Ross Mayfield's Weblog

Collapse: How Startups Choose to Fail or Succeed

Jared Diamond's new book, Collapse: How Societies Choose to Fail or Succeed, provides a simple framework of five forces that lead to collapse: environmental damage and population growth, climate change, hostile neighbors, weakened trade partners and failure to solve societal problems.  I thought I would mash it up with the Techcrunch Deadpool:

The NY Times has a great piece on Dr. Diamond's theory and the academic debate amongst anthropologists.  The above mashup is based on their infographic about the model and collapsed civilizations like the Maya, and it serves as an excuse to discuss the risks facing startups.

• Market risk is the big one.  A little startup has very little control over market size and penetration.  One way of managing this risk is to go after bigger markets, in which gaining a sliver is still substantial.
• People risk is all about the founding, management and larger team.  Get this one right and not only can you execute, but have fun along the way.  Get it wrong and it may be painful.
• Technology risk is both managing technical complexity and innovation as well as product management.  Some say this risk can be managed with sufficient resources, but it is more about the timing and activity of resources against the pressure to go to market.
• Financial risk is the ability to fund the company to get to profitability.  This is both a function of capital formation and the ability to execute on revenue.  Many in the deadpool failed to do the former, but largely because of the latter.
• Disruption risk is a broader category for things like platform shifts, asymmetric competition, legal risk and other force majeure

I find that any substantial startup risk, and inherent reward, can fit into these five categories.  Marc Andressen has a larger post exploring edge cases in the context of when VCs say no.

I'm actually with the anthropologists in this debate, where such simple frameworks help you think about where to pay attention, but larger forces are beyond an entrepreneur's control and vary significantly.

That sucking sound

Mike Arrington: Times are good, money is flowing, and Silicon Valley sucks.

Hard to argue with it.  Except that a lot of us are still focused on technology, burgers and beer.  My read of Mike's post is not the insanity of valuations, marketing budgets and parties.  Maybe a bit of the pitchiness that bloggers and journalists deal with in frothy times.  But certainly the culture that existed here a short bit ago.  Back when I met Mike, actually, and a bit before.

Funny how I couldn't find an entrepreneur who blogged about this gut checking post, even when part of the point is the valley is flooded with itinerant entrepreneurs.  Except Eric Rice, who is from here, like me.  We're the idiots who didn't move out when it got too expensive, for some good reason we believe in.

Deep within me I fear that the region that learns too much about, instead of from its failures, becomes Detroit.

Startupping Launches

Serial entrepreneur Mark Fletcher just launched Startupping, a community resource for Internet entrepreneurs.  He kicks it off with a blog post on the best and worst decisions made by John Battelle, Dick Costolo, Paul Graham, Chris Pirillo and yours truly. Some gems:

• Dick's best decision is hiring, but not the tired A player ego stroke answer, his emphasis is on cultural fit
• John says either keep control or don't act like you have it
• Paul emphasizes being strong with investors
• Chris says to hire salespeople who understand the product and be cautious of handing over control of the business model

Startupping is a blog, wiki and forum on topic.  I've tried similar efforts in the past, notably the Startup Exchange, but got consumed with my passion that more directly pays.  Mark, all the content in the Startup Exchange wiki is CC-licensed, so please reuse.

Being consumed by the primary passion apparently isn't just my experience.  Brad Feld noted this when passing on the launch of Dick's new blog:

Relatively early on in our relationship, Dick stopped blogging.  He’s a classic always working entrepreneur and blogging quickly fell to the bottom of the pile as FeedBurner started its incredibly rapid growth curve.

Dick's new blog, Ask the Wizard, is an absolute must read for any entrepreneur.  Let's hope he doesn't stop.  When to raise money isn't an easy question, because it really varies, but the important point is isn't just when, but how much.  Pitching your company is a topic more of lore than matter, and my approach is to keep it simple, know many pitches and get into real conversation as soon as you can.  There is more on outside directors and non-founder equity so far.  The advice is practical, smart and fun, just like the author.

So Dick, let me ask you one question that I think you are in a great position to answer, at least to keep you going.  How does an Internet entrepreneur overcome not being in the Silicon Valley? I'll bet it is more than being on a plane all the time.  And I happen to wonder if not being based in the Valley explains why Feedburner was to be first to market without any competition for so long.

Entrepreneur Hindsight

I was asked by email to provide what was my best decision and worst mistake as an entrepreneur.

Best Decision -- To become an entrepreneur in the first place

I started my career in the non-profit sector, and then in the public sector, all in hopes of changing the world.  I quickly realized that I could both have an impact and make a living in the private sector.  And am lucky to now work on a company that produces social goods.  Further, as a startup founder I believe you can quickly have a significant impact, possibly more than any other job.  It is a roller coaster of risk.  One day you can be beaming with pride to have created jobs and a fun place to work, and another you stress about meeting payroll and having folks be overtly human with one another.  I may be a little lucky in finding my role (but not so lucky that I don't have to work for a living), but sincerely believe the world needs more entrepreneurs.

Answer #2, to more specifically tie this to a decision...

Best Decision -- Picking co-founders you trust

It is not an exaggerated saying, that you marry your business partners, especially co-founders in a startup.  Some look to partner with the Geek Girl for her technical whizbangery or Phone Guy for the sweet talk and access to capital.  While you want to work with people that are skilled, I'd say the primary qualifier is if you can trust your co-founder.  If you have any hesitation, either work it out or walk away, quickly.  I'm luck to work with great co-founders I can trust with my life.  Beyond trust, I would also put startup experience beyond specific skills.  Someone that has rode the roller coaster before is less likely to barf in your lap.

Biggest Mistake -- Not taking bigger risks earlier

Maybe because in hindsight all risks are clear, but I always find myself regretting not taking bigger risks earlier.  For example, open sourcing the Socialtext code was something we waited on until the company had strong footing.  Partially because we thought there would be cannibalization, partially because we were understaffed to really engage with the community.  But I believe if we bought this bullet earlier in the history of the company we would be reaping better rewards.  As a planning exercise, now I always try to ask two questions: "How could we take more risk?" and "What risk can we take that creates the greatest amount of options?"  I find there is always a way to do a little more, in particular by getting past instinct to control prevalent in so many entrepreneurs.

Pie eating

I'm not sure what movie I saw, or the analogy it applied to, but "It's like winning a pie eating contest, where the prize is a whole bunch of pies" really resonated with me as the saga of entrepreneurship.

Every win comes with opportunities, which creates new problems to solve, and so on and so forth.  The hard part is recognizing a win for yourself, for your team, and building upon it.

Analogies of hills (challenges) and rollercoasters (wild rides) of course apply.

The Wikinomics Playbook

UPDATE: An interesting related project by Penguin Books is A Million Penguins, letting anyone edit a book to be published.  The wiki is down at the moment, but PaidContent notes it began with “It had snowed, and was now raining. Gritty slush covered the pavement. Sharp crystals of snow decorated grass.”  Reuters notes the challenge is finding “believable fictional voice” within the mass collaboration.  This was a big challenge for group editing of the Wired Wiki story.

The last chapter of Don Tapscott's new book, Wikinomics, invites readers to write it: “Join us in peer producing the definitive guide to the twenty-first-century corporation on www.wikinomics.com.”  Today we launched a Socialtext wiki for the Wikinomics Playbook, where people can not only learn about the power of mass collaboration, but participate in it.  The book is already one of the fastest selling business titles and is an excellent primer on how models of collaboration are unfolding from open source to blogging to wikis in the enterprise to enable people to participate in the economy like never before.

The second to last chapter is about enterprise wikis.  Half of it discusses how Best Buy is using a wiki knowledge-base for the Geek Squad.  The other half is an interview with yours truly and shares some of Socialtext's success stories. The first chapter is available online as a pdf.

 

This is a great example of how a book can be augmented with a wiki, as most books are out of date by the time they are published, never quite finished and have the potential for participation. Last month we helped Larry Lessig share the entire Code 2.0 book in a wiki.  I expect that soon such commons-peer production, a wiki for every book, will be common.

10x 2.0

The traditional venture capital invests disruptive technologies that provide a 10 fold improvement and generate 10x return.  However, Web 2.0 consumer internet companies are not based upon disruptive technology, but potentially viral models of participation.  The consistent pattern is sharing control to create value.

Measuring the disruption in performance terms proves difficult and is an opportunity for research.  I have not found a way to measure the lower cost (zero marketing budget) of user acquisition and lower churn through virality and network effects.

But you can measure the impact of disruption.  Craigslist cannibalized the Bay Area classifieds market by $60 million by 2004, when they had $6 million in revenue.  This is asymmetric competition against models that provide less freedom to communities.  Consumer internet startups generally require 10x less capital to get off the ground (although not consumer, Socialtext was seeded with only $5k and six months of sweat, as an extreme example).  Realizing a 10x return with a developed community and functioning business model should be a layup.

But if this model requires 10x less investment, the lingering question is how $1B venture funds invest enough.  Or how much time even a small fund can spend with its portfolio.  The IPO window remains practically closed and burdened with $2M in new SarBox operating costs making it less attractive.  M&A is out of control and potentially furthered by the need for venture firms to exit earlier to make the model work.

We are in a bubble, that is representative of our times.  It began with Google's acquisition of Blogger, and it might have peaked with the rumored $2B valuation of Facebook (hinting at the cyclical tip from consumer to enterprise).  I'm not sure there is a lack of failure in this bubble, or if we just need to give it time.  There definitely are more plays in each category (e.g.  well over 200 in social networking or social bookmarking, possibly over 200 funded in video search).  I've said for a year that this bubble is build to flip.

The problem is there are too many companies being created that have no aspirations to be companies.  Most survey the feature portfolio of tier 1 and tier 2 acquirers and are precision guided towards flipping within 18 months.  Many make no attempt at generating revenue and most that do generate revenue from the advertising of other startups, let alone demonstrating a business model.

A dirty little secret for those actually building these things into businesses is that generating community value takes time.  Beyond the blog bump and 53,651, a community that stays with you and grows virally is tough to achieve.  Today's successful ventures are twice as old as the 18 month window.  They were born when it was a shitty time to create a company, were largely either hacks cast out openly to serve an immediate itch and community (e.g. Blogger, Six Apart, Technorati, Newsgator, del.icio.us) or almost accidental creations that caused a business model iteration (Flickr).

Today the problem is microventures optimized to flip are flopping, but they are too small to see.  It isn't just that VCs are taking the risk of the bubbles.  For every funded company, there are 10 with the sweat and tears of entrepreneurs that fade to black.

This is not all bad.  We are in the risk business.  There is creative destruction with tight iterations that provides a base of vibrant innovation for the economy.  But structurally, this bubble is attracting increasingly less experienced entrepreneurs (and investors) chasing the wrong incentives. 

Ethics Gone Wild

Paul Kedrosky takes a look at Girls Gone Wild.  Or rather, the actions of the entrepreneur behind it, and raises the question -- is there such a thing as entrepreneurship morality?

I tried to comment, but got an error, so posting it here (consider this a disclaimer for not writing more on what could be a very big subject).

Does business have a morality? No, but it has ethics.  Although you can get lost in definitions.

Social entrepreneurship is class of business with a fairly well defined set of ethics. It is also a investment thesis (pornotube.com is an ethical thesis to the contrary).

Enterpreneurship is like many professions without institutional barriers to entry (e.g. PR, and yes, Venture Capital, increasingly in the hedge fund age) -- ethics will be defined in industry groups, in some cases to gain advantage.  In most cases, explicit normative development only happens when egregious errors impact the community.  Then they act out of profit motive and perhaps before regulation is called for.

Innovation, Risk and the Intrapreneur

Scott Gatz picks up on the conversation he started on Intrapreneurship with a thoughtful summarizing post.  I had noted that Intrapreneurs take less personal risk than Entrepreneurs.  While I thought my point was largely true -- following strong opinions, weakly held as blogging practice -- I've second guessed myself firt, and with a mind open for others.

What also bothered me is that what I do for a living at Socialtext is help those in large organizations who take risk get promoted.  Some are Intrapreneurs who instigate a purchase and champion a tool, but many more simply stick their neck out by being transparent and on the side of a truth.

There is no question that Intrapreneurs take risk.  As Andrew Fife pointed out, your salary can fall to zero.  I disagree with him that being part of a large company opens more doors for you than a startup, just being there only counts for television, which further supports my original point that all companies should enable Intrapreneurial activity.  Intrapreneurship is a big hairy audacious mechanism to foster innovation.

Today I gave a talk before the executives of a prestigous R&D unit.  I was followed by none other than William Miller who has modelled The Valley better than anyone, gave me some key informal advice when starting Socialtext and helped me frame what we live and work in as a irreplacable marketing function.  But more than anything, to me, he was the one who realized that the Culture of Failure.

Based on the points in Bill's Habitat for Entrepreneurship, we were discussing what a large organization could do to model the engine of innovation we call The Valley. Quoting one point in full:

4. A business climate that rewards risk-taking and does not punish failure is a prerequisite for an entrepreneurial high tech community. Most high tech ventures fail, so a climate in which the stigma of failure hangs over the unsuccessful entrepreneur serves as a powerful deterrent. This is especially true if the rewards for risk-taking are not sufficiently high. In Silicon Valley, there are many examples of entrepreneurs who have failed and successfully started over. These entrepreneurs view failure as a learning experience.

On the failure side, bankruptcy laws that provide limited liability—that is, laws that limit liability to the invested capital and do not permit creditors to “reach beyond” the company—permit entrepreneurs to be more venturesome. Similarly, the availability of limited partnerships for venture capital firms encourages their formation, and in turn, their capacity to engage in the high-risk business of high tech ventures. Japan, Korea, and India are moving in this direction, or have already done so.

On the success side, security laws that bestow equity credit for ideas, organization, and hard work give larger rewards to the entrepreneur. By contrast, a security law environment that requires company founders to pay the same amount as investors for each share of stock does not result in a large enough payoff for the former. This situation often results in large initial dilution of the founders’ stock, making them reluctant to take further investment — and dilution —to grow the company quickly. In fast-growing markets and markets characterized by increasing returns to scale, rapid growth is essential to survival. Changes in these kind of securities laws are currently under consideration in Japan and India.

A culture of failure is a prerequisite for success, and is based upon both legal structure and business norms.  Liability must be limited and risk respectively distributed.  Corporate venturing and M&A are a proven models for a large company to couple itself with the risk taken and the innovations of entrepreneurs. 

Intrapreneurship, in my opinion, is less developed.  Primarily because organizational cultures do not reward failure.  I am interested to hear of a large companies that have structures and norms for personal risk taking by employees.  By personal risk, I mean organizational, social and financial capital where the more you risk, the greater the reward.  Liability is inherently limited within an organization, which is the conservative strong suit.  But the undiscovered incentive, which goes against the grain of most corporate culture, is the ability for an individual, or team, to play an internal market with their own risk and reward.  And when they fail, be rewarded as well, with the chance to succeed.

Intrapreneur

Scott Gatz is pretty stoked at the ability to be an Intrapreneur at Yahoo.  He gets to make a case for a project, acquire resources and above all, innovate.  Possibly building a profitable business within a business.  Great stuff.

But shouldn't any knowledge worker be able to do this at a BigCo?  I have problems with using the word Intrapreneur, except for describing an innovative spirit.

The difference between an Intrapreneur and an Entrepreneur is the latter takes personal risk.

The Blog Bump

The initial target market of almost every consumer internet startup these days is blogspace.  Smart companies were doing this a couple of years ago.  The cost is nominal, reach expansive and early adopters are exposing their preferences post by post.  Most any company that can carry a conversation can get the blog bump and gain overnight growth of up to 1 million users.  However, bloggers abandon tools as quick as they adopt.  Making it over the hump after the blog bump into the mainstream is a real challenge.  But heck, at least it can get you a first venture round.

Advisorship

In this post, I'll describe the origins of Advisorship, what it takes to run an effective Board of Advisors and the benefits, how to handle conflicts of interest and best practices for disclosure.

Building a Board of Advisors is one of the first tactics any startup should employ.  Initially, this construct was used by startups with a high degree of technical complexity with Technical Advisory Boards largely with experts from academia and research.  Companies increasingly employed Business Advisory Boards to help them with business development and strategy beyond the activies of the Board of Directors.  During the bubble, Technical Advisory Boards also played a role in driving sales and partnership.  Telecom was particularly excessive and replete with conflicts of interest (Om could point us to them), such as gaining Advisorship from potential acquirers and customers.  Direct conflicts of interest were clear, where vendors gained an advantage over others through the leverage of options and in some cases, cash.

With the rise of social software, Advisors also play a role in the marketing mix of a startup.  Advisors have always provided more than advice, but lend credibility to emerging companies.  The opportunity today is to let Advisors lend more than their name, but have their participation in the conversation.  As with most business ethics, the ethics themselves are not necessarily new, are mostly common sense, and are simply a matter of recognizing and complying with best practices.

Running a Effective Board of Advisors

Startups mistakenly think a BoA is a list of references compensated with stock options.  In practice, they can play an active role in the development of a company.  Like a Board of Directors, they need to be actively managed to derive business benefits.  When I was the CEO of a later failed (praise failure!) Risk Management Software company, I worked with an A-list board of advisors that even included startup guru John Nesheim and a nobel-prize nominee.  One of the members, Robert Berger, taught me a structure that participated in at Covad, which was widely recognized for having an effective BoA.

And Advisor should:

1. Be made available for a quick questions or introductions by phone or email on an occasional basis from a single point of contact (the founder or CEO)
2. Participate in monthly conference calls
3. Attend quarterly face-to-face meetings

Calls and meetings follow a simple agenda:

• A presentation by a single strategic issue,
• open discussion.
• Alternate who gives the presentation with each call or meeting, between an executive of the company (e.g. VP of Marketing on entering a new market) and a member of the BoA (e.g. on a trend they are seeing in the market the company should pay attention to).
• Generally, calls should go for an hour, meetings could go for two or three.  Meetings can be shorter and complemented by a social gathering.

Since then, I've made a couple of tweaks.

• In the case of Socialtext, we waived the f2f requirement.  Initially this was done for sake of budget (the company should cover travel costs for participation).
• The entire company is invited to participate in the call, not just the executives or founding team.  It will be interesting to see how this scales, and if employees can follow such practices as "only improve upon silence."
• We use freeconference.com for the conference call, IRC for link sharing and turn taking, and Wiki for notes and presentations.

I'm being eaten by a BoA Constrictor

I liken the role of a BoA as a group with strong ties to the company, playing a role in it's social network as the first degree.  Initially, names alone provide credibility or thought leadership, but to really gain advantage, a structure such as above needs to ensure information flow and set expectations.  Who to recruit should be fairly obvious for your startup.  Look for people who are leaders in their industry, where you can build a foundation of trust and above all make sure you form a diverse group.  I think trust is essential, so you won't hold back on sharing what's really going on in your business.  So is honest conflict -- your BoA needs to be able to tell you when you are on the wrong path or blind to opportunities. 

Some of the benefits of a BoA:

• Thought leadership
• Technical advice
• Strategic advice
• Trusted feedback loop
• Network into customers, partners and VCs
• Increases the perception of scale and maturity
• Properly disclosed influence through blogs and press
• Cash-conservative compensation

BoAs can be effective at scales greater than that of a Board of Directors, because their role isn't to make decisions (where BoDs of 3 or 5 work well).  Start with a BoA that is a mix of technical and business advisors, when conversations start bifurcating you will know so too should the BoA.  The constraint for expanding the BoA is your time managing and scheduling them and your stock option pool.  Compensation for a board of advisors is typically in the form of stock options.  Grant sizes are typically on par with that of a new employee.  Vesting in accordance with the Employee Stock Option plan, which sets an effective term of service to the company.

Advisorship Ethics

Unlike a Board of Directors, they do not have a feduciary duty to act in the best interest of the company and it's shareholders, so as a founder or CEO it's important to watch for and manage potentitial conflicts of interest.  Advisors have this duty as well, ethically, not legally.  Sometimes an Advisor may work at company of strategic value to a startup.  In this case, it is essential for the Advisor to disclose internally, if not gain approval prior to accepting the position.  There may also be conditions in which the Advisor needs to excuse themselves.

Disclosure is the meme of the moment.  It goes without saying that companies should disclose their Advisory Board openly and with pride.  Some of the best advisors these days are also active bloggers.  While blogging is informal and conversational, norms have developed for disclosure.

First disclosure is perhaps the most important one.   An Advisor should disclose the relationship prior to or at the time of writing about the startup.   For example, I have not blogged in mention of Dabble until this post.  When I blog specifically about Dabble, perhaps about playing with their alpha, it's important for me to do specifically within the post, but also recall past posts that may be influential in framing their category.  In this case, I posted that 2006 is a big year for video on the net, partially influenced by more insider knowledge of video sharing startups.  Blogging about companies you advise is natural and should be encouraged given the passion required for affiliation.

Ongoing disclosure, given the nature of blogging, should not be required within each post mentioning or influencing the perception of the startup.  The norm today is to list your disclosures on your About page.  Unfortunately, Wordpress and other blog tools are breaking the genre when it comes to including an About page on the blog.  This oversight fails to encourage other good practices we could borrow from journalism (bylines) and the net (you own your own words, thanks to the Well).

I participate on the following BoAs:

• Dabble -- video sharing (haven't blogged about it)
• Eventful -- event and venue database
• Ookies -- photooki sharing (haven't blogged about it)
• Persuadio -- conversation visualization
• Plazes -- location based social software
• QuantumArt -- content management

Socialtext has an outstanding BoA that includes Tom Gruber, Zack Lynch , Jerry Michalski, Mitch Ratcliffe, Doc Searls, Clay Shirky, David Weinberger and Kevin Werbach.  We'll have some announcements in this area soon.

Free Crap

A directly related issue is disclosure of products received from vendors as a blogger.  Over the past year, I've witnessed a change where bloggers once got a free book or two a year.  Nowadays, an influential blogger is overloaded with everything from free cell phones to toilet seats.  I'm a member of the Silicon Valley 100 and get a bunch of free crap, for example.

The norms for disclosure of free crap are fairly well developed.  If you blog about a product you got for free, you mention it in the post.  The distinction here is you only have a transient attachment to the free crap, as opposed to an Advisory relationship with aligned long-term incentives.  However, there is a very big grey area here.  Journalists who get free crap are required to return it (one of the secrets of living cheap in the Silicon Valley is you can count on free lunch from journalists or VCs).  Bloggers tend to keep free crap. And I'm not sure that's unethical, if the norm for disclosure is further developed.

Instead of the current witch hunt, I hope for more constructive attention by mainstream media to how to pass on practices from journalism.  Ethics are central, but there are things you learn in j-school and on the beat that could make us a better complement to the mainstream.  I also discount the gatekeeping echo chamber impact of blogging, especially compared to the mainstream.  By contrast, the blogosphere celebrates diversity with attention and there is no gate to be kept.

 

Bubblop

David Hornik is calling today's market Bubble 2.0, or Built to be Bought:

I even had one company pitch me at the Web 2.0 Conference that if all went well they would be acquired by Odeo (don't get me wrong, I'm a big fan of Ev's and I certainly think that podcasting is exciting, but it strikes me as a tad premature to bet your company's future on being acquired by a pre-revenue company).

You will recall the last time Venture Blog called a bubble, a bubblet that centered around social network, and they were right.

I'm wondering for the record, if I was the first to call this one, five months ago.

More Entrepreneur Resources

On the Entrepreneur Exchange, I started a section on Entrepreneurship, and someone started an Entrepreneur Blogroll.

Then someone started a section on Angel Investors including an Angel Blogroll and Angel Groups.  Great idea.  You may recall that I met my Angels through blogging.

VC Blogroll

I started a VC Blogroll on the Entrepreneur Exchange.  I know I'm missing some folks, so please contribute a link if you can.

Entrepreneur Exchange

Entrepreneurship is the discipline of starting a company in absence of resources.  Today the Entrepreneur Exchange opened, a renewable resource (wiki) for entrepreneurs.

Most entrepreneurs don't fully understand their own power, especially when they work together.  For example, Venture Capital is an asynchronous market, which should favor the entrepreneur.  You will always know more about your business than they can.  But there is a certain fear first time entrepreneurs have in dealing with VCs, not because they don't know their business, but the process of raising and working with venture capital has been relatively opaque.  This is changing with the rise of VC bloggers, many of them offering their content under Creative Commons licensing, openly sharing otherwise private equity insight.  So the first part of the exchange aggregates some of the best links and resources on venture capital.  I hope VCs jump in and contribute themselves (especially because there is a wiki page about a number of VC firms).

The second starting point of the Exchange is a StartUp Kit created by Andy Stack -- a set of wiki templates and best practices to help entrepreneurs manage formation and growth.  Andy co-founded Stata Labs which was acquired by Yahoo.  Now he is sharing his expertise on how to manage a company lifecycle, timing your spend and organization with small investments that make all the difference when you are acquired.  Andy used Socialtext for a couple of years at Stata, including coordinating due diligence for the acquisition, so he has thought through not only the practices, but the tool.

These two resources are really just starting points.  There is no social contract for the space yet, just a creative commons license.  Take advantage of it, contribute a bit and let's see how this grows.

Stealth is Old Skool

Mark Fletcher has a great post on why stealth mode is a stupid way to start a company with today's web. It's a point I've made before (The greatest market risk in social software is not engaging the network early), but let me add some parallel thoughts:

• Part of the rationale for stealth is competition. But there are more leaks than plumbers, and getting ahead of your competitors matters less than getting in bed with your users.
• Part of the rationale for stealth is stardom. When media was broadcast, you countered lack of access with exclusivity. Now you need to be inclusive from the get go.
• Part of the rationale for stealth is building barriers to entry. But to Mark's point, this stuff isn't about millions of lines of code and complexity anymore.

Entrepreneurship is experimenting at the margin, so get out there and start pushing boundaries.

The Process of Fundraising and Making Sausage

On April 28th we held a contest for the first blogger to post five details of the Series B Socialtext closed.  Now, the details are out in our local paper.  Socialtext raised a $3.1 million Series B round led by Tim Draper at DFJ that closed on April 15th.  From tracking the blog contest, one guy in Chicago actually set up a blog to enter it and got four out of five details right.  Unfortunately, the post and blog are gone, a case of blog churn.  Until he turns up, I'm awarding the Socialtext starter package to Juri Kaljundi who was the first to unearth a detail.

Matt Marshall provides more of the story by blog, noting he tried to participate in the contest, but couldn't uncover a Deep Throat.  Matt also notes that Draper is known for fast growth companies and our bootstrapping roots, whereas I'm a believer in building for the long term.  Perhaps sharing some of the story of how we raised this round will help explain how building for growth and the long term are compatible.

I first met DFJ through Steve Jurvetson back when co-founding RateXchange during the boom.  We happen to share a love for the little country that could and a dog made of velcro.  I've given him a look at each of my deal knowing that the feedback is 10x the price of admission and in confidence.  Two years ago we came in to talk Socialtext with Steve and Andreas when we were raising our angel round, the advice still resonates.

I met Tim Draper at the first Always On Innovation Summit and was immediately struck not only by his presence but his straight talking style.  Also at AO I had a nice lunch with John Fisher, who introduced me later that day to one of best customers. 

In the Fall of last year we were talking to a few VCs and I ran into Steve at the Accelerating Change conference.  We were near a decision point and I stepped back to think, who do we really want to work with?  Every interaction with DFJ provided value to Socialtext -- the one thing an entrepreneur can and should ask from the process of raising venture capital.  They got Social Software, far earlier than most.  So we got to work.

We spent the first quarter of this year meeting every member of the firm and digging through the tough questions.  Joshua Raffaelli and Josh Stein dug really deep into the product and customer due diligence and shared what they found so we could learn from it.  In a last meeting with Tim we talked through terms and they produced a term sheet on April Fool's day (nice touch).

We set up a workspace driven by a due diligence checklist for our Series B lead.  Here is a redacted version of the homepage in my public wiki. We set a goal of getting through due diligence in three weeks and achieved it in two.  When the money was in the bank, the deal was closed with a collective whoo hoo!

Stata Labs also used Socialtext to facilitate it's due diligence when acquired by Yahoo!:

But here's one interesting factoid: Andy Stack, co-founder at Stata Labs, managed that company's acquisition by Yahoo using Socialtext's product.  "It saved on the exhorbitant costs of both legal teams going through all these documents," he told us. "It eliminated re-sending, and re-looking for them. Yahoo’s legal bill wasn’t as high. Our legal bill wasn’t high." Time will tell. Mayfield, though, is ambitious: "We're going after the 500 million business users of email," he told us.

I'm sharing the process and practices of raising venture capital, which is a lot like making sausage (Voiceover from Dana Carvey doing Ross Perot: ain't going pretty).  It is a deeply personal process for a CEO, akin to a job interview where they remove a substantial number of hair follicles for drug testing.  What matters isn't just the pitch, demo and deck.  In the end someone is on the other side of the table thinking, "is this the guy?" while you are thinking the same.  Just focus on building relationships while building your business -- that's how to raise a round.

Now that the deal is more formally announced I'm getting a barrage vendor calls that I'm redirecting through LinkedIn.  We're getting an office in downtown Palo Alto next to the train station.  Hired a person a week since the close of the round and are moving on things we lined up in advance.  Now we are growing the team, with some key engineering and sales hires.

We chose DFJ because the size of the market opportunity is substantial.  Over 500 million business users of email will gravitate towards wikis for group communication.  Socialtext is the first mover, first prover and market leader -- and to sustain and realize this market opportunity we needed expansion capital with a track record in high growth companies. We will benefit from our bootstrapping roots and tradition of investing in the things that matter to our customers.  Borne in the bust, our low cost business model and frugality enabled us to take less capital without sacrificing growth.

Ultimately, our community determines our growth path and helped inform the decision to expand.  With greater resources, we can more actively cultivate this community and serve their needs.  This inclusive model for growth is one DFJ has experience in (e.g. SugarCRM, Technorati) and is in line with our mission to bring wiki everywhere.  Focusing on sustainable growth means setting significant objectives, managing costs and options, engaging communities and driving exceptional innovation.

So what else is new?  Mostly my job, the subject of another post. 

A Flip/Flop Bubble of Microventures?

Vinod Khosla is getting back into seed funding, something closer to what BusinessWeek calls his golden era where half of his investments were less than a buck ($1M). To wit Paul Kedrosky comments:

As one GP put it to me recently when I described our seed investment style here in San Diego, "You put as much as work into seed investments as you do into larger ones, but the management fee is lower and you have to make more investments & track more deals. Where's the incentive?" Absolutely. Agreed. Stay away.

And the entrepreneur cringes. It's easy for me to say when I have passed it, but the seed round underpins everything in the valley. During the bust, all the Angels died and went to heaven. Luckily, some of those that did well during the boom stayed in the game and seeded most of the great new companies known today.

The incentive, putting aside the carry, is higher risk/reward. But it is also the opportunity to develop white space markets. A different kind of challenge I think both entrepreneurs and great investors appreciate. The other approach is short-term investing, which VCs don't do, in theory.

Which brings me to the new micro-bubble. Not related to the Khosla story, there are a ton of former entrepreneurs getting back in the game these days. The lure isn't just that markets are opening again. A mindset is developing in the valley that you can and should develop startups for quick flips. If you have your own cash, you can seed a play like this yourself, filling a targeted niche -- both in product, market and engineering expertise. I even heard of a major portal getting into seed funding to encourage it. Perhaps this whole thing was started by Google's micro-acquisitions. I don't have any data on this trend, as it is the most private part of equity, but it is the talk of many a Silicon Valley coffee shop.

I've always believed the VC No of "is it a product, or a feature" is lazy thinking. All great products start as features and great teams evolve them with a mission in mind. The flip approach avoids this entirely. Just focus on the feature. Think for a minute how inefficient a market can be when the spoils of a previous bubble can be invested by seeding flips targeted to buyers instead of companies targeting real customers with real business models.

When the latter is considered contrarian thinking, here we go again, although microventures certainly limit the scale of inefficiency. To argue the other side, this can be a boon for buyers, a market mechanism for R&D that is relatively efficient. But I have to wonder what happens when this private market activity rolls up to public equity pricing, and the amount of creative destruction this could incent.

I am a big believer in developing a company with the goal of making it as great as can be, with an eye on exit in public markets. I look M&A exits as options along the way. The problem is when you build to flip, you may be focused, but short sighted. Essentially, you loose IPO as the exit option and M&A opportunities you can't foresee.

My grandpa taught me the difference between an entrepreneur and a businessman is the entrepreneur is in it for the quick flip, while a businessman makes a lasting contribution to the community.

How to fire your team and make them happy

Today I fired the entire Socialtext team. Then I fired myself. We are all pretty happy about it.

We were subsequently hired by Administaff, the largest Professional Employer Organization (PEO). They are much better at employing people than we are.

With a back-to-back agreement with the company, we essentially outsourced HR and enabled our employees to gain benefits only Fortune 500 companies get. By pooling risk and purchasing power, they negotiate better rates and provide better services (with employee choice) than is possible for a small company. I did this before with Trinet and there are other PEOs out there.

Some of our goals included making Socialtext a supportive place to work, while letting people work where they work best. Without this partnership it would be an administrative nightmare, as our team is spread across the states. We also want to make Socialtext family friendly, so we elected for a significant portion of dependent co-pay. Now everyone has great PPO or HMO medical, dental, vision and life insurance, a 401k and a bevy of options.

I blog this administrata because not all small companies know that you can achieve economies of scale and scope for such a large line item. In the bootstrapping phase we even had to go uninsured (stupid) for a brief period. Needless to say, my wife is pretty stoked. I am because the payroll service means my hand doesn't hurt signing checks twice a month, but that is a good pain to remember.

Finding a Home

When I was CEO of a risk management software startup, in very risky times, I had the honor of having John Nesheim as an Advisor.  His book, High Tech Startup is a classic guide for entrepreneurs from idea to IPO.  According to these Cliff Notes, we are at stage 9:

Stage 1:  Getting the Idea
Stage 2:  Meeting Around the Kitchen Table
Stage 3:  Getting the Founders' Commitments
Stage 4:  Pullout from Employer
Stage 5:  Creating the Business Plan
Stage 6:  Filling the Management Team
Stage 7:  Raising Seed Capital
Stage 8:  Incorporating and Cash in the Bank
Stage 9:    Finding a Home
Stage 10: Starting Up
Stage 11: Raising Secondary Rounds of Capital
Stage 12: Launching the First Product
Stage 13: Raising Working Capital
Stage 14: Initial Public Offering

The best advice Nesheim repeatedly gave me was to think bigger.  But more on that later, as it is a dangerous thought process when measuring square feet.  Real Estate is the leading cause of death for startups.

The thing is, Socialtext has purposely leapfrogged a few of these steps through net-enabled bootstrapping.  We started with a wiki, me in Palo Alto, Pete in Foster City, Adina in Austin and Ed in Ann Arbor.  Today we are ten, and hiring, spread throughout North America.  We have had product in the hands of paying customers for two years now, served them well, and with almost zero overhead.  Everyone works from their home office, with a social fabric made of broadband and social tools:

• Socialtext -- the building and garden
• IRC -- the hallway
• FreeConference.com -- the conference room
• Skype -- the meeting rooms
• IM -- talking over the cubical
• VNC -- peeping over the cubical
• Our blogs -- the front porch

I am convinced that being virtual is the best way to start a company.  The benefits go beyond cost (although the culture of frugality can go a very long way).  In our case, it improves the product.  But generally it is more productive.  When the bandwidth for collaboration is constrained at times, you gain a certain focus.  And with wiki, you develop a group memory to draw upon as you go forward.

The biggest downside is it is more difficult to celebrate victories.  Pete Kaminski has a saying: time F2F is to valuable to be spent on work. I can order a pizza to be delivered to everyone's home, and we have had our pizza parties, but it's not the same as being able to have that bash when you hit a big milestone.  So instead, we celebrate our victories with the people we our working for.  Our friends and family.

Which brings me to perhaps an even bigger upside.  Working from home has given me an opportunity to be around while my kids are growing up.  Work does bleed into off hours, joyfully, and you have to be careful not to let it turn into Perma-work.

Interestingly enough, being virtual was seen as a plus by customers and employees, but seen as a risk factor by VCs.  In a sign of not getting it, one even used it as a reason to pass.  But you can learn about risk factors, perceived or real, from VC feedback so we took it seriously.  Even considered consolidating the team earlier.  Basically there are two risks:

• You can manage yourselves virtually, but can others manage you?  You never run a great startup to be acquired, but you certainly do not want to rule it out.  There is the possibility that an acquirer may not perceive the distributed structure as a strength.  Something similar to the walking around theory of management, people like to see busy people working in a row of cubes.  And there is the day when I give up my job as CEO, would the requirement of managing a distributed team decrease the candidate pool?
• How will the culture adapt to the somewhat inevitable office?  This is real and what we are working on now.

As we start office hunting while growing the team, our challenge is maintaining the practices and culture we have fostered over the last 2+ years.  Our approach is to have at least half of the team remain virtual and for those the main office to have flexibility to work at home at times as well.  We will encourage travel not just to the headquarters for cheerleading, but for people to get together in the field and various on-sites.  The big risk is bifurcation between "the office people" and "remote people."  Not as in warring tribes, but collaborative practice.

Adina is in town to work with Pete and me this week.  One of our better practices is collaborative note taking sharing for meetings.  For our real estate tour, we are sharing photos of places we like.  With an evenly distributed team, the incentives for sharing are easy -- it is a by product of daily work.  With a partially distributed team, the norms must evolve based on new incentives. 

This is more than finding a home, it's raising a barn that is shared by the builders.  I'll try to share more about this transition and the journey itself.

The VC No and the Entrepreneur Yes

Bill Burnham has a great series (1, 2 & 3) on the Art of the VC No.  Saying No is their business (from thousands of business plans to a handful of investments), and Bill explains how it's hard to say No, common ways of doing it and his reasonable approach.  As an entrepreneur who has heard the word as much as anyone over the years, I thought I would chime in from the other side of the table.

When a VC doesn't say No, they keep a free option to invest.  Even better, they get to see your business as a moving picture instead of a snapshot presented at the first pitch.  They have time and deal flow on their side. 

Entrepreneurs are in the Yes business.  The more you hear that word while cultivating relationships, the greater the valuation of your company.  Same thing holds for hiring and selling your product.  More critically, the enemy of the entrepreneur is time; and an increase in your Yes volume, provided you can make efficient decisions, the more time saved. 

When you first start your business, all you hear is No.  Accordingly you become conditioned to never accept it as an answer.  As your business grows, Yes volume increases and eventually you start dealing with the sell-side in a delightful turn of the table.

For entrepreneurs, there are a couple of approaches to avoid hearing No, none of which I am particularly good at:

• Never engage in active pitching -- not everyone can pull this off, but indeed you want other people pitching you
• Only take meetings where you know its a fit -- have relationships in place, know the timing of their fund, understand the portfolio fit, know who is the guy and their decision making process.
• Create a sense of urgency -- when there is competition for the deal or a milestone where the business will not need venture capital (the best time to raise), you generally increase Yes volume.

I've come across all of the VC Nos in Bill's list, so how do I not want people to say No to me?

• The California No -- part of the Valley culture makes it excusable to be indirect when it is personal (invariably is with entrepreneurs).  While you won't piss me off immeadiately by avoiding saying no, going radio silent or do not return my calls while previously setting other expectations -- is a sure fire way of not getting my business in the future.
• The New York No -- conversely, being an asshole doesn't help

So generally, how do I want people to say No to me?

• Before you take the meeting -- for competitive, portfolio, structural, thesis, geography and other good reasons let's save each other time.  Don't bring me in to educate you.

• The "It's Not Me" No -- communicate if there is a barrier. VCs work in partnerships, and it's reasonable for a VC to say that he wants to do the deal (even when he is not entirely convinced), but needs to persuade his partnership -- when the VC works with you to do it.  One tangental approach is when a VC brings in an "industry expert," usually an under-employed consultant or executive they are trying to find a home for,  and makes their opinion part of their criteria.  Good things can come from working with this person, especiallly if it is a recruiting fit, but it is often less constructive.

• The Constructive No -- I appreciate when VCs believe it is worth their time to learn what they don't know while making me a better entrepreneur.  Private equity is an asynchronous market, meaning entrepreneurs have more information about the state of their business (a justification for lower valuations given inherent risks).  But VCs have a keen eye for risk factors and can help you refine your pitch.  To work through risk factors, the best VCs will introduce you to potential customers and partners.  Not only can this help your business, but you get an understanding of what it is like to work with the VC.

Which is really all I ask from a VC while negotiating -- treat me as though we are already partners.  Show me how you really work, grow our networks together and help me think through strategic issues. When the deal is done, it's not like the hazing stops and you become part of the brotherhood.  How we work together to form the deal sets the tone for how we execute it.

But with all that said, the most important thing is how iterative the Valley is, so do not forsake trust and relationship.  We live in a world of Maybes, time-sliced with decisions.  Odds are you will be back at the same table in a few years, even on either side.

VCs Don't Invest in Ideas

SiliconBeat looks at the overhang in venture capital because interest rates have led to a general glut of capital, and wonders if all that supply benefits demand: So if you think you've got a good idea, you're marginally more likely to raise more money now.

The problem, and I hope you don't think it is a problem, is that VCs don't invest in ideas. This is one of the greatest myths in the Valley. We would like to believe it as it implies a meritocracy simply not present. Part of the Valley culture is a self-perpetuating desire to be more like Hollywood, where talent is discovered and hits are made. But the only people who get funded on ideas alone are serial entrepreneurs.

Techdirt suggests that it may be time for VCs to start pitching entrepreneurs, because Bloglines and Topix have been able to go it alone. But again, the people who don't need the money in the first place are the other half of the supply/demand story. And as Jeff Nolan points out:

Serial entrepreneurs are perhaps even worse at times becuase they really do think they are the dog wagging the tail (us)... even though the odds of finding serially successful entrepreneurs are only slightly better than O.J. didn't do it.

These days it is cheaper to bootstrap products and even markets. If you are only pitching an idea, it may be stolen, and you have lost the option to focus on customers and execution. If you are still at the kitchen table stage, your side time is better spent developing relationships.

VCs invest in real businesses and the criteria today, even in the consumer internet, is still relatively high. When VCs start funding nobodys based on ideas alone again, its time to cash out and move to Montana.

My sense of the private equity market is it is exactly the same as a year ago. Further confirmed by how VCs lag the NASDAQ by a year. The one exception is M&A has taken off, a market with even greater false incentives. Large companies saved cash during the bust, furthered by low interest rates. Someone rang the consolidation bell. Now public equity investors are investing in larger companies because they don't want to own acquired public companies because their price declines in the transaction. Large companies increase their market cap, they start buying with less cash and more equity. They cycle perpetuates until there are greater perceived returns for sellers by going alone. My guess is in a year or so we may be talking about IPOs more than M&A.

Starting a Startup

Paul Graham has an absolutely fantastic essay that every entrepreneur should read.  Here's the summary...

You need three things to create a successful startup: to start with good people, to make something customers actually want, and to spend as little money as possible.  Most startups that fail do it because they fail at one of these.  A startup that does all three will probably succeed.

...but the essay is much deeper than that.  Real experience, real stories and practical advice.

Relationships Over Transactions, A Learning from the Bubble

This post is part of Om Malik's bubble-a-thon.

Five years ago, I was the President and co-founder of a B2B Exchange with a $1B market cap. Seems right on the 5th anniversary of the bubble to revisit the rational insanity and fess up to your part in it.

A few years before, Sean Whelan and I were above a garage in the Mission district with a website brokering bandwidth.  RateXchange was a relatively simple business.  The telecom industry was full of the fattest cats imaginable, arbitrage opportunities abound and the margins were insane.  Sean knew the industry and had a simple concept of bringing some price transparency through a website.  For a year and a half we worked with hardly any salary, publishing rates and having conversations with phone brokers, buyers and sellers.  We pitched every VC and they still didn't get it.  I look back on this period fondly.  We were exploring new territory, creating a market and learning from people who worked profitable magic with only a phone, fax and a rolodex.

Then, Boom.  Suddenly what were doing all along was called B2B.  We raised $35M and $10M in debt overnight.  A dearth of B2B equity offerings drove us to go public with sixty thousand in revenue.  We went on a roadshow to meet people that had already participated in our oversubscribed offering.  Our business model was a fat butterfly, and we had to get fatter. 

Flush with capital, we embarked on an elaborate plan to foster a commodity market for bandwidth.  Not because the bandwidth market was growing like gangbusters, but because the market was grossly inefficient.  This was before there was B2B transaction software.  A year before, Chemdex spent $32M building such a system, cost us about a buck to develop our own in partnership with Trading Dynamics (later Ariba), a year later you could get one for $60k.  Beyond transaction efficiency, delivery was a mess of tangled wires, and contracted to deploy 14 pooling points in colo facilities to trade and deliver 91 routes in near real time across three continents.  We sought to create a spot and forward market to help carriers manager risk. 

For a damn good reason, the value of their assets was declining at 1000% per year for major routes and there was no mechanism to manage volatility.  Yet they kept building and buying.  After all, bandwidth was like a vacumm, and convergence promised smart layering of new services with elastic demand.  The more you build, the greater the demand, blah blah blah.  But for some reason, the sellers largely didn't ask to play in markets they couldn't control.  Around this time the Gorilla came in, Enron and its market making magic, offering their own market mechanisms.  Energy companies were ripe to play, but they still had little to sell.  Eventually we figured it out and liquidity was fostered, but it was too late for the equity markets and companies that were supposed to cumble, did.  Most of the rest is history.

Me, I would get up at the crack of dawn with my wife, logon at the desk I am sitting at now and look at how our paper value increased by a buck or two.  We would laugh in disbelief.  Private Client bankers called us before eight in the morning with schemes to turn paper into cash flow.  I hopped on the train to the city trying to figure out how to get the industry on board before it was too late for all of us.  Surely the market would flock to automated efficiency, to frictionless transactions, wouldn't it?

Around this time I picked up a copy of the Cluetrain Manifesto.  Markets are conversations.  This drum cut my ear, blew my mind, as it did many. 

Somewhere around the peak of the boom we forgot something.  That lowly phone broker who knew how to make money in the market.  Not because he could process transactions straight through to the bank. Near the bubble's pop, we were partnering with energy brokers, as they knew the people at energy-cum-telcos that wanted to play.  They didn't talk about efficient systems.  They talked about talk, they guy they knew they could extend credit or cut a deal because they knew they would get it back when they needed it.  Just like the phone brokers from a couple of years before, they knew markets were relationships.  Markets are social. 

But it was too late and the industry collapsed.  I moved on, and it wasn't easy.

Five years later I find myself with another startup, emulating the lesson learned as much as I can.  Now I am in the business of fostering social capital, of helping people connect through conversation.  Helping groups be more productive by tearing down false walls.  A revolution in simplicity, beyond aspirations of complex efficiency.  Going for sustainable growth, but also making choices based on relationships over transactions.  My customers are my business.  I work with some of the best people I could hope for, something I couldn't have said back then.  Even some of the Cluetrain authors, for which I am not worthy.  My network extends with people that value people.  My company produces social goods.  Even if Socialtext doesn't pan out as we hope (hey, it's possible), we have fostered a social software industry that will change the world.  Which is why I made the move from non-profit to public sector to private sector in the first place.

RateXchange lives on as an investment bank, MCF, thanks to the people that followed me, and one of its competitors went public three months ago.  It all happened so fast I never had a chance to vest or cash out.  Some investors made a thousand-fold return, which is more than fine by me.  I'm not sure I have regrets because I learned what I learned.  Markets are markets and somehow I maintained my own ethical integrity through boom and bust.  I still believe the network is the market, that bandwidth trading could have saved the industry and that similar businesses will thrive. 

I have learned two things from the bubble and have one theory that remains to be proven out.  One, relationships are the only thing you cannot commoditize, which makes them so valuable.  Two, by consequence, it matters who you work with.  Three, if you pursue what you believe to be the right thing, learn from failure, and innovate at the margin -- your rewards will be greater than what you could speculate.

This post is part of Om Malik's bubble-a-thon.

• Andy Kessler: Nazdog & The MOMOs
• Om Malik: The Beholden Years
• Ross Mayfield:  Relationships Over Transactions, A Learning from the Bubble
• Paul Kedrosky: The Bubble and Me