The Ultimate Product Part 1.5

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OK I should build IKEA furniture more often. Spending the last 2 hours building a new dresser from IKEA meant that my mind kept drifting back to The Ultimate Product and why it makes me feel uncomfortable when the Ultimate Product doesn’t match what the entrepreneur is actually building.
I think it means the probability is high that they will need to pivot at some point because they are off target from the Ultimate Product. While pivots are a fact of life for entrepreneurs, the problem for me is at early stage where I invest.
Most entrepreneurs only plan to last for a year on their current fund raise to my chagrin. If only they had planned to last 2 years, it would mean that they have time and money to pivot. But they will die before they can because they will run out of money and begging for more isn’t going to work in today’s funding climate.
So if they are, in my mind, off target from their initial mission and the resulting Ultimate Product, the chance of pivot is very high and they will be out of funds by the time they realize that what they are building isn’t going to be widely accepted by consumers and can’t pivot. Thus, if they don’t plan on lasting two years, it makes me not too confident that they will last long enough to get somewhere stable and growing. As an investor, this doesn’t make me want to invest…!
Do I believe this is a certainty, that if they aren’t quite on target to what I think is the Ultimate Product that they will surely pivot? Of course not. I recognize that I could be wrong, and that a better product than the imagined Ultimate Product could arise which also satisfied the consumer/market need. I think this is all a probability game and I’m just trying to increase the odds of success. This is definitely something the entrepreneur needs to weigh as well, especially if they are off target from the known Ultimate Product.

The Ultimate Product

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The other day, I met with an entrepreneur and we talked about his project.
He first stated his mission, and then dived into his product and service and how it worked. As he talked about the various features his site had, how users would interact with the product, and what would happen when they did, my brain was actually split. Half my brain was following what he was saying, and the other half thought about his initial mission statement. As his talk went on, my brain halves began to diverge.
The second half of my brain was constructing the ultimate product to his initial mission statement. The ultimate product is the product that completely satisfies the users’ problem as defined by the mission statement.
When my brain halves diverged, I was unfortunately very uncomfortable at this point. This is because what the entrepreneur was describing was not the ultimate product, but in fact something different. At this point, I stopped the entrepreneur in his description about the product and we talked about the ultimate product.
I detailed it out and walked through in the ideal case, what that was, and how it would work. But it was unfortunately different than what he was describing. It was one of the reasons why I felt uncomfortable in supporting him in his project, because his product seemed to be enough off the path to the ultimate product that there were more than necessary barriers to getting there, when it seemed to me that there were more direct paths to the ultimate product.
I think it’s a worthwhile exercise to construct the ultimate product for a given need, and then see if you can get there via your startup’s evolution. If you can imagine the ultimate product in your mind, I think it can give you guidance on how to build it. But if you don’t know what that is, how can you know if you’re on the right path to get there?

SMASH Conference Prep Dinner

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Last night I went to yet another great dinner hosted by Dave McClure at the hip Clift Hotel in SF. It was a precursor to a conference series on social marketing called SMASH Summit. If you follow Dave, you’ll know that he is big on the fact that marketing and design in startups are key elements for success, and that most startups don’t do either well.
SMASH is an acronym standing for Social Media And internet Strategies and Hack-tics. A bit forced, but the concept is pretty cool.
Speakers included Matt Cohler of Benchmark, Rashmi Sinha CEO of Slideshare, Stew Langille from Mint.com, and Jeremiah Owyang of Altimeter Group. It was a great round up of information presented, showing the various ways folks are using social media marketing.
Last night’s dinner was actually a preparatory step to a one-day conference series Dave is going to put on both in SF and in NYC. After dinner, the tables had a discussion on what they have done in social media marketing and the goal was to generate some possible topics for discussion at the SMASH summits. As official notetaker, I wrote down some ideas and listed them below, so that you will get a possible taste for what you may see at the SMASH summits:
Marketers that work for sites that are democratic – how do you tell what succeeds or fails with the crowd?
How to gain trust for novice social networkers for social marketing?
How do you manage novices facing more technically savvy social media users? Ex. forum users ragging on novice posters for not knowing a tech solution.
How to use our customer base who are more technically savvy to support call center people?
How do you use cross channel communication?
How do you connect developers with passionate customers?
What’s better than focus groups? What do you use instead?
How do you overcome corporate/executive fear of talking to your customers?
How do you track/prove ROI of social media? Ex. We only have anecdotal evidence of more sales via positive social media response.
What metrics of social marketing are important?
Panel idea: Bigger companies’ overall experiences with implementing social marketing/media (success/fail stories, case studies, techniques, etc.)
Panel idea: Experiences with integration of old school organizations with new social media (more specific than previous: talk about organizational difficulties and how to solve, how to win over the old regime, how to deal with people protecting their turf, etc)
Where does social media belong in the organization?
I’m looking forward to checking out the first SMASH summit for great discussion on these topics and more!

More on the Rise of Small Business on the Net

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I saw this great post by Steve Blank: Make No Little Plans – Defining the Scalable Startup the other day and tweeted out a quote that I thought was very important to me:
A lot of entrepreneurs think that their startup is the next big thing when in reality they’re just building a small business.
His post talks about the fact that many entrepreneurs that create web businesses want to be big, but in fact only create something that is small. There is nothing wrong with this; the world needs lots of small businesses, and even those on the internet. The post also offers some hints and tips as to how to create something that grows large.
When I tweeted, the tweet also showed up on my newsfeed where some of my Facebook friends commented. I thought that the comments there were a nice addition to my previous post, The Rise of Small Business on the Net, and thought I’d post them here:
Me: “A lot of entrepreneurs think their startup is next big thing when in reality they’re just building a small business.” http://ds.ly/8PXB19
Friend 1: Depends what you call small. A lot of room between a hardware store and Google. 🙂
Me: a small biz is one that makes a decent amount of revenue for its employees and is a nice sustainable business, but not much more than that. there is not hyper growth but just nice, recurring revenue. there can be a big spread of revenue that could qualify for this, like from a few 100Ks to even low millions.
The issue is that it is unfortunately a dangerous place for angel investors to be, because the biz is too small to be acquired at a large multiple of its value, or even to be noticed by the big guys. We can’t easily get our return on investment from companies like these.
However, that is not to say that these biz shouldn’t exist. I think it’s a healthy evolution from the storefronts we see on our streets to the virtual storefronts of the internet. not all biz need to go IPO or make a billion bucks from an acquisition for them to have a reason to exist.
Friend 2: Do angels build in other means of acheiving ROI? For instance share of revenue+ebitda over time after a certain agreed to time horizon?
Me: not traditionally, but i have been thinking about applying something like this to startup investing. it’s almost like investing in a restaurant or some other kind of cash business.
however, another problem exists where the entrepreneur is batting for the moon and of course they always think their idea will be the next google, even when we can see … See Morethat it will only grow so big. thus, they are unwilling to accept terms that are not the usual startup investing type terms for investing.
i do think about this every day though, and hope that a solution does present itself. or we just suck it up and try to only pick the ones we think have the best chance for being google-like, or near-google-like, and we just write off the others that we can’t get our money out of, even if they are nice small businesses.
Friend 3: For some reason I think there must be a sweet spot for investors that focus on smaller tech businesses or even projects. I’m thinking about investments in tech analogous to those made by restaurateurs, real estate developers, etc. Where capital requirements are low and return is performance based not exit based.
Me: I call this the Rise of Small Business on the Net http://ds.ly/7X5JM5 and think that there is something here, but just not quite clear yet. in the old days, banks would be the lenders to such businesses, but banks are way too conservative to invest in internet businesses, and with the economy the way it is, they are even less so.
While Steve’s post (and many others) focus on encouraging the entrepreneur to think bigger (even I ask about the world domination plan and more on why), I have not heard much about the plight of investors who end up involved in a startup which becomes more like a small business than the scalable, world dominating startup we all would love to find. Steve does mention those who are OK with flipping startups, but some are simply too small to even flip.
I’d love to hear more about this from others who are thinking about this.

Transferring Hosts

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I have not had much fun, from about end of October until week before Christmas. My previous host decided to “upgrade” me and not only lost random files while transferring to a new system, their new mySQL DB decided to also not allow me to save large blog posts. Of course, they claim nothing is wrong, and of course they cannot see what is wrong because they have a super fast connect with all their servers. But for us poor slobs out here….well I can’t get them to do anything to fix this.
Early December I finally decided enough was enough. I found a new hosting provider based on the recommendations of friends. I spent a week installing to MT 4, upgrading from MT 3 which I had been using for years now. I also tried WordPress and thanks to my friends who are big fans of WordPress who volunteered to help me with the transfer. But I was also using MT as a primitive CMS, which WordPress just was not flexible to do. Even though they had nicer themes and some other really nice functions, I decided to go back to MT.
I’m thankful for my buddies at Sixapart who helped me with some sticky issues, like the fact that my old filenames were created in one way, but the new MT 4 created them in a different way. This was pretty critical; who knows who was linking to me from the outside? Also, I use bit.ly a lot and all those links would have also been broken. And most critical, my SEO juice could have been harmed because Google would have discovered a whole bunch of links that would be broken and who knows how my SEO ranking would have been affected.
I spent the better part of this week getting my URLs to match up and, thanks again to the support folks at Sixapart, I was able to get the URLs mostly translated over. I then packaged up everything on my old hosts and FTP-ed them over. I also exported my blog entries from my old MT 3 and then re-imported them all into MT 4. Somehow this all went off without a hitch.
The next step was to then redesign my blog. That took a while getting to know the CSS and HTML of MT 4 which was different than MT 3. I didn’t have much time to work on this, so I cranked out something that I could live with for now.
In the middle of all this, I was fiddling with domains and messing around with where they pointed to. Of course I screwed this up many times. But thankfully I figured out exactly what they should be set to and now everything should be working fine.
By the way, I HIGHLY recommend NOT hosting your domains with your site hosting provider. It makes changes that much easier when you’re trying to bail on a hosting provider when you don’t also have to transfer domains to somewhere else. Yes it may be cheaper, but man it just made my transition away from my old hosting provider that much more lengthy while I waited for those domains to transfer to somewhere else.
It was really disappointing dealing with my old hosting provider. I was with them for so long and they failed me in the end. It was also obvious they weren’t doing much to improve things, because the control panel at my new hosting provider was so much more flexible and advanced. Then I got caught in IT support hell where I would say I have a problem, and they could never seem to figure out what the problem was on their end. Now let’s see if they actually stop billing my credit card….!
It was an interesting exercise to move hosts. I don’t relish the idea of ever doing this again, and can only hope that my hosting provider doesn’t screw up miserably, forcing me to move yet again.

“WHY aren’t there more consumer internet VCs w/ graphic design skills?”

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Dave McClure posed to Jeffrey Veen and me an interesting question over Twitter which was:
WHY aren’t there more consumer internet VCs w/ graphic design skills?
This is something I’ve been thinking about for quite a while now. When I started angel investing and advising startups, I discovered that pretty much I was the only design guy out there angel investing, or at least that I could find. By that, I mean someone who worked in design in the industry, then switched careers and became an investor full time. For me, I felt that it was a specialty that would make unique in that I could help startups in the area of design and user experience.
However, I had always thought about why there weren’t other design folks out there doing angel investing. Here are the reasons I came up with below. Note that I lump together the design disciplines of visual design, interaction design, and user/usability researchers.
1. There just aren’t that many designers out there, relative to other disciplines. Anybody who has tried to hire designers knows that it is super hard, harder than hiring engineers which is already hard. Think about how many students graduate with design degrees; the number is incredibly low compared to the number of computer science graduates coming from engineering schools. This makes the probability of finding designers who become investors very, very low.
2. Now, take the very low number of designers out there, and meld that with the probability of experiencing a windfall of cash. This windfall of cash can be from any source, like a large inheritance, or winning lotto, or being an early person at a startup who had a mega-exit. Any of these cases (and others) is of extremely low probability. So again, low number of designers melded with low probability of windfall of cash to enable angel investing results in a super low possibility of this happening at all.
3. Of the people we meet in general with a lot of cash, who really wants to angel invest? I have queried some of my affluent friends and they’re just not into it. Some of them don’t want to, some don’t feel the least bit qualified to do it, some know nothing about it and aren’t interested in it. If this is true, then if we take the low number of designers who also have enough spare cash to angel invest, those who feel like investing in startups results in another very low number.
4. Knowing a bit how the venture fund industry works, I’ve been told that it’s super hard to join up with a fund. It’s not like applying for a regular job. Commitment at a fund can be a number of years, ranging from 5 to 10. Thus, adding someone to a fund’s staff takes a lot of deliberation as it is not good for someone to leave a fund’s team in the middle of a fund’s life. A fund’s pool of money is often raised on the fact that there is trust in a team to invest their money properly. If that team is disrupted, it could cause investors in the fund to pull out. Pulling from a limited pool of possible candidates, and the very low probability that any of them have any sort of design background results in just about nobody joining up with funds who are also designers.
5. If you look at who are typical venture fund partners, they are most likely ex-business people or ex-entrepreneurs. These seem to be the favorite candidates for becoming investors as they have experience in managing investments or acquisitions, or have worked in a startup and have some knowledge in startups and how to spot other good entrepreneurs. Designers are more likely to NOT have experienced these conditions and generally are not specifically looked for when a venture fund is recruiting for partners.
6. As one path to gaining successful experience as an entrepreneur, resulting in a potential windfall of cash to enable them to angel invest, designers might become a founder of a startup and grow it to an exit. However, most designers in pre-2002 days, were hired in later stages of a startup’s life, thus limiting their potential return as their stock allocation and strike price are not as attractive as if they came into a startup much earlier. Therefore, even during the dotcom boom years, designers may have been able to reap in a lot of cash, but probably not enough cash to freely angel invest in post-2002 years.
If we expand the list to include design agencies, then there are design companies who invest. For example, Method Design did have an investment operation, and fuseproject is currently making small investments into some of the startups they encounter.
Still, individuals remain almost non-existent.
While all that may be true up to today, I also think that this may change in future years. For example, starting an internet company is a lot easier today than it was in years past. There is a lot more literature about entrepreneurism and general acceptance that entrepreneurism is an OK career choice. Also, it is possible to build something and not be a coder, which most designers are not. There are many inexpensive avenues to getting something built, and use of open source code and other hosted services make creating web businesses much easier.
Also, it is my belief that with the number of me-too products being so high, and the ease that one can create copycat products, design is finally becoming a true competitive advantage as core services are pretty much the same, but it is the user experience and design of the product that allows a me-too product to win over its competitors.
So going forward, we may see a bunch of designers who are part of startups from a very early stage, and thus can have enough equity to get them a substantial cash windfall upon exit, which can then result in enough spare cash to start angel investing. Over a period of time, if they get good at angel investing, then they may get noticed enough to raise their own funds, or join up with a venture fund.

Angel Odds Versus Venture Fund Odds

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When I first tried to raise a small fund back in 2006, I heard about venture fund odds on investments which was that for every 10 investments a fund made, about half would fail, 2-3 would return a little bit, and then there would be the 1 that would return everything that was lost on the failed startups and then some.
It seemed to make sense and also drove the original reason why I thought I should invest more often than not. If I put more bets out there, then theoretically I should have more chances to make my money back…right?
To date, I’ve made 16 investments and two exits. I invested more broadly than most angels, except for the super angels. But looking at the internet industry, the sad state of the economy, and the way early stage angel investing has progressed for me over the last 3 years, I have come to the conclusion that the one in ten odds for this biz doesn’t apply to us; for us angels, it’s more like one in 20, or 30, or even worse.
Why do I think this:
1. The economy sucks. Probability of exits is much much lower.
2. The economy sucks. Making money is harder. Paying consumers are harder to come by. Businesses are already slow in committing to pay for a service.
3. The internet is too crowded. Me-too products are all over the place, creating blur in consumers’ minds, and making it harder to attract customers.
4. The internet is too crowded. Truly unique products and services are super hard to find now, so gaining a competitive advantage is tougher.
5. Too many small business opportunities on the internet. The probability of starting a great small business is a lot more likely. But finding a suitor with a small business is tough because it may not generate enough revenue to be attractive enough to be acquired.
6. Angel investors typically invest in the earliest, most risky time for startups. Venture funds (except for the early stage funds) usually invest after the very earliest money in. Once startups get to a size that is attractive to a venture fund, a lot of risk is taken out already; we don’t have that luxury. We typically go in when there is just an idea, and maybe a prototype built, and occasionally a business up and running. We don’t know if the startup will fail in a few months or not; there is no history that we can look at. With that kind of risk profile for our typical investment, it would make sense that their would be more failures in our portfolio than for a venture fund portfolio.
7. Those that survive have a high probability of needing additional rounds of funding for growth. If we can follow on invest, that helps a lot. But most of us can’t do that. We may have enough capital to put one round of investment, but most likely can’t invest more money in a subsequent round. Thus, dilution will limit our investment unless we get lucky and find a startup that does not require further rounds. The more investment rounds after the initial round, the more we get diluted.
So all this means that it’s super hard to find that Google super-investment that makes back all that we lost and then some.
Solutions?
Ron Conway combats this by going super wide and doing more investments than we could ever hope to do. This increases the probability of finding a Google in his portfolio.
We could try to find more startups that are capital efficient, and that make money from beginning. Those that do not require a lot of cash to scale means they may not need another round. If they make money, then this also reduces the probability of needing more rounds of investment. Of course, companies like this are incredibly hard to find. Nor can we accurately predict what amount of money they will need later.
If we could follow on, this would help a lot. How about playing Lotto and winning a bucket of cash to play with?
Now, if more venture funds played in the early stage space, combining broad, early stage investment with follow on investments into the winners, this would seem to be a perfect combination. However, in thinking how many venture funds operate, it seems like there are problems with making this approach a success.
Any other possible solutions?

bit.ly Offices 12-17-09

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It’s been a big week for bit.ly in the news. Lots of buzz about Google and Facebook coming out with their own URL shorteners, but but they’re not down by a long shot. Bit.ly Pro is really great and of course, I setup my own URL shortener, http://www.ds.ly, just for kicks (by the way, buying a domain from Libya was an interesting experience). Also launched this week was bitly.tv, a bitly labs project that provides a view into the most popular shared videos on the Net.
Here they are in their offices, which are next to betaworks:





If you notice on the walls, there are some pretty cool paintings by local artists that we got from a gallery. For some reason, I’m a fan of this one:

Such a touching moment for Charlton Heston to kiss that ape from Planet of the Apes – touching enough for someone to actually capture it on canvas! After all, aren’t we humans really just a bunch of hairless romantic apes?

Lasting Two Years

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An interesting observation I’ve seen amongst early stage internet startups is that more and more of them are requiring closer to two years to get to breakeven. This is because of many factors, one big one being the fact that there are too many me-too products and that distribution is the number one problem facing entrepreneurs today. But also, many startups end up in someplace different than where they started. They may find that their initial theses is wrong and need to twist/turn/adapt into some other product to be successful. This also takes time.
I talked with an early stage VC and she mentioned that she had seen the same thing, which was a large percentage of them coming back for bridge rounds after working for about a year. We talked about the fact that they always seem to raise money for about a year or runway, but yet most of them just need a few months more to get to breakeven.
Even in my own startups, there are a number of them that “just need a bit more time.” If only they had a bit more runway, if only they had a bit more cash, if only they could raise more….we are seeing that startups with mediocre metrics aren’t finding it easy to raise cash so they are dead in the water, and soon to die in totality.
I talked with another investor about whether or not we should get more of our startups to raise more cash at the beginning. He actually was less of the opinion that we should demand startups find a way to last 2 years from the get-go. It was an interesting conversation and I think the difference in perspectives comes from the fact that I’m an angel investor with limited resources, and that this investor had far more resources to bring to bear on successful versus mediocre or dying startups. Also, given that this was my own money I’m investing, it was far more important to me than investing someone else’s money. Strategically, it makes sense for them not to care as much. We already know startups will die; it’s a ruthless culling process that startups experience. A professional investor can just move on and invest in the next big one, or invest in the winners in his portfolio. But given that my personal money is at stake, I care more about startups lasting long enough to make something with their businesses.
I’ve been tooting the “last 2 years” horn ever since the economy tanked. But universally I have been ignored. Remember that there are two levers to apply here: one is how much money to raise, the second is the burn. However, I never see anybody produce a 2 year plan ever. A host of reasons why not:
1. Entrepreneurs are unwilling to reduce their burn. There are a number of reasons for this, ranging from families that need support to those unwilling to reduce their lifestyles, to inability to hire people at low salaries.
2. Entrepreneurs are unwilling to go out and raise more. Yes, begging for money sucks and takes too much time and is not fun. Entrepreneurs just want to get back to work building.
3. Entrepreneurs are unwilling to take the dilution. They already have sold part of the company and don’t want to sell more.
4. An investor assures an entrepreneur that they will give them more money if they need it. Entrepreneur decides to trust investor.
Great reasons all, but the reality is that a huge majority of startups are all taking 2 years to get to a good place. The marketplace for products and for investment is not like it was 2-3 years ago before the economy tanked. In previous years, you could go raise money on no revenue but a ton of users. Now it’s near impossible. Second chances are hard to come by. Raising money on mediocre metrics is near impossible.
One last appeal: Entrepreneurs, do what you can to last 2 years. Expect it. Raise enough money and/or adjust burn assuming no revenue. It’s become unfortunately the norm.