Stay tuned. I’ll be posting the next article on the common problem of dealing with bloated requirements for minimum viable product (MVP).
Early-stage founders spend a large portion of their time raising capital to fuel their startup’s continued growth. Receiving a term sheet from an investor represents a key milestone in the fundraising journey. First-time founders often scramble at the last minute to educate themselves on the concepts and terms found in a typical term sheet. There are many web resources that provide insight into the definitions of concepts captured in the term sheet. However, in addition to learning the mechanics of a term sheet, I strongly advise entrepreneurs to take a step back and consider the big picture of what each party wants from the investment. This is key to driving an effective and reasonable negotiation.
I’m often surprised to find that very few advisors counsel their startup founders to understand what the incoming investor cares about. Failure to do so can unnecessarily complicate negotiations. I advise founders to apply a principle from my blog posting The Art of War on competing effectively: know your enemy. I do not suggest that founders take an adversarial stance with their incoming investors. I do encourage founders to put themselves into the investor’s shoes to know and understand what’s important to them. Once you understand the investor’s goals, you can formulate a positioning that addresses the investor’s issues while still maximizing your negotiating stance.
What Investors Want
Investors fundamentally care about three key factors when negotiating a potential investment:
- Ownership structure: how much each party will own.
- Governance: who will be able to influence and control the key decisions of the company.
- Down-side protection: what happens if the startup doesn’t meet expectations.
There are many other lessor considerations, but fundamentally, these three dominate the others.
Ownership reigns as the most important consideration in the term sheet. Ownership share directly affects each party’s potential payout. Multiple factors affect the ownership, but the pre-money valuation and the size of the unallocated option pool often have the largest impact on each stakeholder’s final ownership share.
The pre-money valuation combined with the amount invested determines the post-money valuation. The amount invested and the post-money valuation determines the investor’s ownership share. The diagrams below illustrate this.
The size of the unallocated stock option pool can sometimes surprise founders as a negotiating point. Most early-stage companies only have a fraction of the employees needed to grow and scale. Many investors expect the founders to carve out a large share of stock to allocate to future employees. Investors typically want a larger pool (25% or more) created while founders want a smaller pool (15% or less). The investors want to minimize the likelihood that the employees hired will exhaust the pool, so they ask the founders to create a larger pool before the funding closes. This dilutes the existing stockholders, but does not dilute the incoming investors, as the dilution happens before the investment closes. In contrast, the founders prefer a smaller pool to minimize their dilution. Additional stock can be issued to replenish the pool if it is exhausted in the future. The dilution from any stock issued in the future gets spread across a larger group of stockholders, resulting in less dilution for the founders.
The point isn’t to get a perfect projection of how much stock will be allocated to employees the startup hasn’t even hired yet, but to position for possible future dilution.
The pie chart below illustrates a representative ownership split after the investment closes — obviously, your specific situation may vary.
Investors also often negotiate for pre-emptive rights (the right to invest their pro-rata share in all future financing) to protect their ownership percentage as the startup grows. Many investors fight hard for this right so they can continue to invest in their best performing companies. In most cases, pro-rata share is reasonable. Founders should be wary of multiple pre-emption or “super pre-emption,” which grants the existing investors the right to invest more than their pro-rata share.
Founders should also be wary of right of first refusal (ROFR), which allows existing investors to take the entire round at the negotiated terms. ROFR often scares away incoming investors, as they have little assurance that their due diligence on the potential investment will result in closing the financing, as the existing investor could exercise ROFR and take the deal away from them. If incoming investors are reluctant, founders then have fewer options for their next round of financing, resulting in the existing investors getting much more favorable terms (i.e., lower valuation) on the next round.
Probably the next most important consideration is the governance of the startup — who controls and influences major decisions or events in the company’s future. The most important component of a company’s governance is the composition of the board of directors. The board votes on major company decisions such as an acquisition, accepting new financing, large budgetary expenditures, who holds the CEO role, etc. The party that controls the board for the most part controls the company. It is common for both the founders and the incoming investors to jockey over the number of board seats. One approach is to have the board reflect the ownership ratio of the major shareholders. If the founders own 70% and the incoming investor owns 30%, this approach gives the founders two board seats and the incoming investor one. Another approach is to agree to a balanced representation on a five-member board consisting of:
- Two common stockholders: typically, two employees/founders.
- Two preferred stockholders: typically, two investors.
- One neutral, outside party mutually agreed upon by the founders and investors.
Investors also often ask for the right to block certain corporate actions, regardless of the distribution of board seats or percentage ownership. Common actions requiring approval of preferred stockholders include:
- Creation of a senior security (typically, the next round of financing).
- Changes to preferred stockholder rights.
- Changes to the size of the board of directors.
- Company acquisition.
- Entering into a contract above a certain size.
Founders often negotiate to limit the number of protective provisions granted to preferred stockholders. However, some protection provisions are common. Very few investments are closed with no protective provisions granted to the preferred stockholders.
Both the founders and investors contribute time, money, and effort because they expect the company to significantly grow in value. However, some companies grow slower than projected. Early dreams of 100x returns are dampened by the realities of an acquisition that is just two times the valuation of the most recent funding round. Double the previous valuation is still growth, but typically doesn’t provide a reasonable return in the high-risk game of venture capital.
Investors often lobby for a liquidation preference with full participation (commonly referred to as a “double dip” for the investor as they have two different pathways to be paid upon an acquisition) in order to provide protection against an underwhelming acquisition price. If the founders enjoy strong leverage during the fundraising, they can negotiate for a liquidation preference with no participation. A reasonable middle ground can be a liquidation preference with a cap on the participation.
In other scenarios, the startup may stumble, encounter circumstances beyond their control (e.g., geopolitical unrest, global economic weakness, etc.), or fail to execute, resulting in the value of the company actually shrinking. In such cases, the startup may need to raise additional funds in a “down round” — where the next round’s valuation is lower than the previous round of fundraising. Or, none of these situations may happen – the company may decide to issue warrants or additional stock to address a specific business need. To protect against these dilution scenarios, investors negotiate for anti-dilution rights.
Positioned for Win-Win
Term sheets are full of complex concepts and legalese. It’s important to understand the legal constructs, but it’s more important to understand why they exist. When founders strive to think like an investor – when founders walk a mile in the investor’s shoes – you can understand what the investor wants and even anticipate what they will ask for. By knowing the investor and their goals, founders can: 1) explain why some concerns do not apply in your specific situation, 2) formulate responses that mitigate the concerns that do apply, and 3) propose more palatable alternatives that accomplish a similar outcome as the investor’s more aggressive request. With this understanding, founders become more effective at negotiating win-win agreements that both parties can feel good about.
Every startup aspires to grow. But too many founders lack a structured, methodical way to plan their growth beyond hunting for the next hire to address the most significant current pain point. Too often, founders settle for a cobbled-together hiring plan based a high-level guess on what roles might be needed two to four quarters in the future. This becomes problematic as investors often ask for revenue and expense projections that look at least two years out – with the expectation that entrepreneurs reach these projections. Failing to build a detailed plan that aligns with the business objectives results in inaccuracies and imprecision – increasing the likelihood of unfulfilled expectations among both founders and investors.
With dozens of seemingly urgent needs, founders often fail to make time for the important task of building a realistic and reasonable plan. Because of poor planning, many startups find themselves nowhere near where they expected to be one year after closing the initial funding round. Missed or unfulfilled expectations can include: higher than expected cash burn rate, staffing that fails to align with business needs, poor product development progress (minimum viable product and beyond), lackluster customer traction, and disappointing revenue. To avoid these challenges, entrepreneurs should develop actionable plans by:
- Modeling their required functions
- Prioritizing each business function
- Building scaling plans for each function
- Tying this scaling to bottoms-up staff plans and budgets
Model Required Functions
All businesses have a fundamental organizational structure similar to the one depicted below.
Except for the fundraising function at the bottom of the graphic, both established businesses and startups largely share the same functional organization. Fundraising is included as a key function because it consumes a huge portion of the time, energy and effort of every startup. The diagram shows fundraising as a foundational function because it requires resources from multiple parts of the business. In time, fundraising becomes less important – but usually only after the startup generates self-sustaining and growing profits. Until that time, it consumes a significant portion of a startup’s resources and needs to be part of the functional plan.
Entrepreneurs should customize the model above to reflect the needs of their specific company. For example, not all startups need a separate manufacturing team focused on building a physical hardware appliance. Or, your particular startup may emphasize one sub-bullet within a function and de-emphasize another. Maybe your startup depends heavily on social media, so you add a social bullet to the marketing function. Or maybe your company doesn’t provide managed services, so you delete that from the pro services function. It doesn’t take much time to customize this model to reflect your specific situation. The resulting clarity pays great dividends for several years, so it’s well worth the time invested.
Prioritize Business Functions
Once you’ve customized the model for your startup, entrepreneurs need to prioritize each function. Not all functions require the same level of investment and resources at a particular point in time. In order to build a roadmap for organizational growth, it helps to identify specific stages of your startup’s development. The Founder Institute defines three phases of a startup: idea, startup and growth.
The table below provides additional insight into the characteristics of a company in each of the three startup stages.
With these three phases defined, entrepreneurs can assign priorities to each function in each stage of the startup’s journey. For example, while in the idea stage, a startup may focus on building out its minimum viable product (on a shoestring, self-funded budget) while also raising funds for future growth. As such, the engineering, product management and fundraising functions receive the top priority. Maybe the startup has two or three founders, with a founder mapped to each of these top functional priorities. If the founders lack engineering skills, then they may need to focus on recruiting the right technical resource to own this function. Because the product is not yet designed or built, functions such as manufacturing, channels, pro services and customer experience receive lower priorities. Operations are outsourced to contractors as only basic bookkeeping, human resources (HR), and legal services are required. The diagram below illustrates this sample scenario.
Scale Business Functions
After establishing the priorities for the idea-stage, founders should repeat the process for the startup and growth stages. For continuity and clarity, the model captures the priorities that changed from the previous stage to the current stage. This helps to highlight the areas of increasing investment. For example, as the minimum viable product starts to take shape, the marketing function rises to become a top priority alongside the technology, product management, and fundraising work. And as early beta customers begin to receive previews into the product, the sales and customer experience teams also become more important.
Continuing this example, the growth stage sees the company potentially quadruple in order to meet the expected customer demands in sales, customer experience, and pro services. As the product matures, so does the need to develop a resale network and alliances with companies offering complementary solutions. Manufacturing no longer borrows resources from the product management and technology teams, but becomes a standalone function. As such, it shifts to its tradition role under the oversight of the operations team – which itself expands to cover the growth in finance, HR, IT and legal needs. Note that, at this point, the company should have a clear pathway to profitability, so investment capital is less about keeping the company running and more about the money needed to accelerate existing traction. As such, fundraising is still important, but no longer a top priority of the company.
Build Bottoms-Up Budget
Having a high-level growth plan by function is a necessary, but not sufficient requirement to ensure great startup execution. Many startups compile a high-level or mid-level revenue and expense projection, but fail to include the low-level actionable detail needed to effectively track and manage progress. In such situations, the numbers on the projections aren’t rooted in any reality and are only slightly better than random numbers on a spreadsheet. When doing battle with a limited number of artillery shells, taking the time to carefully aim your weaponry becomes very important. Even with a solid high-level strategy, the absence of low-level tactics still results in poor overall execution.
To use a football analogy, the high-level game plan to emphasize the passing game may be sound (since the opponent has a weak secondary). But, failing to design specific passing plays that exploit individual mismatches results in sporadic and inconsistent success. When it comes to execution, details matter. Given this, a well-built bottoms-up budget plan needs to include the following aspects:
- Monthly granularity.
- Functional granularity.
- Headcount granularity.
- Alignment between revenue and expenses.
Most startups only build a plan on a quarterly basis. However, any seasoned executive knows that managing by quarters is insufficient in a fast-moving environment. In order to maintain healthy oversight on the progress against plan, the budget needs to be built at a monthly level. Quarterly tracking doesn’t provide sufficient granularity to make course corrections at the frequency needed to keep the company on track.
Most budgets are built at a company-level only. If one or two specific functional areas significantly impact the expenses, they should be broken out separately on the monthly budget spreadsheet. For example, if all the core software and operational hosting will be done in Amazon Web Services, then the budget needs to have a separate line item for engineering cloud costs. In fact, if the AWS costs are projected to be significant, breaking down the costs among the primary cloud services expected (e.g., Lambda serverless, S3 storage, Aurora database, Kinesis streams, etc.) would be appropriate.
Headcount usually represents the largest single cost for idea, startup and growth stage companies. Given this, I strongly recommend a separate section that projects each individual worker needed. With a monthly granularity, the spreadsheet can capture the month when the headcount will be added and more accurately predict the employee costs. (Quarterly granularity on the hiring plan introduces unnecessary budgeting variances – is the employee hired in the first, second or third month of the quarter?) The budget should include both the cash and equity compensation costs. Capturing projected equity compensation is important because determining the size of the employee option pool is often a negotiating point during fundraising. In addition, the headcount plan should be broken down by major functions, allowing the heads of each function to take ownership for executing to their portion of the plan
Alignment Between Revenue and Expenses
Finally, the budget plan should include a rational alignment between revenue and expenses. I’ve seen startups that project 2x-4x revenue growth in the first two quarters of the plan, but fail to grow the customer success team until the fourth or fifth quarter – which would likely create a poor customer experience for the early (and arguably, most important) customers.
The spreadsheet below provides a summarized example of a bottoms-up budget. Note that the spreadsheet is built with expandable and collapsible groups (across both rows and columns) to expose or hide wanted or unwanted detail.
Great Execution Starts with Great Planning
The fundamental point here is that a structured, methodical approach to create a detailed, monthly plan provides an actionable roadmap to growth. I’ve seen many zealous founders launch promising startups to build out a great idea. They quickly create a high-level strategic business plan to change the world with their vision. But the knowledge encapsulated in a strategic plan represents only the potential for power. To unlock that potential requires great execution. Great execution starts with great planning. Entrepreneurs who follow a similar framework create actionable plans that serve as the blueprint and roadmap for successful growth.
Every venture capitalist, board member and startup advisor counsels the entrepreneur to focus on building their minimum viable product (MVP). Successful startups do a great job of executing on their MVP buildout. Once their MVP is established, adding prioritized functionality transforms the product from acceptable, to good, to great.
Everyone understands the concept behind MVP. But how exactly does a company build out its MVP? What does “viable” look like? Because every company has a different product, it’s impossible to provide specific advice for each situation. However, by drilling down to the next layer of detail, insights become more clear. When discussing MVP, I typically prefer to use the following five terms:
- Earliest showable product
- Earliest testable product
- Earliest usable product
- Earliest likable product
- Earliest lovable product
The diagram below shows the MVP progression from a user’s current state to an early lovable product.
An MVP Example
These abstract concepts frame up the process, but I find it helps to provide a specific example. In this case, let’s assume we’re trying to improve the infrastructure of a package delivery business. Today, the delivery couriers (generically, “users”) have very little infrastructure — packages are hand carried by the users to the destination. Building a delivery truck for the courier may look something like the process below.
Some may ask “what is the benefit of creating something that the user can see, but not use?” This is actually done all the time across many different industries. I’ve often been to trade shows where a vendor has a product in development that isn’t quite ready for anyone to use. In such cases, a very early prototype of the product might be in the vendor’s private “whisper suite” sitting under glass. A few invited visitors that have signed a non-disclosure agreement can look, but can’t touch. If the product is an application, maybe the visitor can watch a recorded demo video, but there’s no ability to deviate from the pre-recorded demo script. There are still many benefits to this as users will start to talk and ask questions. You learn from listening to the questions asked. You get a sense for what users consider important. Often, the user asks some questions that leads to a low-level requirement that wasn’t previously considered.
In this example, the delivery truck is nothing more than a barren truck frame with four wheels. Without an engine, someone has to push the truck frame like an overgrown hand cart. The user might ask how the cart is steered or whether it makes more sense to push or to pull the platform. Regardless of what the question is, you want the user to be engaged.
In the software world, the earliest showable product might be nothing more than a bunch of web pages stitched together to demonstrate the flow of a small application. Each web page has a few constructs on it (text, fields, photos, diagrams, buttons, etc.) but there’s no material code behind anything. Everything is hard-coded with static data. The only thing that works is the navigation between web pages and maybe one or two simple features. You just want to open the eyes of the users to what you have in mind.
For this evolution of the delivery truck, the earliest testable product adds a folding chair, a steering system and a braking system to the platform. You can invite a small number of users to test the product. Users can actually sit in the cockpit and manipulate some controls. The platform may still be missing some key features. In this example, because the truck lacks an engine, the only way for the user to test some package deliveries with the truck is if the platform is going downhill. Yes, that’s clearly very limiting, but you’ve properly set the users’ expectations by communicating in advance. The point is it’s possible for a few users to put their hands on the product and provide feedback. The initial feedback might be nothing more than: 1) it’s very difficult to turn the steering wheel (because it has a manual steering system) and 2) the folding chair lacks lumbar support and gets pretty uncomfortable when you sit in it all day. Users might not be thrilled, but they are seeing rapid progress and starting to ideate with you.
After receiving the initial user feedback, the engineering team adds a few quick enhancements to the product roadmap. The plan for the earliest usable product already included an engine and a fuel system, but the engineers also replace the folding chair with a traditional automotive bucket seat and install a power steering system. Since the truck platform now has a small engine, it can carry more packages and has a maximum speed of five miles per hour. A limited number of beta users can make deliveries with the truck. Since the platform doesn’t have a body or a roof, it can’t be used in inclement weather, but at least it’s no longer limited to downhill roads only. After using the truck, the users ask for: 1) higher speed (which was completely expected), 2) something to help them lift heavier packages from the ground to the cargo area, and 3) a way to organize the packages in the cargo area. None of the engineers previously realized how back-breaking it can be to lift packages all day. Nor did they understand how it slows down the courier if they have to move other packages out of the way in order to get access to a specific package in the middle of the truck. One user specifically requested the shelving system when they needed to deliver package #2, but had to move packages #1, #4, and #5 first. These last two feedback items would not have been uncovered if the product wasn’t actually being used.
At this point, the product is really starting to take shape. The engineers add a transmission and design a shelving system to organize the packages. The lift gate couldn’t be added yet because the weight that needed to be lifted required a larger battery system, so it’s been deferred to a later release. A larger pool of users signs up to use the product. Adding the transmission increases the truck’s maximum speed, but since the engine is still undersized, the truck tops out at 35 mph. The engineering team also builds a body around the driver cockpit and passenger area, but the packages in the cargo area are still exposed to the elements. With a larger pool of users, product suggestions start to really flow in. To deal with some of the user expectations, you begin sharing a high-level product roadmap.
Finally, the engineers build the body around the cargo area, resulting in a fully enclosed vehicle. Engineers have been busy, as they’ve also added the lift gate, upgraded the engine (so the vehicle’s max speed is now 65 mph), and added basic wireless / GPS / navigation capabilities. The marketing team begins to salivate as they envision advanced real-time tracking and telemetry, giving package recipients unparalleled ability to track their deliveries. As a bonus, the marketing team also hired a graphic artist to advertise the delivery company’s logo and services on the side of the van.
Typical Pathways to MVP
The table below helps illustrate how the product development evolves from showable, testable, usable, likable to lovable.
Each of the five key designated releases (showable, testable, usable, likable, lovable) have specific goals, benefits and limitations. Each release also grows from a very narrow, restricted user base to a very broad community. The table above includes an estimated ideal timeframe to help product teams determine the general rate of progress.
Avoid the temptation to rigidly analyze the specific wording of any given cell in the table above. It is more important to remember that this represents an approach to rapidly evolve the product. Also remember that the earliest usable product will not likely be the most usable product, the earliest likable product will not be the most likable product, etc. This approach emphasizes targeting the earliest release that fits the designated goal.
Where’s the MVP?
So, what exactly is the MVP? For a very, very simple solution, it might be the earliest showable product. For typical companies, it’s often the earliest testable product. However, for a very demanding solution involving public safety, human lives, large financial risk, sensitive data, or something similar, it can be the earliest usable product. In many cases, the product team may designate the MVP as one of the Agile sprints one or two releases before or after the earliest testable product. Every startup has to adjust their definition of MVP to align with the nature of their product.
Regardless, the point isn’t to get fixated on a specific definition of MVP, but to focus on the overall process to get to MVP and beyond. The key lessons here are: 1) to iterate quickly, 2) to be very disciplined not to overload features into each release, 3) to engage users on every release after the earliest showable product, and 4) to steadily gather feedback. Entrepreneurs who diligently follow this recipe usually make consistent, predictable progress with their product development, which often leads to great success.
We’ve all heard the adage that a picture is worth a thousand words. Sadly, I rarely see business users take advantage of this simple truth, particularly in the sales process. The best performing sales teams excel at understanding the customer’s pain, demonstrating how their product soothes this pain, and differentiating their solution against the competition.
Customers buy when they understand how a proposed solution benefits them. Given this, a short Mean Time To Understanding (MTTU) accelerates sales. I’ve often worked photos into my sales presentation to quickly communicate key concepts and shorten the MTTU. And if there’s a way to use a funny photo, even better.
As an example, I once sold against a competitor that cobbled together their solution by acquiring multiple, disparate companies. We however, designed and built our product from scratch as a single integrated solution. Having been a VP Engineering and CTO for multiple companies, I knew the challenge of trying to connect Ford engine to a Chevy transmission and dropping it into a Toyota chassis. Here’s the photo I used to illustrate the problem:
Software Mergers Don’t Produce Seamless Products
In another example, I needed to communicate the benefits of modern automation in an administration console. Many engineers configured and controlled their data center equipment using a command line interface that had a huge learning curve and required significant experience to operate. Our product had a graphical user interface that was easy to learn and use. To illustrate the contrast, I used the photos below of an old Boeing 727 cockpit and a modern Boeing 777 cockpit.
Old, Complex User Interface
Flying a Boeing 727 requires three people: two pilots and one navigator.
Modern Graphical User Interface
The Boeing 777 requires just two people – the dedicated navigator is not needed. In addition, auto pilot capabilities eliminate routine work tasks, improving employee morale and enabling resources to focus on projects that create business value. Boeing actually advertised the comfort of the pilot rest area in the cockpit of the Boeing 777 using the photo below.
Auto Pilot Eliminates Routine Work Tasks
In another instance, I had to sell against OpenStack — an open source cloud solution typically used for Infrastructure-as-a-Service (IaaS) deployments. I have nothing against open source. In fact, I frequently use open source software when building solutions. But back in 2012, OpenStack just wasn’t ready. OpenStack was the IT craze of the year, but it lacked functionality, needed new patches every week, was a bear to install, and required an army of impossible-to-find experts to get working. The software was free, but any up-front savings were quickly lost as almost all OpenStack projects at the time consumed four times the manpower and took five times longer to execute than expected. Gartner found that early adopters of OpenStack found very poor value relative to the investment required. One of our prospective customers spent more money sending three engineers to the OpenStack Summit than they would have spent to license our product! In fact, we successfully delivered a proof of concept using our product in just one week, while the internal team that championed OpenStack still had nothing working after five months!
To help people understand the realities of an unproven, build-your-own solution, I created the messaging below:
Early-Stage, Build-Your-Own Often Means:
… Some Assembly Required
… Underpowered Solutions
… Inappropriate Shortcuts
… Patchwork, Incomplete Solutions
… and Mismatched Tools for the Job
Once we made clear the challenges customers regularly faced, we built significant momentum among the thought leaders and trusted advisors in the market. Shortly thereafter, we started beating the competition handily. Not long after we netted some significant wins, Cisco took notice and acquired the company. I can’t guarantee that great storytelling will lead to an acquisition, but the momentum we gained certainly made a difference.
I’m a speed junkie. When I was young, I used to watch A. J. Foyt battle Richard Petty in NASCAR. Since I didn’t own a fast car, the best I could do was take my bicycle off road and imagine I was a motocross racer. As I’ve aged, I’ve migrated from NASCAR to Rally racing and from motocross to MotoGP.
MotoGP racers are crazy. They ride machines capable of heart-stopping acceleration and dare to brake at the last possible second before entering a turn. And in each turn, they lean the motorcycle to the extreme, threatening to either scrape their body on the inside of the turn or lose their grip and go sliding through the outside of the turn. All of this with what appears to be minimal protection.
Every seasoned entrepreneur lives a similar experience. Running a startup demands hyper-aggressive acceleration and iron nerves to push the limits in order to hold your line in a turn, and maximize your speed. Riders must make dozens of split second decisions to accelerate, downshift, brake, lean in, and position the engine in the power band (the range of RPM that produces peak power output) coming out of each turn. Founders must do the same, except instead of a motorcycle, they jockey a company.
If you aren’t lucky enough to race for an established team like Ducati or Red Bull with big funding and a large support staff, you have to wear multiple hats: from racer, to mechanic, to marketer and sponsorship fundraiser. Founders often have to be proficient in multiple business disciplines — particularly in the early stages of the startup. Founders have to be willing to pick up a wrench, pull apart an engine and get greasy. Then they might need to clean themselves up, change into business casual attire, and pitch to a potential investor. After that, they may have to play diplomat and negotiate with a new customer who complains that the solution doesn’t match the claims made during the sales pitch. And then at a lunch interview, they need to quickly determine if a job applicant with a promising resume will really be a good fit for one of the few engineering roles that the startup can afford.
It’s a difficult mix of demands that call for very broad, experienced, executive skills. Unfortunately, I often see recruiters, investors, or advisors glibly counsel the entrepreneur to pull out all the stops to hire a Senior VP from a large Fortune 500 company to run their sales, business development, marketing or engineering team. The Fortune 500 SVP clearly has a strong set of skills that enabled him/her to play their role in leading 1,000-person teams that drive $1B or more in annual revenue. However, many people fail to recognize that most Fortune 500 SVPs have skillsets unsuited for startup life. Yes, they carry huge responsibilities, but the machine they ride is not a motorcycle, but a jumbo jet. Yes, Boeing 777 and Airbus A340 pilots are responsible for the lives of hundreds of passengers, but their job requires them to focus more on following rigorous safety protocols, maintaining control, and making fewer, more deliberate decisions – usually with the assistance of advanced instrumentation.
Pilots of commercial jumbo jets aren’t asked to pick up a wrench and sling code, create the detailed requirements to earn a badge in your channel partner program, analyze a competitor’s features against your own, or write copy for product marketing assets. They typically surround themselves with large teams who do these tasks for them. They are usually best at developing policy, working the politics, or mining industry contacts. (I won’t even get into the topic of whether a small startup can afford the high-six-figure salary that a Fortune 500 SVP will command.) When joining a startup, many Fortune 500 executives either move too slowly or make the wrong decisions because they aren’t used to making dozens of judgment calls in just a few seconds. I’ve seen some very senior people who have enjoyed great success in a large company stumble when going to a small company because the job responsibilities – especially at startups with less than 100 employees – are completely different. I’ve also seen some founders and investors accept a jumbo jet pilot who averages 20 mph each lap around the track because they don’t know that the real racers will average well over 100 mph a lap. The founder often doesn’t realize they are only averaging 20 mph or don’t know that a 15-minute lap time is really, really slow. Inexperienced leaders don’t recognize the problem until they’ve been passed multiple times on race day. But by then you’re way behind the competition or you’ve lost your market lead.
To be sure, many Fortune 500 SVPs are very skilled and are great at their current job. But smaller startups have very different job responsibilities. There are some Fortune 500 SVPs who also are (or recently were) motorcycle or rally car racers, but they are very rare. When you’re fighting a global war against terrorism, you definitely want the three-star general in the driver’s seat. You need their inspirational leadership, political moxie, ability to shape public opinion, and experience running multi-year campaigns. However, most young startups don’t need someone who has experience reporting to the Secretary of Defense. Startups need the Navy Seals to execute a hostage rescue operation or a special forces sniper to neutralize an enemy combatant a quarter mile away. Make sure you understand the actual detailed requirements of the startup role so you can add candidates with the right skillset. For most startups, one or two jumbo jet pilots could possibly help in an advisory role (maybe sometime near the Series B financing) or serve as a full-time employee once the startup reaches some scale. But more often than not, you’ll want a lot of MotoGP racers and pit crew chiefs.
Every startup targeting a large market opportunity will face competition. When competitors are present, every sales opportunity becomes a battle. Founders must prepare their war strategy in order to be well-positioned for victory when the time for hand-to-hand combat arrives. Sadly, I’ve seen countless companies fail to prepare their teams to compete, resulting in weak sales. Founders need to ensure they install a framework that allows them to compete strong.
Lessons from Sun Tzu
Every business would benefit from adopting the wisdom from a 2,500-year-old book: The Art of War, by Sun Tzu. One principle from this ancient tome is the importance of knowing both yourself and your enemy, as summarized below.
Effective competitive frameworks must include a thorough understanding of yourself and the competition. Some teams charge blindly into a competitive sale without any preparation. I’ve seen many teams begin preparations for a sales presentation while sitting in the lobby waiting for the customer to escort them to the meeting room. Needless to say, in competitive situations, these meetings rarely deliver the impact that they could or should. Opportunities progress slowly through the sales pipeline, if they move forward at all.
Other more seasoned sales teams learn that multiple vendors will compete for the opportunity and only prepare by highlighting their own product’s strengths. They know their product well, but fail to really understand the competition and how they will attack. This leaves sales teams scrambling when the competition effectively highlights their own strengths or points out your weaknesses — resulting in a loss of confidence, credibility, and sales momentum. This approach is similar to a sports team that competes by only emphasizing their offense and ignoring their defense. As a long-time San Diego Chargers fan (yes, I know the Chargers moved to Los Angeles), I celebrated the vaunted “Air Coryell” offense that led the league in passing yards an NFL record 6 consecutive years from 1978 to 1983. Sadly, the Chargers’ defense also surrendered the most passing yards in 1981 and 1982. The team could easily score 35-40 points in a game, but their opponent often did the same. In the documentary “America’s Game: The Missing Rings”, the 1981 Chargers received the dubious distinction of being one of the five greatest NFL teams to never win the Super Bowl.
Companies that build a competitive infrastructure that highlights their differentiators and provides prepared responses to their competitor’s lines of attack enjoy the best chances of success.
Build a Solid Competitive Framework
Just as it’s key to structure your product’s value into features, advantages, and benefits, it is important to structure your competitive content. I usually classify competitive content into three categories: objective, subjective, and speculative, as depicted below.
Objective content is customer viewable, which means it needs to be based on fact or broadly accepted opinions. It needs to be unbiased in order to pass the credibility test. Subjective content is targeted at your trusted partner network and may be shared with the end customer in select instances. Because the subjective content may be disputed by an extreme skeptic, it should be built on conservative, plausible assumptions in order to be defensible. Speculative content is based on experienced opinions and logical projections. However, because the core content is often anecdotal or non-public, it is subject to claims of bias. As such, it should be only be delivered in very carefully crafted messages. Subtle messages that shine a light on a certain topic or that encourage the customer to explore a subject more deeply may be appropriate to convey the point. Simple examples of objective, subjective, and speculative messages are captured below.
The Audience Matters
Another key consideration is the target audience for your competitive claims. I encourage product managers to create bullet-point messages for executives, mid-level managers and architects, as well as staff engineers. Similar to the functionality available in Google Earth, the bullet points should differ only in the level of detail, providing zoomed-out perspectives for senior management and zoomed-in details for front-line staff. I’ve created a sample competitive 3×3 battle chart to illustrate how each category of competitive content intersects with the target audience to create a specific message.
Snacks, Entrees, and Banquets
Finally, competitive content should be packaged and delivered in three different formats:
- Short bullet-point summaries (such as the sample above) that can be quickly leveraged by a sales team in as little as 10 minutes.
- Overview presentations that provide reasonable detail behind the summary claims that a pre-sales engineer can review in 45-60 minutes. Without this level of detail, your sales teams will not have the confidence to be credible and will likely crumble when challenged with an opposing viewpoint.
- A library of detailed evidence supporting each individual claim. Each library item may take 10-15 minutes to digest. In some cases, the customer struggles with accepting the competitive messages you tell them. In such cases, you need to be able to show them the specific detail. In one instance, I claimed that our product could be installed in about two hours, while the main competitor’s product installation took about two weeks. To back up the point, I referenced the competitor’s installation guides. Their installation process had six major steps. Each step had a long checklist of individual tasks. I copied the tasks for each step directly into my internal competitive presentation, giving the sales team hard, actionable data. The first step alone consisted of 41 individual tasks! In another instance that proved quite effective, an engineer created a video of the actual troubleshooting process of a common problem (loss of a network connection). The recording of the terminal session captured all the command line steps required to gather individual pieces of data in order to determine the correct course of action. The video illustrated the difficulty of troubleshooting the multi-layered, distributed solution that was not apparent in the competitor’s high-level product pitch. Both of these examples required a significant investment in order to understand the enemy. But, as Sun Tzu correctly observed, the fact that we knew the enemy very well enabled us to approach every battle without danger.
The Path to Game Day Sunday
Every football fan understands that games are won by creating a strategic game plan and then executing to that plan. Professional football players and coaches prepare and practice for six days and play for just three hours, one day a week. As Sun Tzu asserted, “every battle is won before it is fought”. Set your company up for success by knowing both yourself and your competitors. Invest the time required to learn your most effective offensive plays as well as defensively counter the opponent’s likely lines of attack. Classify your competitive talking points into objective, subjective and speculative categories in order to help your sales team know how hard to push and how to position each message. By adopting a structured framework for your competitive content, you can avoid reckless street fighting and build effective battle campaigns for your sales force, enabling you to compete strong.
Shakespeare famously spoke through Juliet, asking “What’s in a name? … a rose by any other word would smell as sweet.” That’s true, as long as you know you are truly holding a blossoming rose (and not a seedling or a plant that has yet to flower).
Many startups bring on promising talent to run large portions of the business. Because cash is usually tight and equity pools are limited, founders scramble to offer compelling packages to attract top talent. One common “carrot” or concession offered during the interview cycle is a big fancy job title. The rationale is that, if you can’t increase the salary nor the stock options, then let the candidate take a VP or a Director title. It costs you nothing, so the prevailing logic goes.
Pay Me Later
But the reality is that job titles are not free — you eventually pay for it later. Founders should think carefully before doling out executive or senior job titles. Founders need to ensure that the candidate’s skills truly match the expectations of the senior job title. Multiple challenges can arise when an employee is over-titled, including:
- Insecurity that leads to defensiveness. Difficult personnel issues surface when it becomes apparent that the employee isn’t capable of playing the senior role. Employees who are overly hungry for a big job title usually have a hard time facing the facts if they aren’t meeting your expectations of the role. Their insecurity often takes over when you try to provide constructive feedback and they resist any notion that they aren’t truly VP or Director-level material.
- No room at the top. If the candidate is over-titled, eventually founders need to bring on a truly senior employee to take over. But if the current candidate already holds a VP title, then you are left with few options other than to bring in the new person as a Senior VP. Top-heavy small companies easily become unbalanced when they have too many generals and not enough infantry. You need a typical distribution of titles within a team to properly allocate work between leaders and staff. New investors will also question your management decision making when they see an unbalanced, top-heavy organization. In addition, if you bring in the next person at a higher title just because the current person is over-titled, you run into more problems with compensation. The new person will expect a salary and equity package that is commensurate with the higher title, further draining your limited resources.
- Low morale among the troops. The staff working for the over-titled executive will eventually recognize that the team leader isn’t meeting the expectations of the role. The front-line staff are often the first people in the company who recognize that the leader isn’t doing the job well. They won’t want to work for the person, which results in disunity and dysfunction. Their expectations put pressure on the founders to deal with the over-titled individual, creating a messy people issue to resolve.
- Can’t right-title. In many cases, the over-titled individual is a hard worker and a reasonable employee, just not at the title he/she currently holds. The right thing to do is to change the person’s title to one that more appropriately reflects their current capabilities and contributions. But just about everyone will see this as a demotion. Very few people are comfortable with being demoted, leading you right back to cleaning up a messy HR issue.
Because most people hate dealing with messy HR issues, I often see founders avoid the problem altogether. Avoiding the HR issue means your company will just limp along, under-performing along the way. Progress will slow, investors will sit on the fence or lose interest, and employees will get disillusioned.
Right Titles, Right Foundations
Occasionally, you’ll find a promising candidate with great potential. Chances are the candidate will have many options to choose from, forcing you to compete for their services. Don’t give in to the temptation to over-title the candidate in order to make your offer more attractive. Do talk about your solid HR practices and culture and how you want to provide many opportunities for employees leverage their preparation. Every team member wants to feel successful, so highlight the fact that success is likely when opportunities and preparation intersect. Bring the candidate in at a lower title — the right title — and offer regular feedback and coaching. If the candidate exceeds expectations of the lower title over a sustained period of time, promote them. This approach avoids the risk of over-titled employees. It also motivates the employee when they see their contributions being recognized and their career opportunities growing.
As I wrote in my posts on interviewing and finding the right candidates, hiring game changing employees has to become a strength of every startup. Employees are the foundation of your startup. It is important to align the job title with the candidate’s true capabilities and proven experience. Over-titling employees runs the risk of creating multiple layers of complex, messy problems. But rational, consistent and accurate mapping of roles and titles can form a solid foundation for you to grow your startup. Hire well and grow well!
Founders dream big. Founders see a need, envision a solution, then work tirelessly to realize their dream. Founders should shoot for the stars, but need to remain rooted in the reality that they might have to settle for landing on the moon. When setting goals, it’s important to aim high, but it’s also key to keep the realities of business or technical constraints in mind.
I witnessed this first hand in my first startup, an e-commerce retailer in the jewelry space. I joined after the company closed its Series A funding round and grew to about 20 employees. We embarked on a crazy schedule to build out an e-commerce web site in order to handle the upcoming Christmas shopping season and the expectation of hockey stick growth. We built out a beefy technical infrastructure, hired marketers and merchandisers, and installed an enterprise-grade inventory system with Amazon-like pick, pack and ship functionality. In the fall of 1999, we launched a beautiful luxury retail web site graced with glamorous super-models decorated in gold, diamonds, and pearls. Early sales were good, as we benefited from a strong Christmas shopping season, fueled by a big marketing and advertising budget.
But then reality hit. With the Christmas season behind us, sales slowed and web traffic waned. Given ambitious projections of big revenue, we built a muscular V-12 engine that guzzled gas like there was no tomorrow. We raised a lot of money, but were quickly burning through it. The Internet frenzy in 1997-1999 led to the B2C e-commerce crash in 2000. Our startup was no exception, as the investors lost confidence and pulled their support. The company shut down in fall of 2000.
As my team packed up their personal effects, someone found the original pitch deck used to raise the early-stage funds. One thing stood out: a graph with a $200M revenue projection by the company’s third year: classic hockey stick growth. This projection drove many key decisions around the size of the marketing budget, the “weight” of the big iron running the web site, and the bells and whistles in the inventory and logistics engine. I immediately recognized this as what it was: a catastrophic crack in the foundation of the business.
After I joined, one of the veterans from the jewelry business informed me that 70% of jewelry sales are Christmas gifts. So in order to do $200M in sales, that meant that we would have to do $140M in Christmas revenue. The Christmas shopping season is effectively about four weeks long. If you oversimplify your facts and assume the revenue is evenly distributed across the four weeks, that works out to $35M per week. Assuming an average order size of $300, that works out to 116,667 jewelry orders per week. If we further assume 90% of e-commerce orders are placed Monday through Friday with 12-hour shopping days, that works out to 21,000 orders per work day, 1,750 orders per hour, or basically one order every two seconds. There weren’t any reliable statistics that gave us the number of individual jewelry purchases in the US each day. But to assume our little startup retailer could rocket up to booking one order every two seconds — for luxuries funded mostly by availability of disposable income — is at best hyper-aggressive and at worst, fantastical.
But the jewelry industry sanity check above could be criticized on one important assumption: the average order size. Because the business plan included both high-end, low-volume luxury products and low-end, high-volume consumer products, predicting the average order size was an imprecise exercise.
Given this, a second sanity check is justified. So let’s take a look at it from a logistics perspective. In 1999, FedEx shipped about 1.2M Express boxes in the US each day. Our target of 21,000 orders per work day would represent about 1.8% of the total daily FedEx Express package volume. For a single fledgling Internet jewelry startup to go from zero package volume to one of FedEx’s top 10 customers in just three years is completely unrealistic.
The MBA Sniff Test
When you combine the unrealistic projection of how much of the jewelry market share this startup could capture with the equally unlikely logistics operations growth, you get an unfeasible business plan that was destined for failure.
The lesson learned here is that a couple of hours from an MBA analyst would have caught the overly optimistic projections. The business was viable, but the projections drove the company’s burn rate and investor expectations to an unsustainable level. Realistic targets would have given the company a fighting chance for success instead of a premature shutdown.
Grand Slams vs. Base Hits
It’s fine for founders to step to the plate and swing for the fences, but expecting to win by hitting grand slams every inning is poor game planning. When every batter tries to knock the ball out of the park, you end up striking out way more than you hit home runs. A better game plan focuses on getting batters on base, then advancing them methodically.
Every founder dreams of hockey stick growth, but most startups grow steadily, not explosively. Because a core premise of the business plan was unrealistic, the company overbuilt and overspent trying to hit an unachievable goal. Build a game plan with reachable stretch goals, execute well, and you’ll have a strong chance of success.
As I’ve written previously, every startup needs game changing players. You can hire them if you have a good interviewing process, know what to look for, and can offer a strong compensation package (cash + equity). Sadly, even if you have all of these, the ridiculously competitive job market (especially in areas such as the Bay Area, New York, and several other tech hot spots) may frustrate your ability to bring on ready-built veterans. In such cases, your only alternative is to hire candidates with raw talent and potential and then grow them in house.
Every owner of a fantasy football team would love to draft the top quarterback, top two running backs, and top three wide receivers in the league. But the realities of most leagues typically limit any one team to maybe two veterans with a proven history of production over several seasons of gameplay. The rest of the team must be built around role players and younger, unproven athletes.
In order to develop unproven players, founders must build an atmosphere and system that cultivates growth. Veterans who are chartered and able to develop the younger staff serve as the anchor of high-growth teams. These veteran leaders need to buy into the fact that a key part of their success depends on their ability to raise up their teammates. Team leads need to balance the efficiency of doing tasks on their own versus delegating, coaching, training and empowering others to take ownership for key parts of the project or team.
Once you have the veterans in place, you need to find the right rookies to add to the team. Take a moment to review my previous post on building a strong interviewing process. As I’ve previously written, success is usually the combination of preparation and opportunity. Younger-in-career candidates haven’t have many opportunities, so your goal in the interview process is to identify candidates that have great potential because they’ve done the necessary preparation. You should focus on:
- Strong technical ability. Front-line staff typically need to demonstrate very strong technical capability in the role they are hired to play. Make sure your interview process goes the extra mile to identify raw technical talent with real-world “show me” demonstrations and tests rather than “tell me” stories.
- Executive abilities. Don’t ignore analytical abilities, methodical / structured problem solving, organization skills, communication skills, and attention to detail. These are common requirements on a resume, but rarely assessed in an interview.
- Emotional intelligence. Daniel Goleman published a landmark work where he asserted that a person’s Emotional Intelligence can matter more their Intelligence Quotient. Because of the demands of a high-growth team environment, candidates need to have some basic emotional intelligence in order to thrive. Goleman identifies five key components of emotional intelligence: self-awareness, self-regulation, internal motivation, empathy, and social skills. Make sure your interview team evaluates these aspects of every candidate.
- Humility. Finally, each member of a fast-paced, growing team needs to be willing to learn from others and not be afraid of owning up to any mistakes. Humility is essential, as individuals with a modest view of their own importance tend to be better learners and less defensive when mistakes are made.
The Farm System
Once you have the veterans and the rookies lined up, you need to create a system that provides a safe environment to grow. Give people challenges that stretch their abilities. Capable, well-prepared team members really need just one successful project to go from a novice to a strong apprentice. Two successful projects will often be enough to forge a journeyman from a strong apprentice.
When you task a team with multiple stretch goals, regular check-ins become very important. Create daily and weekly processes that have your veterans providing regular inspection, direction and coaching of younger team members. Agile development processes are very well-suited to rapidly develop younger team members.
Keep in mind that, as you challenge teams with stretch goals, failure is not just possible, but likely. Mistakes will be made. Bugs will always plague software development. But failure shouldn’t be fatal. When honest mistakes happen, make sure the team knows where they went wrong and are diligent about recovering from the error. Hopefully, your regular check-ins will uncover the mistake before the freight train flies off the rails or the project goes completely sideways. Plan for problems because, with fast moving young teams, mistakes will happen.
On the flip side, when a young team or team member executes the stretch assignment well, be quick to recognize and reward the achievement. Correct mistakes privately, but praise successes publicly. If the young team member strings together a couple of wins in a row over two to three months, find a way to recognize that with a small bonus. If the team member continues the winning streak over two to three quarters, step up the recognition with either a larger bonus or a small bump in compensation (cash or equity). If the team member demonstrates consistent growth for about a year, recognize it with either a job title progression (e.g., Associate 3 to Associate 4), or a promotion (e.g., Associate 4 to Senior Associate 1).
Building a strong team from a pool of raw talent is very difficult. Few people do it well — even fewer can do it at startup speed. But most startups need to learn how to do this as it’s not likely they will be able to always fill their roles with seasoned veterans. You basically need to find diamonds in the rough, then cut and polish the raw stones to brilliance. With a few strong veterans, a pool of promising rookies, and the right farm system, success with younger teams becomes not just possible, but likely.