Worth Zero

Now that I have your attention, I have bad news … nobody has it.

To quote Frank Peters, the former chairman of Tech Coast Angels in the US, “If there was one, it would’ve been worked out long ago.” My observation is that there is a rough process you have to go through, but there are no absolutes. I think that Paul Buchheit’s musings here are good and he concludes that:

Idea * Judgment * Ability * Determination * Luck = $$$

Every Angel Group group and VC will tell you that you need:

- preferably a serial entrepreneur

- a good product … actually make that a ‘paradigm shifter’

- an addressable market with a minimum of $500m

- some intellectual property

- a team with domain experience

- etc

I think that there is a growing body of evidence that current investment screening criteria is not working. If it were working, this article would not have to struggle so hard to say that Angel Investing is good … in fact, you strip a few big deals out (and their winners) and everyone else loses. Frank Peters was saying in one of his podcasts recently that one of the Tech Coast Angel founders, the late Luis Villalobos, estimated that you need to be in 25 deals before you could (by his analysis) be unlikely to lose money. Whether it’s 10 deals or 25 deals, it’s still pretty ordinary odds when you are playing with real money. It seems to me that the screening formula might be broken if the result is that over 50% of investors are getting a negative return even without putting a time value on money.

If you think further about the traditional model where Angels invest and then VCs follow, you can look at VC exits / success to approximate Angel success.

• The VCs only expect between 1 and 3 of every 10 of their companies to survive (exit positively).
• Only 1-3% of companies that seek venture capital get it … so they say.
• Let’s be generous and say that 30% of angel companies get funded by VCs.
• Let’s also say that most of the ones that don’t are dead, or ‘lifestyle businesses’.

We now have 21/30 Angel funded startups dead. (write them off) Of the remaining 9 … maybe only 1 gets a big exit. So, 1/30 Angel funded businesses are going to give the big return … maybe even only 1/30 will give any return. It’s easy to see how you need to be in a hell of a lot of deals to ‘guarantee you won’t lose’ … Compare this to a black / red bet on roulette (1:2) or the average horse-race where you have a 1:10 chance usually of at least doubling your money (usually). Betting on the horses should not be better odds than investing in early stage companies.

My observation is that the companies that get there (and this needs some definition, but for the purpose of this particular point let’s call this exits positively returning to all parties) have a few things that stand out.

1. HUSTLE / FRONT You are going to be punching above your weight for most of the company’s existence, so you need someone (preferably more than just the CEO) with the ability to ‘hustle’ (entrepreneurial X factor, gut feel, sales ability). It’s the ‘how the hell did you get them to do that’ deals that make the difference. The journalist that writes you up, the contract you get with a massive partnering organisation, the supplier that carries you when they should send you to the wall. These may also be classified as luck, but I think that to some degree you can make some of your luck with massive coglioni.

2. GENERAL BUSINESS ACUMEN

That is, professional execution of day to day business matters. I observe that a lot of early stage folk think that someone else will write the business plan or build a financial model or do the market research or make sure compliance issues are dealt with. They will, as soon as you have the money to pay them. Until then, it’s all up to you.

3. SUFFICIENT SALES OF A PRODUCT PEOPLE WANT AT A PRICE YOU CAN MAKE MONEY

Your product needs to at least be perceived as unique by the purchasers. They need to want your product enough to want to pay you for it. The amount they are prepared to pay, and the number of the customers who are prepared to pay, needs to enable you to make a profit which will ultimately give your investors between 6x and 10x exits. Pretty simple really

4. CONTACTS

Mostly you have find these but if you already have them, you have a big advantage. Contacts are one of those things you would have if you have domain experience. Domain experience is one thing that I think can make success just that little bit more likely. From my own experience, not having it means you have to learn ‘a whole industry’ … I found some good mentors / contacts from within the particular industry, but it would have been a hell of a lot easier from the inside. This said, I probably wouldn’t have become involved with the particular company if I did have domain experience because it was just too left field. I think domain experience is a lot more important than doing a startup before (serial entrepreneurship). With contacts you can raise capital, get customers, and generally give whatever it is the best chance of getting there. You still need the right CEO personality type, although the jury is out on which is best. With the right CEO and domain experience I believe that a startup, with everything else being equal, is in with a proportionally better chance.

5.  CAPITAL

I would say that no more than 1% of the hundreds of inventors and entrepreneurs I have dealt with have capital. In most cases, perhaps 95 to 98 per cent of cases, they do not even have the basic amount of capital required to begin the process.  Capital is something you simply cannot do without and there is no doubt that whatever you estimate you’ll need, you can probably triple it to get to the real number.  You can find ways to bootstrap some things, particularly if you’re a tech company and you can write the code to get a Beta out. But you cannot get by with no capital.  This is particularly true if you start the patent process … bring your credit card/s.

6. PERSISTENCE

You needs lots of this. There is a very fine line between persistence and insanity with respect to startup companies.  It might be that the difference between the two is whether your gamble to put more time, money and effort into your project comes off for not.  If it comes off, it was persistence … in fact sheer business brilliance. If it doesn’t come off, then it was insanity.  I think if I look back at my own experience, and those I have observed, persistence is one of the things that stands out with the companies that are still going. It is the unwillingness to give in. You might be out of money and really looking to have no way forward. Maybe you aren’t really dead, just having an NDE … it seems to me that most companies that get there have them. I recall Frank Peters telling me that when he had his software company he had to make a sale on a particular day in order to pay his outstanding tax. He made the sale and ultimately  ended up turning Plaid Brothers Software into a big business that was sold to an even bigger business. Almost Dead … sounds like my next book!

7. LUCK

Often defined as preparation meeting opportunity or right place and right time. It’s much more than this though.  Every company that makes it seems to have had some major luck at some time.  In fact most companies that make it seem to have had multiple NDEs (near death experiences). Startup company histories don’t happen in a nicer linear organised structured way. It’s generally frantic and chaotic.  Luck often comes in the form of securing a first large customer / sale. Or it might come in the form of securing the financial support of a supplier.  Sometimes luck even comes in the form of a chance meeting on an aeroplane. There is a famous example of this in Australia where a former journalist was selling a car to fund her product development and got talking to a gentleman who came to look at the car.  The guy was the well known business identity and ended up being her investor and long-term mentor. Luck happens. Call it Grace (if you are an M. Scott Peck fan), call it serendipity, call it whatever you want. You can’t order it, but you are going to need some, so hope it arrives.

So, here is my magic formula:

A great Idea is WORTH ZERO without the following:

+ Business Acumen
+ ‘Front’
+ Persistence
+ Enough Demand at the Right Price
+ Luck
+ Capital

Then maybe you’ll get $$$.

Thanks for joining me here for a regular serving of BBQd startup sacred cow. I have developed a deep need to deliver reality to the early stage ecosystem. Penn and Teller do BULLSHIT, I am doing WORTH ZERO. You might be the Anthony Robbins type who bounds out of bed in the morning, does few star jumps and then runs 5 miles before updating your personal wealth and happiness plan. Please go somewhere else, you will get hurt here.

After almost 6 years around early stage ecosystem (inventors, investors, entrepreneurs, ‘consultants’, IP Lawyers, etc) I either have to put my head in an oven, or write about my experience and observations … I am a coward, so I am writing. Also writing a book about this stuff, but that’s a topic for another day.

It’s not to say that I don’t like the space. Actually, I love it and my own (ad) venture as investor / shareholder / CEO in Scarpar has been a huge learning experience. I can genuinely say that I had absolutely no idea what I was doing when I started the process and have, like most, made a stack of mistakes. With what I have learned, if I had the same opportunity again to get involved in Scarpar I would run a million miles. This said, it looks at this stage that despite half a dozen near death experiences we’ll get to market late 2010 / early 2011 thanks to a couple of  investors taking a punt on us at proof of concept phase. Pre-revenue investments are actually not as common as you might get the impression from the outside.

So, don’t take it that I think everything about Startup Land is bullshit. I don’t. However, there seems to be a disproportionate amount of bullshit around this space. I would say order of magnitude higher than corporates based on my experiences although granted there are deluded people surrounded by their own personal layers of bullshit there also. It reminds me of that famous scene in the movie The Accidental Hero with Dustan Hoffman …

I feel it is my duty to deliver a massive reality brochure. If I hear one more ‘power of the idea’ or another inventor tell me that they have found a solution to the Mexican Gulf oil disaster, I may still take the oven option.

Back to the point … so, why Worth Zero? That’s because I have learned that a great idea is in fact worth on it’s own; ZERO. Nada. Nothing. Ideas need action / execution and:

In addition, and I am the master of understatement here, it is really helpful if people actually want your product or service (idea) enough to pay for it! It’s also really helpful if they want your product or service enough that they’ll pay a price at which you can, not only make a PROFIT, but you can justify the cost of establishing the business. That relevance of whether or not the product or services is ‘good’ / unique / legendary / world changing / etc is small compared to having sufficient demand at the right price to justify commercialisation! Butter stick anyone?

This is clearly about commercialising new ideas / knowledge / intellectual property, not about establishing a corner store, a handyman business, or any similar business. The complexities of commercialisation do not exist in these types of ventures. Product managers do deal with commercialisation, but they have capital available not to mention colleagues with complimentary skills needed. This is not reality for most startups.

Many inventors I have come into contact with seem to think that they should be paid for their ideas. Bad News (and not the last) … nobody is going to pay for your good idea. In fact, in my day job, I deal with inventors as part of my role … about 500 in the past 18 months. There are some common themes. I have met and spoken to some very nice and bright people who are inventors as a result of my day job. I have also met and spoken to some absolute lunatics. Unfortunately, invention is seen as an easy path to riches. Nope. Well, rarely at best. So, the inventors are likely to get a fair bit of friendly advice here. Let me start by saying nobody is going to buy your ‘idea’ and do it for you, and we can build up from there.

Now onto investors. Most members of Angel Groups in Australia rarely invest. There are some exceptions, but groups have a lot of spectators in the form of consultants (looking for work), government folk, people who ‘just like to be around startups’, and (as perverse as it sounds) people who seem to like the gladiatorial aspect … Christians to Lions = ‘Pitchers’ to Angels.

Very few angels in Australia have done more than a couple of deals. In the US, it is (well, was) mostly different. I say was, because the GFC (and the years of very few exits) have greatly slowed the rate of investment. There does appear to be a higher level of honesty amongst many of the US investors on the good / bad / ugly of early stage. There is still a healthy amount of denial though even when faced with the facts. I do observe some common issues.

I haven’t met many investors who’ve made any money out of arms-length investments in early stage companies. This is not to say nobody makes money out of early stage investing, only that it’s hard even for people who’ve made a lot of money before as a senior exec or entrepreneur. Not many people do well out of it for a variety of reasons. I have a few theories about this, and since this is my blog kingdom, and I am the king here, I will be publishing my official royal decrees on this topic over time

A quick note to all those asking, “If you’re so smart why aren’t you rich?” The answer is because I invested all my cash into Scarpar! Not that I’d be rich now, but it has put a significant dint in the retirement schedule.

There are some powerful personalities in the investor ecosystem in the US and in Australia. Frank Peters talks about a room full of Type A personalities … I am afraid that I do not defer to their greater knowledge unless they publish the honest answers to the following:

1. How many arms-length companies have you invested CASH (not just time) in?

2. How many in the past year?