As an uncreative VC, I figure I’d find a way to outsource idea generation for my blog. So I was excited to partner with the good folks at Intelligent.ly on a regular series of posts where we would collect a bunch of questions from the local tech community and respond to a few that I think are relevant to a reasonably broad group of readers. Here are my first two questions and responses below! If you have questions, please post them in the comments or on intelligent.ly here.
What are some common-sense tips for startups as they seek to avoid the “Trough of Sorrow” that Brian Balfour has blogged about? That is – running out of cash, letting staff go, facing potential failure. What can founders do in advance to make the trough as shallow as possible?
[Rob Go] This is a great question! There really aren’t many easy answers – honestly, most startups face some sort of trough of sorrow. Even Mailbox (which just got acquired by DropBox for likely a big number) I’m sure faced a trough of sorry when they shifted resources away from their original product (behind which their raised their seed round) and pursued what could have been yet another email client. The trough I’m sure happens even for every successful companies.
That said, I have a couple basic tips of advice:
1. Know that the trough is coming. Sometimes, just knowing that hard times are ahead allows you to get yourself and your team ready to push through. These troughs tend to happen at somewhat predictable points. First, the first time products hit the market and it’s clear you don’t have 100% product market fit. Second, when you do have PMF, but growth starts to stall. Third, when you have PMF and growth, and you find yourself needing to really build a repeatable business model. Fourth, when major team members start vesting serious chunks of their equity and start finding themselves unmotivated or lured by other companies. etc etc. Be aware that these milestones are ahead of you and be prepared!
2. Don’t fool yourself for too long. The challenging points I mentioned above happen to nearly every company. The trough is worse when you have less time and resources to deal with these problems. You don’t want to fool yourself into thinking your product is great, or just one or two features away from success until you have 3 months of cash left and it’s clear that things aren’t working. Be brutally honest with yourself. The best trick I’ve heard (which is actually really hard to do) is to talk to customers, but to do it from the perspective of a skeptic. If you are in the pre-product launch stage and want to ask random people what they think of your idea or product, don’t say “hi, I”m the founder of XYC company, can you tell me what you think of this product?”. Say instead “hey, a good friend of mine is thinking about quitting his job and starting this company. I think it’s a pretty risky move, but I said I’d help him get feedback from potential users. Do you mind having a look? I just don’t get it… but maybe I’m missing something?”. By positioning a question like that, you are way more likely to hear the negative feedback, and probably the honest feedback vs. the sugar-coated feedback of someone not wanting to crush your dreams. Find ways to get realistic feedback so you know sooner not later that trouble is brewing.
3. Find good financing partners. You want to find financing partners who help you in the situations described above, don’t become yet another impediment. When you are going to be dealing with growth and business model scaling issues, it’s nice to have big VC’s that are committed to your company because they can write you one more check if it’s just taking a bit longer to figure stuff out. If you are still really early and aren’t sure exactly how big your venture could become, you might not want to take money from big VC’s who could kill you with signal risk, but instead finance your company with angels who can help you navigate a plan-B type funding path if things are going well but it looks like your opportunity isn’t as big as you hoped. Which leads us to our second question:
Two friends and I are building a company part-time. We all have full-time jobs elsewhere, but hope to work for our company full-time by the end of 2013. We want to bootstrap as much as possible and believe we can because we should be profitable by summer (not a lot of profit, but some). Our desire to bootstrap may be a good thing because we don’t believe our industry is one where we could have a huge exit and potentially attract investors before we get there. So here is my question: should a company that wants to bootstrap apply for an incubator/accelerator? Is it possible to take seed money and not go for the Series A, etc, and just earn revenue? If we never want to exit and plan to own and run the company forever, would anyone invest any money at all?
[Rob Go] Sounds like you are being very realistic about the company you are building and smart about thinking through your financing options.
On the accelerator question, it depends on the accellerator. I find that accelerators that are run more by ex operators (and in many cases, operators who have been successful without huge sums of VC money) are pretty good at helping companies that might not go the VC route. Usually, accelerators do build a portfolio of companies, some of which are kind of binary, others that might be smaller but more straightforwad businesses. Also, many companies that come out of accellerators are funded by angels who would be happy with a non VC outcome that happens through capital efficient financing (and potentially faster).
Now, I will say that all investors in a company will hope to see some liquidity from their investment at some point. Hopefully, anyone investing in an early stage private company knows that that liquidity will not come for at least 5-years+. But if you think you are building your company in a way that it mgiht never go public or get sold, then you probably want to have some concept of how investors will get their money out in a reasonable amount of time with relatively little headache. There are a number of ways to do this. One is to do a royalty based financing, where some percent of revenues goes back to investors. John Landry has been a proponent of this for certain companies.
Another option is the investor put-option, where the investor at some point as the right to sell a portion of their holdings at a pre-determined multiple. The third is some sort of dividend structure. Whatever approach you pursue, do more research and talk to your lawyer and fellow entrepreneurs about the pros and cons of each approach. As an investor who focuses on companies with GOLAZO potential, I rarely contemplate these sorts of structures, but I do respect the fact that different types of companies can be financed differently. And for many investors, this kind of company can be quite attractive!