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Startup general interest

Pre-seed investments work best when there’s a clear plan for short term value creation

By | Forward Partners, Startup general interest | One Comment

Most VCs will say that to evaluate deals they look at the market size, the product and the quality of the team. Different investors place different weights on the three elements but as a rule earlier stage investors place more emphasis on the team and later stage investors place more emphasis on the market. That’s because early stage companies find it easier to change their market than their team whilst later stage companies find it easier to change their team than their market.

Some very early stage investors go as far as to say that for them team is everything. If the founder is great that’s all they need to know to write a cheque. At Forward Partners we don’t go that far. We always say that the minimum requirement to back a company is a great founder AND a great idea, then for us a great idea encompasses an inspiring product vision in a large market.

Breaking that down a little further, what we’ve learned over the three and a half years we’ve been operating is that our pre-seed investments work best when the ‘great idea’ includes a clear plan for value progression in the first six months. In the sectors in which we invest that nearly always means building momentum with customers. Completing product development and hiring team members definitely helps, but it’s dangerous to assume that will be valued by new investors.

With seed stage investments and later it’s usually obvious how value will be created – by maintaining current growth in revenues or engagement. Hence spending time thinking hard about short term value creation is mostly a discipline for the pre-seed stage.

This week our thinking was put to the test by a highly competent serial entrepreneur with a great team who has a strong idea in a large market but who has yet to build out a clear plan for driving value in the short term. We compared his case with a couple of others in which we’ve invested where the short term plan was much clearer but the longer term thinking was hazier and decided we prefer the latter.

Here’s why.

Given time great entrepreneurs will find their way to big opportunities. The question then becomes “how do we give them the greatest chance of having enough time?”. The best answer to that is to generate the short term momentum which will allow them to raise more money and buy more time to navigate to the big upside. If the short term momentum doesn’t arrive then either the next round will be difficult or the company will fail – both outcomes we seek to avoid.

With most things in life, if you plan for it you are more likely to get it, and generating the momentum required to create value in the short term is no exception.

 

Fear of failure can be a good thing, absence of courage never is

By | Startup general interest | 3 Comments

Last night at FPLive I was chatting with an entrepreneur called Nick who has just closed his startup. He talked impressively about what he’d learnt and has an interesting idea for his next company which I am keen to investigate.

There’s an important point lurking in there. He has just failed with his first company but that isn’t putting us off looking at his second. In fact, the lessons he’s learned help his case.

It doesn’t happen as much as it used to but people still talk about the ‘fear of failure’ as being a much more acute problem here in the UK than it is in America, and how that dissuades people from starting companies and holds our startup ecosystem back. That talk gets my back up a bit, partly because fear of failure is rational (it hurts), but mostly because it becomes a self fulfilling prophecy – would be entrepreneurs hear that fear of failure holds our startup ecosystem back which makes them think that failure is more likely and deters them from starting their company.

Returning to my conversation with Nick. He has been working with a large corporate innovation lab and we were talking about what large companies can do to hold onto the entrepreneurs in their ranks and harness their creative power. Getting the incentives right is a big topic, covering 1) how much money they should be allowed to make, 2) how much control they should have and3) what should happen if they fail.

As an investor who’s worked with lots of entrepreneurs I know that if the aim is to retain the best talent the answer to the first two parts of this have to be 1) they can make an awful lot of money and 2) they need to be given control of their startup.

Prior to last night my view on the third point was that companies should make it easier for their employees to be internal entrepreneurs by guaranteeing their jobs in the event of failure. Now I’m not so sure. Nick pointed out that fear of failing is often highly motivating. When your back is up against the wall you are more likely to be out of bed at 6am fixing things, morel likely to burn the midnight oil, and generally more likely to keep battling when the odds start to look impossible. What he has seen is that when people can walk back to their old jobs they are less afraid of failing, that they work fewer hours, and that they give up on the startup idea more easily.

So my emerging view is that fear of failure is not really the problem here. Rather I think we should be working on the other side of the equation – courage. More specifically – how do we help people muster the courage to start companies, even when they understand that painful failure is a possibility.

Strong convictions, weakly held

By | Startup general interest | No Comments

I first came across the phrase “strong convictions, weakly held” through Marc Andreessen, but a bit of Googling showed me it was originally coined by Paul Saffo, then Director of the Palo Alto Institute for the Future. According to this post he advised his people to think this way for three reasons:

  • It is the only way to deal with an uncertain future and still move forward
  • Because weak opinions don’t inspire confidence or action, or even the energy required to test them
  • Because becoming too attached to opinions undermines your ability to see and hear evidence that clashes with your opinion (confirmation bias)

Saffo came up with this logic almost 15 years ago, and as change happens faster and faster it has become increasingly compelling, to the extent that the importance of having “strong convictions, weakly held” is starting to become somewhat of a cliche amongst many of the best investors I know.

However, it applies to the whole startup world, not just investing. In fact it applies to anyone who is (or should be) searching for the truth, or more properly the closest approximation we can get to it. Much of the time in startups we have to make decisions based on minimal information in an environment that is fast moving and where there is no objectively ‘right’ answer. The best we can do is form an opinion based on the facts in front of us and then have the courage to act on that opinion. Then, and this is often the most difficult bit, we must find the courage to change our opinion if new information suggests we were wrong.

When investing as a VC that means quickly deciding which companies make attractive prospects, having the courage to divert time from other prospects to dive in and investigate them thoroughly, then having the courage to advocate them to our partners, then continuing to be courageous by continuing to search for reasons why a deal might not make sense, and then (if necessary) having the courage to say “I was wrong about this, I don’t think we should invest in this company after all”. This last part is tricky because it requires us to park our ego on the side of the road at a time when we’re already feeling bad about our wasted work and the lost opportunity. What makes it particularly hard is that often the reasons we find for not investing are ones that in hindsight should have been obvious earlier on.

I chose investing as an example because that’s the world I know best, but I could equally have chosen startup product decisions, marketing strategy, choice of tech stack, or hiring decisions. These are all areas where the best people have an ability to form strong opinions quickly and then remain open minded.

Note how this process is about a disciplined search for the best truth that we can find. That search is undermined when ego gets in the way and opinions get entrenched, which is the more natural human behaviour. Our confirmation bias makes us look for supporting data and makes us blind to counter arguments. In the best case this path leads to poorer decisions and in the worst case it results in conflict where protagonists read different sources of information and quote orthogonal facts at each other.

Ultimately it’s the job of founders, CEOs and leaders at every level to build a culture where people have the self confidence and courage to put themselves out there by forming strong opinions quickly and where it’s ok to change your mind later. Leading by example is crucial (as ever) but it’s also important to foster an environment where everyone’s opinions are respected and given space. We make ourselves vulnerable when we express an opinion, especially a strong one, and if we get shut down or dismissed it’s harder to find the courage to do it again the next time.

In defence of liquidation preferences

By | Startup general interest | No Comments

I just read a New York Times article that led with the sentence “Deep inside a Silicon Valley unicorn lurks a time bomb”. It turns out that ‘time bomb’ is the much maligned and, I suspect, little understood, liquidation preference.
To be clear, liquidation preferences are sometimes used badly and founders should generally turn away from investors who ask for multiple liquidation preferences. Additionally, they introduce a small amount of complexity and an element of misalignment between the investor and the common stock holder (usually the founder).
For these reasons our investments at Forward Partners are always in ordinary shares.
However, most of the later rounds or companies raise feature simple 1x liquidation preferences and we’re fine with that. To explain why I’m going to look at the role liquidation preferences play in getting deals done.
In any negotiation it’s helpful to look for ways in which the counterparties see things differently to reach other. These differences create the space for win-win solutions and without them negotiations are a zero sum game.
Liquidation preferences are a useful tool because they exploit a difference in the way investors and management see the future. Generally speaking management teams have more confidence in their success than investors do. Not by much, but by enough that it makes sense for them to accept a liquidation preference in exchange for a higher valuation. That trade gives them less dilution and therefore more cash in upside scenarios but less cash (and potentially nothing) in extreme downside scenarios.
This trade off is now so entrenched that it’s become a market standard that most investors and founders make unconsciously, but they are all aware of the implications. Moreover, in the rare situation where investors offer a choice management almost always go for the higher valuation.
Furthermore, provided the instrument is kept simple (i.e. a 1x non-participating preference share) and the company is successful enough to raise a couple of million or more the complexity and misalignment are more than manageable. Then as companies get towards unicorn status management and investors get increasingly sophisticated and their ability to exploit more complex instruments increases.
None of this is to say that some companies haven’t been overvalued and that liquidation preferences haven’t contributed, but it doesn’t sound like a ‘time bomb’ to me.

Automotive data – believe the hype?

By | Startup general interest | One Comment

McKinsey have just released a report which predicts:

that the global revenue pool from car data monetization could be as high as $750 billion by 2030

That caught my attention for two reasons. Firstly $750bn is a truly huge market to come out on nowhere. For context Gartner predicts the wearables market will be $29bn this year (including Fitbit and smart watches). Secondly, in my experience it’s hard to make money out of data that’s produced as a by-product of another service, at least directly. Lots of startups have ‘sale of data’ lines in their business plans and they very rarely come to much. Rather, the way most companies make money out of the data their service produces is to use it to build better products – the way Google uses our search data to sell better advertising (and build a better search product).

The excitement is coming because cars, particularly electric cars, are increasingly connected and will generate huge amounts of data. To their credit McKinsey developed 30 use cases for automotive data. Most of the aforementioned startups don’t go that far. They just assert that their data will be worth something to somebody.

However, the excitement doesn’t make it much beyond that. Some of the use cases McKinsey lists out are interesting (predictive maintenance, usage based insurance), some a bit so-so from a revenue perspective (emergency call service, over the air software add-ins) and some are merely enabled by internet in the car (car pooling, in-car hot spots).

There isn’t much in the report on how they get from these use cases to a $450-750bn market. There are around 1.2bn cars on the road now so that would be $375-625 per car – which is quite a lot. The most obvious way that will happen is if a chunk of the maintenance and insurance markets start to become counted as part of this total.

That’s already starting to happen, particularly on the insurance side. Overall, I haven’t found the new opportunities I hoped I might when I read the report’s $750bn headline figure.

 

How aggressive should your business plan be?

By | Startup general interest | 2 Comments

I was talking with an old friend on Friday about the fundraising pitch for his startup and how his conversations with VCs were progressing. He’s got a great business and I think he will get his round away, but he felt that he was losing some potential investors because they weren’t buying into the upside of his story.

We discussed how he could add a slide making a better link from his impressive recent results to his vision of the endgame and I hope that will make a difference. We also talked about his personal style. He’s low-key and likes to present plans he feels sure he can deliver, and he has a tendency to caveat the upside. The danger with this approach is that investors are used to a punchier presentation style and assume that if the entrepreneur isn’t punchy, the upside is less likely to be realised. As an investor I feel the same way. I know that there are some founders who successfully under-promise and over-deliver, but the majority of successful founders are the other way around – they have a tendency to over-promise.

Since then I’ve been thinking about how aggressive founders should make their business plans. Here are some guidelines:

  • VCs want to back aggressive plans. That means your growth should be as rapid as possible.
  • The plan must be believable – you must believe it is deliverable.
  • Investors expect most of their investments to fail, and that nearly all under-achieve initial plans. If when you look at it objectively you have a 30-50% chance of hitting yours that’s more than enough – although you should believe in your gut that it’s much more certain than that.
  • You should believe more strongly in the first couple of years than in the out years. If you deliver over 24 months opportunities will almost certainly open up.
  • It’s important to show the path from today to the big upside. A series of big steps with no risky big leaps works best.
  • Increasing your financial projections in the expectation that investors will discount them falls foul of the earlier points, and undermines trust.

It’s common for entrepreneurs to start with a big endgame that they think will work for VCs and then work backwards to build a plan that gets there. If you’re going to take that approach then make sure the plan is credible, as per the advice above. If not think about a smaller goal and perhaps different types of investors.

 

Uncertainty: startups’ unfair advantage

By | Startup general interest, Uncategorized | One Comment

I just read a review of a new Wiley book Design a better business which argues that:

better businesses are ones that approach problems in a new, systematic way, focusing more on doing rather than on planning and prediction

For them, of course, the point is that design thinking is that ‘new, systematic way’, but this sentence made me think of startups, where the emphasis is very much on doing rather than planning. Since Eric Ries wrote The Lean Startup in 2011 smart founders have understood that the best way to progress is to get onto the ‘build-measure-learn’ loop and iterate to success. That’s doing rather than planning.

Whilst doing rather than planning has been a hugely successful tactic for entrepreneurs and their investors, before I go any further I want to note that as with everything you can take it too far. To get the best chance of achieving huge success, and avoid getting stuck at a local maxima, a certain amount of thinking should be done before building starts. There’s a balance to be struck and whilst best practice is definitely to maintain a bias towards action in our experience an increasing number of f0unders are starting to build product before they’ve done enough thinking, sometimes encouraged by investors who want to play with product before they invest. Many of these founders end up failing when with a little more customer research they might have built a slightly different product which would have resonated much better and allowed them to iterate to success.

The reason that Design a better business advocates doing rather than planning is that the world is becoming increasingly uncertain. Consumer habits, technologies, and other trends are uprooting once-thriving businesses and disrupting entire markets with an ever increasing cadence. In this environment every year gets more difficult for those who like to plan, whilst it gets easier for those with a bias to action.

The increasing engagement of big business engagement with the startup ecosystem through accelerator programmes, incubators and acqui-hires is a reaction to this trend. However, these small-scale programmes don’t solve the fundamental challenge of every business leader, which is deciding which actions to endorse. At good startups it’s easy (or easier..), all action is directed towards achieving their vision. Larger companies have a much more difficult challenge. They need to launch new products, attack new markets, or take radical steps to defend existing revenues, they can only put significant resources behind a small number of projects, and anything that won’t reach the scale to impact their financial statements isn’t worth doing. Historically planning has been the tool they used to figure out which projects have the best chance of moving the needle for them, but as planning is becoming less effective they have increasingly less confidence that putting resources to work will generate the scale of returns required.

That’s a problem startups don’t have. At least not to the same degree. Most founders want their companies to be huge successes, but if it turns out to be a medium sized success that’s still a worthwhile endeavour. A business that grows to £10m in revenues over five years and sells for 1-3x that amount can still be a life changing event. For large companies that’s not the case. If a £200m turnover business goes after a new market and it only adds £10m to the top-line after five years the project will not have been worth the effort.

 

This is one of the reasons why companies are increasingly buying back shares instead of re-investing profits.

In summary, increasing uncertainty is an unfair advantage for startups. And it’s an advantage that gets stronger every year.

The learning and growth trade off

By | Startup general interest | One Comment
I’ve finally got round to reading Andy Grove‘s High Output Management, widely regarded as a classic on management that was originally published in 1983. The Foreword to the latest edition is written by Ben Horowitz of A16Z fame and includes the following paragraph:
As he describes the planning process Andy sums up his essential point with this eloquent nugget of wisdom: “I have seen far too many people who upon recognising today’s gap try very hard to determine what action has to be taken to close it. But today’s gap represents a failure of planning sometime in the past.” Hopefully, the value of this insight is not lost on the young reader. If you only understand one thing about building products, you must understand that energy put in at the beginning of the process pays off tenfold and energy put in at the end of the program pays off negative tenfold.
Ben’s point is that investing time in proper planning pays huge dividends when building products. In practice that means not simply growing as fast as possible, but taking time out from focusing on growth to find and iron out issues that might slow growth in the future. In startups that entails diverting resources to learn from customers, learn from data (including building the tooling to extract data), and to think deeply about product.
Finding the right trade off between growth and learning isn’t easy and is a debate we come back to time and time again at Forward Partners in the context of individual partner companies we are working with. There’s no universally applicable answer, but here are some guidelines from our experience:
  • Growth is the biggest driver of value. Once revenues are established, then maintaining some level of growth is hugely important. If you’re not growing investors will assume that’s because you can’t grow.
  • If you have venture scale ambitions in your first year but have less than 20% month on month growth, picking up the pace should be the priority.
  • Once there’s enough growth to hit the milestones needed for the next round then you have the luxury of diverting resources to learning.
  • In a high growth scenario, tell-tale signs like falling conversion, worsening engagement and increasing churn are signs that the trade off between growth and learning is too skewed towards growth.

It’s more common to see founders insufficiently focused on growth than it is to see them insufficiently focused on learning, but we definitely see both.

How we can find our ‘flow’

By | Startup general interest, Uncategorized | 2 Comments

the-flow-channel

‘Flow’ is the almost magical state of extreme creativity and productivity. Most often associated with artists and developers, but I believe applies to a lesser extent to all of us.

What follows is an extract from How anyone can enter flow state for maximum focus. I wanted to get these tips for enabling ‘flow’ down in one place that I can refer back to.

If you want more detail on what ‘flow’ is from a neurological perspective or much more detail and colour on the subject generally then please read the article above. It’s good. The most important point for me is that the more people work in a flow state, the more productive and happy they are.

These tips work for individuals and managers.

  • Find work that is in the ‘flow channel’ – flow only comes after a struggle with a difficult task, so the work should be stretching enough that it’s genuinely challenging, but not so difficult that it  creates fear that ultimately blocks creativity. This is a matter of balance – some boring work is inevitable in all day to day roles, but too much creates disengagement.
  • Create the right environment – all necessary tools and information should be at hand, to minimise distractions and excuses for not focusing on the task in question.
  • Remove distractions – Slack, emails, team meetings, colleagues wanting a quick chat and a cluttered desk all detract from focus, making it harder to enter flow state. Again, this is a matter of balance, but eliminating necessary distractions and giving people long periods of uninterrupted time will help. Permitting people to say ‘don’t interrupt me now’ is a good trick, maybe just by wearing headphones.
  • Break difficult tasks into smaller chunks; my dad used to love the following joke: Q. “How do you eat an elephant?” A. “One steak at a time”. Now that’s chunking! It’s an old productivity hack, but very relevant here because it helps break through the struggle.

 

Sports fans, founders and the psychology they share

By | Startup general interest | No Comments

I just read an old post by Nir Eyal about The psychology of sports: How sports affect your brain. Nir makes the point that our obsession with sports is weird. Writing at the time of the 2012 London Olympics he said:

“This week, fans packed stadiums in London wearing their nation’s colors like rebels ready for battle in Mel Gibson’s army. They screamed with excitement and anguished in defeat. Many paid thousands of dollars to travel around the globe to be there.

Among those who did not attend, 90% of people with access to a television tuned-in during past Olympics. In 2008, that was 2 out of every 3 people on the planet.

What the hell is going on here? How do sports engage, delight, and motivate people to put their lives on hold and become totally engrossed in watching other people play games?”

I’m sure you can think of plenty of other examples of sports fandom producing highly unusual behaviour too. The one that leaps immediately to mind for me is the tens of thousands of Chelsea FC fans who descend on London’s Fulham Road for every home game, wearing team colours and singing songs that we wouldn’t dream of singing anywhere else (I have a Chelsea season ticket).

Why do people do this?

Nir says it’s because the combination of hope and variable rewards is a dizzyingly powerful cocktail for the brain. We all know that hope sells and is a powerful motivator, and as Nir has been saying for some years variable rewards are addictive because they kick the brain’s dopamine system into high gear. That’s why people play slot and fruit machines for so long.

Entrepreneurship is the same.

Except 10x.

The hope is much greater. The promise of changing the world and making millions of dollars is way more exciting than winning a football game. And the variation in rewards is much greater too. I’ve felt the highs and lows of football fandom, waking up the morning after a game instantly excited or groaning depending on what happened the day before, but that’s nothing compared to the euphoria that comes when a startup is doing well or the gut wrenching stress when it isn’t.

This psychology also explains why it’s so important for entrepreneurs to remain positive. If the hope goes, the motivation goes too, and then it’s a downward spiral. When things don’t go according to plan, balancing the need for positivity with the need for realism is one of the most difficult tasks founders face.