May 25, 2012
Back when I was single, like most of my single peers, I had a pretty good image in my head of my dream girl. I won’t bother with the specifics, but after working my way through a handful of serious relationships, by my mid-twenties I thought I had a pretty good picture of what worked, what didn’t, and why.
My sense is that most people go through some degree of reflection on this topic – it’s a natural instinct, it seems, to create some idealized composite of what we’re seeking in a partner. And while most of us probably don’t think about it explicitly this way, having an ideal creates an implicit framework through which we can run every date we have. Having a good time but she’s a real mismatch on a couple key elements? Probably time to go back to the well. Find a nearly spot on match? Stop wasting your time and start ring shopping.
I think companies should think the same way about their customers. And so when I meet with companies, one of my most common questions is “Who is your absolute perfect, ideal customer, and why?” This is relevant for b2b or b2c companies alike, and it’s a question I would expect that anyone who has been thoughtful about their market would consider a total softball.
But too often it’s no softball. I am consistently amazed by how frequently I get a response along the lines of “Hmmm. . .that’s an interesting question. . .let me think. . .” When I hear that lack of certainty, I immediately know two things about the company. Number one, they have a product first, not market first strategy. Number two, they lack focus.
Neither of those, ladies and gentlemen, are good things.
There is almost nothing more important for a startup than exceptional product development and management. Most great tech companies are product-driven, be they b2b or b2c. Companies that can inspire “holy sh&# that’s fantastic!” responses from their audience usually win. Salesforce, Intuit, Apple, Google, Uber – they’re all brilliant, product-driven companies.
Being product-driven doesn’t mean that your strategy is product-first, though. The companies above build products that are brilliant in their ability to address real market needs. Their magic lies in the marriage of product design to genuine market need.
Deploy a product-first strategy and there’s a small chance you’ll get lucky enough to meet the market in the right way. Go market-first and all you have to do is execute on product to win (well, it’s not quite that simple, but you get the point).
Even Steve Jobs, famous for his disdain for market research, took a market-first approach. He disliked market research because he thought he intuitively had a much better feel for consumer needs than consumers could ever describe to a researcher. And he was right. But while he ignored research, he was probably more committed to building products that he believed would deliver against real market needs than any product guy in history. Jobs knew just how his products would be used, and why they would delight customers.
As for focus, there are few things more important to a startup. And if you can’t clearly articulate just what you’re focused on, I think you’re lying if you tell me you actually are focused. Sounds obvious, but you’d be amazed how many companies can’t do it. If you can’t describe your ideal customer to me, then how do you know which customers to direct your sales and marketing efforts at?
I recently met with a talented entrepreneur who had developed an interesting product that had applications for both consumer packaged goods companies and the retailers who sold those goods. I thought it was a pretty compelling bit of technology, but I wasn’t sure how he was focusing his go to market strategy, so I asked him, “If you could snap your fingers and have any one customer in the world, who would that be?”
He stumbled a bit, not coming up with an answer. I tried to save him. “Would you rather have Wal-Mart, or Kraft?” He replied, “Boy, I’m not sure. . .they’d probably both be great.”
And right then, I knew he was in for an uphill battle, and that I wouldn’t be fighting that battle with him.
As a startup, you must be able to answer the Dream Girl question. Not because I’m going to ask you, but because the process of answering it will ensure that you are building the right product to meet the market need you’re after, and that you have the relentless focus that is so crucial to the success of every resource-constrained startup.
Start with a clear image of that perfect girl (or guy), then build the right team, the perfect product, and find the ideal channel. Then go get her.
May 11, 2012
The report, dramatically entitled “We Have Met the Enemy … And He is Us” (link to a summary and download of the full report here; or, better yet, Felix Salmon’s scathing summary), details the rigorous analysis that Kauffman recently completed of their own experience investing more than $650MM as an LP in over 100 venture capital funds (managed by 60 separate general partnerships) over the past 27 years.
The Kauffman Foundation, self described as “the world’s largest foundation devoted to entrepreneurship” is a leader in thinking and research on entrepreneurship. Through its research efforts, it’s Kauffman Fellows program and its activities as an LP has made important contributions to the cause of entrepreneurship in America for decades.
In this week’s report, they make a bold effort to tackle some long term, systemic issues in the way the venture capital industry works. More simply, they call out the industry, and the relationships between Limited Partners (the individuals and institutions who invest in venture funds) and General Partners (the venture capitalists themselves), as being fundamentally broken.
Kauffman ultimately places blame on themselves and their peers in the LP community, saying that they have collectively lacked the courage to do the right work to fix some known flaws. Fred Destin, one of the best thinkers I know in the GP community, has provided some valuable thoughts about a path forward for LPs. Fred Wilson, on the other hand, quipped (after offering some constructive thoughts) that as a last resort, “We can just retire.”
In the days since the report was released it has dominated the dialogue in the industry, and there’s certainly been a lot of understandable jumping on the Kauffman bandwagon. It’s been cool for awhile, after all, to say that VC is broken. I agree with much of the commentary – particularly the following:
- Industry returns are ultimately driven by a small number of the best funds
- Large funds, on the whole, struggle mightily to perform
- Industry dynamics have created incentives for aggregating assets under management rather than driving for asset appreciation
- Management fees are a black box that often result in bloated GP W-2’s
- Industry data and standards for performance reporting are deeply flawed and likely misleading
But after a collection of interesting discussions about the report in recent days with a handful of sophisticated, experienced LPs (whose confidentiality I shall respect here), I’m left with a couple key questions.
First, what was Kauffman’s motivation in writing the report? Certainly there are issues in the industry, and questions that need to be brought to the surface of the discussion about the relationship between LP & GP. But were they actually interested in discouraging investment in the asset class? Clearly that’s part of what’s going to happen, as asset managers on the margin view this as the clear invitation to stop worrying about venture.
For someone who is by their very mission focused on supporting the nation’s entrepreneurial ecosystem, this aggressive stance against a critical component of that ecosystem may be counterproductive, despite being on point about a number of the issues.
Of course, as one LP pointed out to me, every LP out there probably wishes that a lot more LP capital would leave the market. After all, nobody questions that industry returns are indeed driven by a handful of the best funds. And those funds are VERY difficult to get into. So it follows that if a bunch of LP capital left the market, access to top funds would, on the margin, improve. I doubt that was Kauffman’s motivation, but as I spoke with a few LPs, there was an undeniable twinkle in their eye as they thought about that effect, and the opportunities it might open for them.
Regardless of their motivations, there seems to be a material issue in that Kauffman chose to only look at their own data, but then make sweeping statements about the entire industry and asset class. Sure, they have a lot of data over a long period of time, but is it truly representative? Any proper academic study would have made a point of working with data from multiple LPs and to build a representative data set. After speaking in the past couple days with LPs representing 5 other large, experienced venture portfolios, it sounds like the Kauffman venture portolio is both not representative and, in fact, a really poor performer.
In fact, one of these LPs shared with me their own detailed data, presented exactly the way the Kauffman analysis was presented (they were scrambling together a private rebuttal to use with their clients and prospects). The difference in performance was staggering. It kind of felt like I was looking at Tom Brady’s passing stats after spending 2 days digesting a damning report on the passing game based on Mark Sanchez’s stats. Sure, both guys play quarterback for good NFL teams. If Mark Sanchez was your quarterback, you might conclude that a heavy emphasis on the passing game wasn’t that good an idea. But if you had Tom Brady, well. . .
Having now seen an array of data from multiple LPs, it seems like we might have had a Mark Sanchez report dumped on us this week.
I hope some group of thoughtful LPs out there will have the courage to write something of a public rebuttal to the Kauffman Report. But I have little confidence that it will happen, because nobody has real incentive to do it.
It’s hard to imagine a public pension fund doing it – they don’t want to wade into a debate like this. And it’s hard to imagine a fund of funds manager doing it – they’re in the business of aggregating assets of their own, and are probably better served doing the sorts of analyses I saw this week, but then keeping it to themselves and using it in their sales efforts. That leaves the foundations, university endowments, and private pensions. Will they feel more motivation to support the reputation of the asset class or to make a rational choice to sit back and let some of their competition fall away? Probably not, as their self interest is maximized by dollars leaving the asset class.
It will be interesting to see where the discussion goes from here. As I said earlier, I do very much agree with many of the remedies Kauffman has proposed for challenges in the industry. Smaller funds, greater GP commitments to the funds (where practical), and rethinking management fee structures and other efforts to better align GP-LP interests. Their suggestion that LPs get into direct investing strikes me and others as rife with challenges, but that’s a story for another post.
Kauffman has done us a service, at some level, by shining a bright spotlight on a set of issues that people have been talking quietly about for quite awhile. And maybe this will help push some solutions that help the industry in the long run.
But I’m also concerned that the alarmist and less-than-scientific way in which they chose to present their analysis will likely get a number of good babies thrown out with the bathwater. That’s both a shame, and a bad thing for our economy.
May 9, 2012
These are heady times in startup-land, as we all know. $1 billion Instagram acquisitions, Facebook roadshows, dozens and dozens of companies raising private capital at valuations deep into nine digits. It’s an exciting time, for sure, but it also leads to some delusional expectations and crazy behavior. We’re seeing a lot of it these days.
So in that context, it was especially striking – and refreshing – when I heard a nearly forgotten term used the other day to describe an entrepreneur. I was talking to one of my co-investors in a great company that we helped seed called RealDirect. Doug Perlson, the RealDirect founder/CEO, is an experienced entrepreneur, and we think he’s building a very important platform that is going to put a pretty massive dent in the residential real estate brokerage market.
We were talking about the fact that late this year Doug will be out on the road to raise a new financing round, and were projecting what we thought people would find appealing about the company. After a robust discussion of what we love about the company and why we think Doug’s a great leader for it, my colleague said “And on top of all that, Doug is just a good steward of capital.”
“Absolutely,” I replied. “Absolutely.” And then I was struck by how unusual that comment seemed in today’s environment.
What is a “good steward of capital”? Let’s start with a quick glance at Webster’s:
steward |ˈst(y)oōərd|, noun, a person employed to manage another’s property, esp. a large house or estate; a person whose responsibility it is to take care of something
It’s pretty simple – a good steward of capital is someone who is going to “take care” of the capital with which he has been entrusted. He’s someone who, unlike many of today’s entrepreneurs, recognizes that he has been entrusted with his investors’ capital, not given it.
Like all good stewards of capital, Doug is a guy who respects the implicit contract between investor and entrepreneur, and knows that it is his responsibility to work for the benefit of all his shareholders. As a result, he manages cash carefully, and does things like initiate conversations about the next financing round 9 months before he needs it, because he doesn’t want himself or his shareholders to get caught off guard.
This may sound like conservatism, but being a good steward does not at all mean being especially conservative or risk averse. Stewardship and rapid fire, nimble risk-taking can very mutually coexist. But stewardship does mean being transparent about risks and choices, communicating effectively with your board and investors, and not surprising people with bad news.
Bottom line, Doug’s a guy in whom you can have extreme confidence, that he is not going to do anything crazy or immature. And that makes him a pleasure to be in business with. He also, by the way, happens to be a damn good CEO.
Contrast Doug’s behavior with some of what’s going on these days and it almost makes me long for a flopped Facebook IPO and a 30% correction in the NASDAQ (To be clear: I said almost, and I didn’t even really mean it!). I’m seeing entrepreneurs increasingly treat prospective investors as little more than glorified, outsized ATMs.
Last week I had an entrepreneur whom I was meeting in person for only the first time tell me that, on the basis of our two prior phone calls and this face-to-face meeting that I must be at the end of my decision process. This was a first-time entrepreneur, and we had had a couple of 30 minute phone calls prior to this meeting. Yet here we were, in a room together for the very first time, and he was pushing me to deliver him a term sheet the very next day. I respectfully pointed out to him that if I were to invest in his company that he and I would be effectively married for the next five or so years. If he was looking to get married after the first date, I told him he was talking to the wrong guy, and suggested he find another partner.
It’s crazy, but like so many things, you have to see the worst to appreciate the best. Guys like this certainly make me appreciate the Doug Perlsons in our portfolio. Fortunately we’ve got a whole bunch of them.