Fred, what constitutes a reasonable net burn, and for how long? Or better, what is a reasonable net burn ratio
net burn=expense - revenue;
net burn ratio= net burn/revenue (want it to get to zero ultimately)
I also like Steve Blank's take that more startups fail from a lack of customers than from a failure of product development. According to Blank, we have processes to manage product development, but no process to manage customer development. Emphasis should be on learning & discovery before execution or putting the pedal to the metal as you've mentioned.
Delving into dark alleys is all about learning & discovering from failures--quickly. Keeping the burn rate in check during the early customer discovery & validation phase is key to survival. I know this first hand having dealt with a runaway burn rate from my first startup in the late 90s. Once I had the burn rate under control, I was able to transform and adapt to successfully "bring the nose back up."
I am now in the trenches with my second startup. My #1 focus is to keep the burn rate in check while we get to product fit as quickly as possible.
Fred,
This is fantastic stuff. I worked for a company before which suffered from the problems you describe above. Excellent article.
Some good ideas never get to the VC stage! I have made quite a tour of the dilution system before finally realizing that my tried and tested, blue collar mobile messaging plan for automotive trades will have to be bootstrapped through working partnerships and equity sharing with developers.
A hard lesson learned. A lot of abuse taken at the hands of Junior partners.
http://bizcast.typepad.com/clients/vencap/index.html
Some good ideas never get to the VC stage! I have made quite a tour of the dilution system before finally realizing that my tried and tested, blue collar mobile messaging plan for automotive trades will have to be bootstrapped through working partnerships and equity sharing with developers.
A hard lesson learned. A lot of abuse taken at the hands of Junior partners.
http://bizcast.typepad.com/clients/vencap/index.html
Fred is the best. The key in my experience is giving up fast when the going gets tough; what does it generally mean when your product is tough to sell, it means your product is not superior, maybe even sucks. It's the exact opposite of "don't give up". My philosophy is to give up readily...I look for reasons to give up. The times when I have made money as an entrepreneur is when it was easy to sell my product to advertisers. The times when I lost money and wasted time was when I worked my hardest to sell product, canvassing prospect after prospect with my salesguys and our wares, but people weren't buying or not at the right CPMs or quantities (in my case advertising as I'm in the media business). The problem stems from this: The smarter to you are, the more difficult it is to admit your thinking was flawed and you were dead wrong initially. But the longer you wait, the more money/time you lose. My advice is to believe in your product less and desire money more. If something is validated by the market, there is no question of "belief" or reason to "believe", it simply is. All entrepreneurs should substitute the term "belief" with "speculate"; this will help you get away from a bad read on the market. When you "believe" your product or service will be a hit, you "speculate" that your product or servide will be a hit. It's easier to walk away from one's speculations than it is from one's beliefs. Business is not religion, it's a means to make money and show people how smart you are. Most people I know treat their product vision as a lottery ticket with a lot of hopes and wishful thinking behind it. It often seems most entrepreneurs value their product vision more than they value the money; this is what leads to faulty resource optimization. Would you rather have $8 million and have your vision realized fully or $10 million without realizing a single part of it, most would take 8 and that type of thinking usually results in 0 except for the very few. I am far more sentimental about my money (my money represents sweat, blood, and tears) than I am about any business I have been involved in (and ironically the brands I have founded are enthusiast media brands in the most fun categories). This is a good way to keep your emotions in check and hang on to your oxygen supply. Cut your losses, fire when necessary, and go as slow as you can, you'll know when to speed up. Be conservative, the act of starting a business is the riskiest thing you can do. Offset your initial risk assumption with total conservation.
We had a great product, great customers (Big 4 accounting, national consulting firms, millions in revenue) a great core group of developers and a great board. We took the first $25 million, hit the gas and burned a lot of it on worthless ventures that weren't related to the core business (EMEA and a West Coast acquisition). The second $25 million was to survive. We sold it too early and too cheaply because we, in a couple of our investors cases, were their only opportunity near-term liquidity event.
Fred:
I think it's great you started a dialogue regarding who's to blame for the failure of a startup venture. Share, and share alike, seems to be a reasonable place to .
Thanks for your insights on how best to view VC funding investments in light of failure, and success.
Happy Friday,
Anthony Kuhn
This is a great post, Fred.
What I'm curious about are cases like Friendster or some of the other VC horror stories where the venture capitalists were pushing the founders to spend the money at such a high rate.
Does this happen often?
i.e. I'm a founder; you just gave me $3million. But I tell you, I want to keep a slow burn rate until we have gone down a few of those dark alleys and finally found a sensible model. Maybe make a few key hires, but not the kind where VPs of X are just sitting around twiddling their thumbs & building powerpoints, because the product/service isn't ready or fully flushed out yet. (seen this first hand several times)
And if you don't do this (pressure to burn), have you seen it among other VCs much? =)
Thank you, Fred. In Arizona, where I work, there is very little capital and we (Stealthmode Partners) help our companies bootstrap. They hate it. They beg to go for funding. I flat out tell them they can't get it most of the time, because they can't.
However,every once in a while, I send a guy who needs $1m to a VC in Silicon Valley. Always in the meeting, the guy comes out thinking he needs $5m because the vision has grown/changed when the VC inserts his own idea o where the market is.
The blame goes equally: entrepreneurs who think money makes success, and VCs who want to give them too much money too soon.
Really great post and great comments! It is so true about having to go down several dark alleys, figuring out the dead-ends, and moving on fast. It's much harder to do when bootstrapping.
I liked Alan's points about 'the reasons to give up' and give up quickly. It is hard to do because as entrepreneurs we become really enamored of our company and its products. However, having observed the success of several companies many do not sell now (or have the same strategies) as when they first started. It's important also, to get out there with something and start testing the waters to see what works and doesn't...bootstrappers just don't have the financial wherewithal to keep doing that for long!
To Anthony's point...having been a founding CEO back in the late 90's I saw a push by VCs to burn money. They didn't want you to be conservative even if you felt you should be. Several discussions arose among my founding peers that this was a tactic by some VCs to push through the money fast that the Company would have to go ask them for more thereby giving up more of the company. It's kind of a jaded view but isn't it funny how different people view the same situation?
Fred, thanks for sharing your perspective! The 2 hour bike ride(s) help a crunch, er, bunch.
Re: "...going down lots of dark alleys..."
In 1987 (eighty seven!), I visited San Francisco promoting a software app I developed. So many smiles with completely blank stares. The worldwide market I passionately spoke of wasn't born until 1997-99. Ten years...
I remember visiting with one known VC in his home. He watched me demo my product. His eyes lit up and he stopped me. He excitedly asked me if the feature he was looking at was done? He wanted to know if I could strip it out as a stand alone product? I foggily remember him saying he'd fund me immediately if I answered yes.
I answered no. No doubt I could do what he wanted, but it didn't make sense to me based on my business plan, the plan never funded. The VC continued on to develop his app. I continued on making a business succeed in a tiny ski town, selling my app to a niche national market, cashing out in 1996. This app was re-acquired a few times, continuing on to this day selling to a larger niche market.
Today, in my ninth year of developing a new app, I learned quickly to describe it as organic - one mistake layering another upon another - watching the growing humus with humor. I don't have a business plan. I don't have an income model. I don't have a single customer. I don't know when I'll cash out. I live simply and ride my bike a lot. The market I need has arrived, and this time society is passionately speaking up, demanding, hmmm, change. Perhaps I'll know the model in 2009 - ten years again...
Michael ;)
ps: The VC's app? A networked contact /calendar. He cashed out but the app failed. Enter web 2.0, and we still have the idea cashing out, but failing. wuwt?
Great post Fred, thanks for sharing. The idea of numerous dark alleys points to the other key to success and that is in any venture investment you are betting on the quality and ability of management. They must be able to not only have the vision to conceptualize the intial product but execute the plan to realize it and if necessary - all those dark alleys - shift that plan into a new vision. The bet is as much on management as on product.
In most cases, having too much money in any business, startup or not, will lead to bloat.
If you are bootstrapped you will ultra-prioritize your goals. One thing I have noticed time after time is that having a long engineering queue due to limited engineering capacity in a bootstrapped company can actually save you. When the 3-6 months roll by and you look back at the jobs in the queue, half of them don't make any sense anymore, yet if you had the capacity, you likely would've pushed them all out- much of it garbage.
Secondly - And I think it was Lucille Ball who once said never ask anyone who is not busy to do a job for you. Well, guess what. More cash, means everyone has assistants, longer lunch hours, and shorter working days. Most company's could probably lop off 1/3 of their staff and get more done if they could only bite that bullet and take the leap of faith. People often work better under tighter conditions, they collaborate better, they don't have to go through 3 layers of management, and generally feel they can personally move the needle, which is rewarding to most.
Stay lean, be a boot-strapper. Once you build up a value, then go sell equity at a premium.
re: " ... having a long engineering queue due to limited engineering capacity in a bootstrapped company can actually save you"
I'd like to highlight Victor's post above - the funded web 2.0 community should take heed of that paragraph.
Fred,
Thank you very much for the thoughts. I am left with the question, if business practices that extol the virtues of capital allocation, efficiency and a focus on the realities of the business model are hallmarks of success what value do pure financiers, without operational backgrounds, bring to an early stage entity other than capital?
Bryce
Let me comment on your quote
"I should also say that for businesses that don’t have the benefit of venture capital backing, the reverse is probably true. Almost certainly non-venture backed businesses will not have the ability to get too big too fast. They will mostly fail because they have the wrong business plan and they don’t have the wherewithal to survive for the period of time it takes to figure out the correct one."
I think this statement is a bit ignorant (and I mean it respectfully) of the process of bootstrapping. I've been bootstrapping for two years now and when you're a bootstrapper, you rarely have a business plan (as business plans are for getting money).
Generally, I think most bootstrappers start out with a fuzzy idea of where they want their product or service to go but end up taking it towards market segments where there is real, yet unexpected demand.
Let me comment on your quote
"I should also say that for businesses that don’t have the benefit of venture capital backing, the reverse is probably true. Almost certainly non-venture backed businesses will not have the ability to get too big too fast. They will mostly fail because they have the wrong business plan and they don’t have the wherewithal to survive for the period of time it takes to figure out the correct one."
I think this statement is a bit ignorant (and I mean it respectfully) of the process of bootstrapping. I've been bootstrapping for two years now and when you're a bootstrapper, you rarely have a business plan (as business plans are for getting money).
Generally, I think most bootstrappers start out with a fuzzy idea of where they want their product or service to go but end up taking it towards market segments where there is real, yet unexpected demand.
Fred,
What another great post! Cuts through the typical bull and over analyzed scenarios ... the value of knowing what actually matters. Reminds me of the "thin-slicing" concept discussed by Malcom Gladwell in Blink. It would be great if you could elaborate on this with some more specifics and examples. Of course, your loyal readers read this your blog to get some real advice but many of us are also trying to figure out how you think so that we can one day get funded by you. No surprise I'm sure.
The company I co-founded is presently bootstrapping in the media personalization space and launching an app in FB imminently. We have many features and tech development in the pipeline and they are popping slowly due to minimal resources. At the same time, we have the opportunity to white label our service (ASP) to a couple of media companies .... pretty darn proud of that for such a young company. White labeling brings its own development requirements. I know I could sign on more white label partners but am holding off because we won't be able to support more customers without growing beyond our boots. I struggle with this all the time. I've dreamed of signing on customers and now have to hold back. This is probably a good thing but somehow it doesn't feel that way.
I've been thinking a lot about this since the post came out. Being the CEO and co-founder of a young startup looking to raise money, this question is so crucial.
We've already gone down some dead-end alleys and am glad we were not funded at the time ... would have pulled the trigger in the wrong direction and would have been pressured to deliver the wrong thing. In my last start-up, we also re-vectored, and it paid off hugely.I totally get this ...
But something has been bothering me with the comments around failing fast. Things like "I look for reasons to give up" are really disturbing to me. Anything really disruptive and major requires people with balls that are willing to go against the grain and persevere. It isn't about the romantic aspects ... it just takes perseverance to do something hard. That's how I was brought up in the eastern block ... fight for what you believe in. Would google have ever existed? The list is long of companies that went against the grain and did something incredible.
I think the point of your blog was not give up or fail fast ... it is that it is important to run lean and hungry and keep looking until you get it right then go like stink. The trick is to really figure out when you have it right.
"So it’s pretty clear to me that most venture backed investments don’t fail because the business plan was flawed. In my experience at least 2/3 of all business plans we back are flawed."
Further to Shafqat's post I imagine that this may be the reason why microfinancers such as Y Combinator and Charles Rivers (and Y Europe and Seedcamp over here) have set up - to thrash the dust out of the business model, plan and product in a short, intensive period, with the benefit of hands-on experienced support. If done well, should reduce the risk of the above ...
For early-stage companies gaining market traction is often difficult, resulting in slower growth that disappoints.
Why does this happen? Not because the product or service is not ready or has no value....
From experience of working in, with and for technology-based businesses, one main reason is because the company's response (product, service) is a mismatch with one or several of: the nature of the need, the size of the pain, the value of the solution and the timing of its offering. But that is all relatively motherhood...
The second principal and often unadressed reason for failure is the lack of a sound approach to marketing (and no, I don't mean wasting money on PR and advertising...).
This starts with inaccurate understanding of the size, value and life of the market opportunity continues through indistinct positioning, undercooked market strategy and the lack of actionable plans to underappreciation of the strength of the competition, failure to understand why rates of adoption are slow and persuasion harder and, of course, unprofitable pricing.
So why does this happen? Well, in early stage companies there are those that build and those that sell - anyone else is generally considered an irrelevant and unacceptable overhead, right
(imho) Including an experienced strategic marketer (and the "VP of Sales and Marketing" is not this person) in the early-stage team will help the business to side-step some of these common mistakes. (Selling too early is a mistake - see scale/burn discussion).
We all like to believe that backing past winners is a successful strategy. Unfortunately the evidence points in the opposite direction. One study by Carhart looked at every managed fund from 1962 to 1993. They top decile performers were tracked for the following years - to see if yesterday's winners are tomorrows' winners. In the second year more of the past years' top performers were in the top quartile again than the 10% that chance would suggest (but also 20% of them were in the last decile the following year!) But after this mild one year winners' effect there was no correlation at all. There are differences between picking stocks in mutual funds and backing start-ups with VC money. And yet we all believe in winners. The interesting question is why do we believe it when it isn't true. For a neat explanation you need to read Shefrin's coins thought experiment (Beyond Fear and Greed) for the interplay between luck and skill. There is always a lucky winner and we always assume its down to skill. Competence does play a part but you can't tell if the winner is skilful or lucky!
I cannot relate more to what you said about businesses so often having to "transform" or reinvent themselves. I also agree that investors need to be able to fail from time to in order for them to be real veterans.
Thanks for the great insight.
I dont have much experience in this field, but this was a great article to read.
Thanks :)
Excellent article. Great reminder to start up entrepreneurs to keep burn rate low and be flexible to changes in the business model!
Difficult when you have a model that requires critical mass to prove itself! Good luck trying to solve the chicken and the egg problem?
I really appreciated this post. I wanted my readers to see this also so I've provided a link to it from one of my recent posts:
http://northstarthinktank.typepad.com/northstar_thinktank/2007/06/the_founders_fu.html
Keep up the good work!
Jeff
having helped to start a number of successful VC backed companies, the concept of having a healthy skepticism regarding the market really resonates. Painfully, I have seen companies spend $50-70Mil on development based upon flimsy "customer interest" and a good set of PPT. Focusing on the marketing / sales element is something I believe too many founders just don't get.
For the next time around, I want a P.O. before any major investment!
All this time I have been a bootstrapper without knowing it?!
Starting without a traditional business plan is tough, but success can be had if you can stay afloat long enough (and pay attention to that which drives your market).
Tahnks for posting
Thanks for the trip down memory lane yesterday Fred, I enjoyed your talk.
I agree with you that New York's tech community is "more connected to media and business." New York also is the capital of banking and real estate. I know you didn't have time to discuss yesterday but you and many others could on CREOPoint.com, a global community for professionals in that space.
I founded that company in April with former executives from E&Y, Citibank, Morgan Stanley, NAI, CNET and WPP as I believed that hundreds of thousands of people would need a place to reinvent themselves and the industry.
If you are intrigued by my story and plans, I'd love to get your views on how to best scale the business with a low burn rate.
Best, JC