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Startup general interest

Uncertainty: startups’ unfair advantage

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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

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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’

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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

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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.

Monetisation: Why it matters

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I read two great posts advising founders on fundraising this morning. The first was a deck with pointers on fundraising from Jason Friedman of LionBird, which made two points I want to pick out and expand on (the rest of the deck is great too, and well worth a full read):

  • 60% of fundraisings take three months or more (slide 2). “How long should I leave to raise my round?” is a question founders ask us all the time and we always answer 3-6 months. Sometimes we get pushback from people who have had success raising in shorter times than that in the past, and the data shows that 40% of companies don’t need three months. However, it’s advisable to hope for the best but plan for the worst and give yourself three months or more. A couple of quick additional points: people with strong investor relationships need less time to raise; the data in the slide is for the US where fundraising times are shorter than in the UK.
  • Few companies have the luxury of holding off on meaningful monetisation (slide 40). This is another one that comes up a lot. Investors like to see evidence that the revenue strategy works because it removes a major risk in the business (that nobody will pay) and because it improves capital efficiency and hence investor returns. There are, of course, a number of highly successful startups which put off monetisation for years, but they are a tiny minority of venture backed companies characterised by extremely rapid growth in huge potential markets. We all believe passionately in our companies, but unless they can genuinely be the next Facebook, Twitter or Google, early monetisation is advisable.

The second post was on evolving fundraising milestones for SaaS companies from Ash Fontana and Mark Gorenberg of Zetta Ventures. Again, lots of solid advice and well worth a full read. I’m going to pull out the point they made about partnerships:

Partnerships are a distraction before the seed stage [defined as a $2-5m raise]. However, companies can leverage a few key marketing partnerships with complementary product companies to get enough traction to raise a Series A.

It’s super common for founders to spend time pursuing partnerships very early in the life of their companies and super rare for them to make any difference to revenues. Ash and Mark are spot on to advise ignoring partnerships before Seed and to then only focus on targeted partnerships until after Series A. This point hasn’t been spoken about enough and I’d advise all founders to consider it carefully to avoid misallocating their time.

Helpful cognitive biases and their interplay with rational thought

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In November 2013 I saw the headline Five cognitive distortions of people who get stuff done, and thought “wow – all the cognitive biases I know get in the way of rational thought and are unhelpful”. My surprise at finding that irrational thought could be useful prompted this post at the time.

Since then I’ve been on a (slow) journey to understand the interplay between intuition and rational thought, particularly helped by Daniel Kahneman’s Thinking Fast and Slow and Richard Haidt’s The Righteous Mind. I wrote a number of other blog posts too, most notably Thinking fast and slow at a VC fund, Debating with intuition as well as logic, and How our rational brains justify our intuitive decisions.

The more recent posts are mostly about recognising the role intuition plays in our decision making and how to counter it when appropriate. My understanding of the importance of intuitive thinking was limited to the fact that it helps when decisions need to be faster.

Then this morning I read How Our Delusions Keep Us Sane: The Psychology of Our Essential Self-Enhancement Bias on brainpickings. It took me right back to the November 2013 ‘aha moment’ that in the right places and right doses irrational thought makes us happier and more successful. The article opens with the following paragraph:

“Optimism is the faith that leads to achievement; nothing can be done without hope,” Helen Keller wrote in her 1903 treatise on optimism. But a positive outlook, it turns out, isn’t merely an intellectual disposition we don — it’s a deep-seated component of our evolutionary wiring and the product of powerful, necessary delusions our mind is working around-the-clock to maintain. At the root of that mental machinery lies what psychologists have termed the self-enhancement bias — our systematic tendency to forgo rational evaluation of our own merits and abilities in favor of unrealistic attitudes that keep our ego properly inflated as to avoid sinking into the depths of despair [and keep us motivated when times are good].

There are two points of interest here. Firstly we are wired to be irrationally optimistic about our own abilities. Early primates who kept believing when times were hard survived and mated more often than their more pessimistic brethren. Hence being rational is hard. Secondly, being irrationally optimistic is useful – at least sometimes. Puncturing the bubble with rational analysis might result in a loss of motivation with no discernible gain.

When I think about this in the context of business activities it seems to me we need a switch. The vast majority of our opinions and hence decision making should be rational, but allowing a dose of unconscious irrational optimism helps us motivate ourselves and others. It’s how we achieve the seemingly impossible. However, we need the switch when that irrational optimism stops serving us well. When I was at Reuters Venture Capital, for example, we worked like crazy to raise our second fund in the tech nuclear winter of 2001-2003 and kept believing, but there came a point when we flipped the switch and gave up. That was painful, but it was the right thing to do. To keep trying would have been like banging our heads against a brick wall.

The challenging thing for teams is that different people have different levels of optimism, and it gets really hard when one person wants to flip the switch and others want to keep believing. That’s where the leader needs to carry her organisation (and make sure her switch is in the right place). The example I gave above was literally life and death for us, but the same dynamic plays out all the time at much smaller levels. In VC firms it often relates to whether investments will get made, in startups it often relates to whether partnerships will deliver, sales will be made, and key metrics will move. Establishing clear parameters in advance that will lead to the switch being flipped takes discipline, but is one useful trick.

Fascinating stuff.

If you have a few minutes I heartily recommend you read the full brainpickings article.

How our rational brains justify our intuitive decisions

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I’m sure you’ve heard about how unless we’re careful we very often make our minds up about things in just a few seconds – decisions on candidates in job interviews is a well known example. Here’s how that happens.

  1. We make an intuitive, largely subconscious, decision based on what we’ve seen and learned over the years, a decision that will often display all of our prejudices and biases.
  2. The rational side of our brain seeks justifications for our decision
  3. As soon as it finds a justification the search stops. The case is closed and we move on to thinking about the next thing.
  4. We become resistant to opening up the debate again.

You might have spotted the flaw in this process already. The rational side of our brain doesn’t make a balanced assessment of the evidence it only looks for one piece of evidence to prove the case. There are pros and cons in every complex decision so we are always able to find something to justify our position, even if the weight of the evidence is wholly in the other direction.

If more rational decision making is the goal, and in a business context it generally should be, then the first step is to be aware that we all have this tendency. If you are hit by a wave of irritation when someone presents you with data that suggests you should change your mind try to take that as a signal that your rational brain might be losing out to a faulty piece of intuition.

None of us can get over this problem entirely, and rapid intuitive thinking is often appropriate.

Four reasons why startups fail

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We see a lot of startups that fail, it’s the nature of the beast in an environment that is so incredibly fast moving and competitive. These are some of the more common and avoidable mistakes that we work hard alongside our partner companies to help them avoid.

This post was inspired by John Zeratsky’s post Eight common dysfunctions of design teams. Design is at the heart of a lot of the early important work at a startup, hence the overlap.

  1. Starting with solutions – founders start by having an idea and then most check it’s feasibility by visualising a solution. That’s the right thing to do. However, having established that there’s one potential good solution the best next step is to go back to building a deeper understanding of the problem space and customer to check if there’s a better solution. This applies to everything – product features, visual identity, copy, UX, tech stack and go to market strategy. To avoid this mistake spend time with customers and establish goals and metrics before creating solutions.
  2. Groupthink – these days companies and their products and brands need to be remarkable to win. In Zeratsky’s words: “Groups are no good at making decisions—at least not the way we normally do it. We want everyone to be happy, so we talk and talk until we’ve reached consensus on a decision. And we let social dynamics get in the way: power relationships, seniority, loud mouths, etc. This all leads to decisions that nobody is excited about—decisions that don’t reflect a unique, opinionated perspective.Solution: Use voting to capture everyone’s opinions, then lean on the decider to make the call.”
  3. Polishing a brick – as Zeratsky says, we spend far to long polishing and perfecting unproven solutions. These days a minimum level of quality and design is required before people will take notice of a new solution, but understand what that is and ship as soon as you’ve reached it. If you find yourself believing that your product will only work if it’s fully featured and highly polished you should go back and double check whether your core proposition is strong enough. To avoid this mistake give yourself deadlines that you can’t get out of. Being clear on what you have to achieve by when to get your next round of funding and breaking that down into monthly targets is a great discipline.
  4.  Shaky foundation – every startup is built on a foundation of assumptions about the customer, the product, and the world. Too often founders let those assumptions go untested, even unstated. In The Path Forward we advocate first making sure that the company’s idea is valid – and that requires listing out the assumptions and testing them to know that the fundamentals of the business are strong, that there is a need for the product and that the company has the right skills to prosecute the opportunity. Many companies move too quickly to focus on the product or even on scaling the business, but if the foundations aren’t strong growth will always be more challenging and will eventually falter. Solution: Follow The Path Forward to validate your idea and lay strong foundations that will allow you to build a valuable business.

Evolving “openness” at marketplaces

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I just read the following quote in a post about platform failures:

Because platforms depend on the value created by participants, it’s critical to carefully manage the platform’s “openness” – the degree of access that consumers, producers, and others have to a platform, and what they’re allowed to do there. If platforms are too closed, keeping potentially desirable participants out, network effects stall; if they’re too open there can be other value-destroying effects, such as poor quality contributions or misbehavior of some participants that causes others to defect.

Marketplaces are a type of platform in which Forward Partners routinely makes investments. They make up around one third of our portfolio. We love these companies because (done right) they are better for the supply side and the demand side and because at scale they exhibit significant network effects which make them very valuable.

The early marketplaces were modelled on stock markets and were very open. Companies like ebay offered full visibility over supply and demand, few restrictions on who could use the platform and let the marketplace determine pricing. More recently marketplaces have started operating more curated models with much less transparency and more control over pricing. Uber is one of the more extreme examples – as I imagine you know passengers have to accept the car they are given and Uber decides on the pricing.

Amongst our more recent marketplace investments Lexoo is a good example of a highly curated marketplace. They connect companies with legal services but rather than have an open marketplace where customers browse through lawyer profiles they’ve built a sophisticated matching engine which identifies the best lawyers for a particular job and gets four of them to quote within twenty four hours. Similarly ClickMechanic, another of our partner companies, fixes the price of jobs that mechanics do through the platform and finds the mechanics rather than asking the customer to do the work.

In the Uber, ClickMechanic the Lexoo examples the marketplace is doing much more work than a more traditional model. Companies like ebay find the supply and demand, optimise the browsing and search process, build trust systems, and then process payment, whereas marketplaces like Lexoo, ClickMechanic and Uber are doing that, but also assisting much more with selection and making sure the transaction runs smoothly.

Getting the right level of ‘openness’ is critical to marketplaces’ success. In our experience finding the optimum level starts with the founders’ vision and then evolves following customer research and how the supply and demand side respond to early versions of the product. There’s no generic right answer but rather individual marketplaces need to find the solution that works best for their supply and their demand, as measured by conversion. The less work a marketplace does the cheaper it is to build, of course, so there is a trade-off between cost and time to market on the one side and conversion and customer satisfaction on the other. As marketplace models are moving to new industries with more complicated transactions the trend is definitely towards more cost.

 

When to hire big company people into your startup

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Investors often put pressure on startups to hire senior people from big companies. Sometimes that’s for good reasons, but sometimes it’s because it gives them good sound bites and the illusion of progress. When VCs can say “Our investment just hired the product manager for ‘XYZ important product’ from Facebook” it makes them feel better and look good at cocktail parties. Cynics call these ‘CV hires’, and it’s not just VCs who make this mistake. CEOs and founders do too.

Over the last few years it’s we’ve seen an explosion in the number of European startups that have reached scale, and that’s changing the hiring equation. It used to be that if you wanted a big name on the CV you had to go for a large established business, and probably one that was headquartered in the UK. There are now a good number of sizeable scaleups with people who were there when they grew from being a small company to a larger one and want to go and do it again at another startup. These people combine bigco experience with an understanding of startups and are gold-dust if you can get them.

However, if you can’t, and I’m thinking about companies with up to around 40 people, I would say that generally speaking it only makes sense to go to an established big company when something specific in your business is lacking or broken. If you’re digital marketing is failing, then there’s a good chance that someone from Booking.com or Expedia might be your best bet to fix it. They have large teams of people who live and breathe data and someone there has probably seen your situation before.

Conversely, if the requirement is continuous incremental improvement then hiring for talent over experience is often better. If your digital marketing challenge is more about squeezing the pips or looking for the next leg up for growth then going lighter on experience and longer on raw talent and hunger (and salary) often works better.

Thinking about the general case, the advantage of big company people is that when they work you have a solution that should scale effortlessly with the company for some time to come. The disadvantage is that when they don’t work the cost is much higher – not only will bigco people be on larger salaries, they typically demand more resources and hence waste more money before they leave than less experienced alternatives. Worse, experienced people demand more autonomy and are often more skilled at managing upwards, so it takes longer to know when they aren’t working out and it’s harder to fix when they go.

Finally, and this is the kicker, from what I’ve seen, high salary hires from big companies work out much less often than you would expect. I think that’s because there’s an adverse selection problem – the best people from large companies generally don’t want to work at startups. They prefer to take the high salary and continue with what’s working for them. When people do risk weighted analyses of total comp likely to be earned in a startup vs a bigco it shows that bigco is the rational path.

Additionally, adjusting from big company life to startup life is famously hard. Work at a startup is invariably broad and scrappy. You have to work across the whole product or business and without much admin support of many team members. Big company folk are used to working on narrow subsets of products or on segments of the customer base and they are used to having most of their small problems and tedious admin tasks taken care of for them.

Once startups get bigger than around 40 people they start becoming more like big companies and have more resources, so the calculus changes.