The mythical startup

By Rowan Simpson, May 6, 2011 @ 9:49 am

An online idea that’s snapped up for squillions— it’s the modern fairytale, but tech startups don’t always have a happy ending. Rowan Simpson has been a key part of startups-done-right Trade Me and Xero, and as a tech investor he’s been pitched some great ideas and some real dogs. Along the way, he’s learned a few things about building teams, raising cash, learning from mistakes and getting customers who pay

Read an extended version of this article on the Idealog blog

Here is the popular mythology about how a new technology business becomes a success. Our hero, a lone genius, slightly lacking in social skills, one day comes up with an amazing new idea for a website. He locks himself away in his bedroom and stays up all night building the software. He launches the next morning and is immediately inundated with customers. Shortly after that, he cons some dumb fat corporate into buying the company for squillions and then retires to spend the rest of his life happily sipping mojitos on the beach of a remote tropical island.

This fairytale narrative is pretty harmless, I suppose. But for anybody actually working on a startup, or considering it, it’s a real distraction: as a result of this expectation many of the things that you think you know about what it takes to create and grow a successful business are wrong.

The path you need to follow is unlikely to be the exact same path taken by somebody else who was successful. Besides, those who have been successful find it much more difficult to pinpoint the reasons for their success than you might imagine. The decisions they made were typically a mixture of strategic foresight paired at just the right time and place with good execution, ultimately inconsequential mis-steps and lucky stumblings. It’s only much later that they get to decide which of these were which.

On the other hand, we rarely get to hear from the founders who tried something and failed, despite the fact that the lessons they uncovered in the process of not making it are likely much more relevant than the post-rationalisations of the lucky winners.

One-man band

“People are to startups what location is to real estate”
–Paul Graham, Y Combinator founder

Any successful technology company requires a mixture of different skills:

• Software development
• Design and user experience
• Operations
• Sales and business development
• Marketing
• Strategy
• Finance and administration
• Customer support (last, but not least)

Even within each of these areas there are conflicting demands. A good software development team needs a combination of people who are heads-up (thinking about people and how they use the software) and heads-down (thinking about the machine and how to make everything run as fast and efficiently as possible).

Smart strategy requires a very rare mix of faith-based and fact-based thinking.

All of this means that it’s extremely unlikely that you can do everything. Instead, you need to surround yourself with people who can cover the areas where you’re not strong—and ideally generalists who can cover more than one area, like somebody who can code and answer the phone when it rings.

Here is a good rule of thumb: if you can’t convince at least one other person to work with you on your venture, it’s likely that your idea is not great.

In a technology company it’s also extremely important that at least one of you is a technical person. If this seems unfair to the majority of people who can’t code, consider this: what is the most successful technology company you can think of that didn’t have a co-founder or early employee who was a developer?

Most of the people who contact me with a business idea are not technical people, and so have no idea what is really involved in building software. And yet most developers seem to prefer to be employees, not realising that the skills they have mean they are effectively sitting on a goldmine. Why is that? My guess is that they are intimidated by people, be it potential or existing customers.

Another important ingredient is choosing the right investors. Perhaps you have enough money of your own that you don’t need investors, or perhaps you can get by with funding provided by people who share your surname. But probably not.

The good news for founders is that these days it seems everybody with some spare cash wants to call themselves an angel investor and fund the next big winner. The recent surge in popularity for early-stage investing has seen the unionisation of investors into networks and clubs. Unfortunately this sort of structure often seems to select the worst ventures, because in a club everybody tends to rely on everybody else to do the work to identify and validate good opportunities, meaning that actually nobody does.

Investors are the tender to a new venture, not the engine.

You should have a preference for investors who take a founder-centric approach. My advice is to choose based on the contribution they can make. In the long run that is likely to be much more meaningful than the amount of money they can provide in the short term. The best way to judge this potential is to look at the trail they have left from previous ventures. It’s worth trying to understand why potential investors care about your success, or even what success is from their perspective.

Whether you are looking for a co-founder to share your vision or an investor to provide the fuel and push you along, choose carefully. You will soon discover the true character of these people, when the going inevitably gets tough.

Eureka

“If you’re not embarrassed by the first version of your product, you’ve launched too late”
–Reid Hoffman, LinkedIn founder

Most founders are very focused on their idea. But when you look at ventures that have actually been successful, they often look completely different to what they were first intended to be. In fact, there are lots of familiar examples where the idea that eventually worked is so different as to be unrecognisable.

In 2000 at Trade Me, we thought free online classifieds would create a business opportunity to sell online advertising. The tagline ‘Only turkeys pay for classifieds’ had a nice ring to it. It turns out that there are over 1.7 million turkeys in New Zealand, and counting.

The only way you learn which parts you need to be embarrassed about later is by launching and listening carefully to the feedback you get.

You need to listen to what people say, but most of all pay close attention to what they actually do. An empirical approach like this makes you humble. You quickly learn what little things you got right and what big things you got wrong.

So, don’t try to partially complete the whole product: complete a part of the product (preferably the part that will demonstrate value to paying customers). Then extrapolate from there based on how people actually use it. It’s nearly always better to implement a smaller number of features really well than trying to do everything averagely.

If you get this right over time then you too can look back and retrospectively invent a story about the mythical magical moment when the idea popped into your head, perfect and fully formed.

Inventor in a shed

“Sometimes the people who invent things and the people who find out what things are for are different people”
–Kevin Kelly, Wired co-founder

A natural instinct of an inventor is to hide themselves away from prying eyes, waiting for the opportunity to reveal the completed invention to a wowed audience. The danger with this approach is avoiding the temptation to constantly add just one more feature.

It’s easy to spot an inventor, as opposed to an entrepreneur. The inventor will ask you to sign a non-disclosure agreement before they are prepared to tell you anything, whereas the entrepreneur will want to talk to anybody who will listen.

If there is information that you’re reluctant to reveal because it could jeopardise your venture if a competitor got hold of it, that is a good indicator that your idea is not very good. Likewise if you think someone could take your idea and execute it better than you, even with your head start.

So don’t lock yourself in a shed. Talk to everyone you can. Perhaps one of them will suggest an improvement you haven’t thought of or, even better, offer to work on it with you—both great outcomes. That is easy advice to give, but much harder to do in practice. It takes a lot more courage than you would expect to tell others about your ideas, because chances are they won’t be that impressed.

Inventors have a bias towards creating something innovative and new. But to be successful, your idea doesn’t necessarily need to be original. Amazon wasn’t the first online store, Facebook wasn’t the first social network and Google certainly wasn’t the first search engine, but they have all done okay.

(On the other hand, all three, while not original, had something that was remarkable. More on that soon.)

There is even a school of thought that says the idea itself is irrelevant. It doesn’t really matter how original your widget is, instead impress us with your unit economics and business model and repeatable plans for selling (that last bit is what most frequently seems to be really hard).

Inventing something genuinely new is great, but working out what something is for is where things really get interesting. To create value you need to execute a good idea.
You don’t typically win by getting one big thing right, you win by getting thousands of little things right. And to do that, you need to be willing to get lots of things wrong.

The firehose

“Optimism is a genetic defect that helps keep entrepreneurs going”
–Sam Morgan, Trade Me founder

Lots of effort is wasted by startups who are worried about being inundated at launch. Unfortunately, despite all the work done in preparation, the deluge of customers rarely eventuates.

Trade Me, like most of the overnight successes you read about in the media, actually took about seven years from launch to acquisition, and remains under development over a decade later.

These days Trade Me is a juggernaut. But the numbers in the beginning were much less impressive. It took four and a half months to get to 1,000 registered members, even though it was completely free at the time. The first 10,000 members took over a year.

When you first start out, and actually for quite a while afterwards, it’s hard to differentiate between a hockey stick growth curve and a flat line. To make this even more confusing, the customers you attract at the outset are probably not even representative of the audience you’ll eventually chase. In the beginning, the biggest category on Trade Me was computer parts. Later it was womenswear.

There isn’t a lot of overlap in those categories. When you’re just getting started, you need different strategies. You need to make sure that you are selling to those people who are ready to buy, and there may not be a lot of them.

At Webstock in 2006 I spoke about the Team New Zealand mantra, which helped them to focus on the critical things: “Does it make the boat go faster?”

I still think that’s great advice for companies that are underway, but before you can worry about that you need momentum. You can’t steer a boat that’s not moving.

I don’t have any magic bullets, but here are a couple of things I’ve observed that I think can increase your odds:

1. Have a number to obsess about. Work out what one thing you can focus on that will create a positive feedback loop and drive the success of your business model.
   Once you’re paying attention to that, it will hopefully highlight what is currently constraining your progress and help identify the things you can do to move that number in the right direction.
2. Do something different. People only tell their friends about things that are remarkable. Unless there is something genuinely different about your idea it probably won’t be news, so you’ll need to find some other way to spread the word.

Your idea may or may not be inherently viral, and it makes a big difference—alternatives will almost certainly be more expensive.

“Expand your operations once you have operations”
–Jason Fried, 37signals

It’s very tempting, especially for technical people, to focus too soon on designing for scale, aka premature optimisation. You have more time to worry about this than you think, and adjusting for it if and when it arrives is probably not as difficult as you might imagine. At that point you will be starting not with a blank sheet but with all of the information you have gathered and lessons learned about what works and doesn’t work in your particular circumstances, which bits of your application are actually used a lot and where the biggest bottlenecks are.

Before you have customers there are definitely more important things to be working on. Like getting customers.

No matter how well you execute, it’s almost certainly going to take longer than you think before it becomes a success. But, that’s actually a good thing: creating something really great is going to take time and if you realised up-front how long it will likely take you might not bother to start at all.

Pinch me!

“While you are still searching for a business model, your company is worthless”
–Steve Blank, Silicon Valley serial entrepreneur

In 2006 Trade Me was sold to Fairfax for $750 million. At the time, some people thought that Sam Morgan had somehow tricked David Kirk into adding an extra zero to the price tag.

Why was Fairfax prepared to pay this much for a website?

In simple terms, the price was a multiple of the earnings and the trajectory the business was on. Trade Me now makes around $2 million a week, which makes that price back in 2006 seem much more reasonable.

So, what do you need to do to attract the interest of an investor or acquirer for your venture?

You can start with two basic motivating emotions:

• Greed
• Fear

In other words, you need to have new and (often even more importantly) growing revenues, or you need to be threatening existing revenues.

The good news for founders is that the strategy you should follow in either case is the same: build momentum, prove you can sell repeatedly and create a business that makes money. If you do that, you will have no problem selling the company or attracting investment if and when you decide that you want to.

And in the meantime, don’t get too far ahead of yourself.

In 1999, Trade Me took on $100,000 of investment, and in return the investors got 50 percent of the company. In the end it was a great deal for both sides (and indeed for me, too, as Sam used some of that money to start to build a team).

These days most of the people I talk to think just their idea alone is worth more like a million dollars. The vast majority have no revenues to speak of yet, and no idea what it will really cost to get to a point where they do, and therefore no basis at all to put this sort of valuation on the business. Worse, when you really dig into it, most know that what they have isn’t really worth that much yet, but they have convinced themselves (or been convinced by advisors) that they can somehow trick somebody into investing anyway.

This is crazy. In my opinion, you should choose someone you want to work with, be honest with them (for example when somebody asks for your five-year revenue projections, tell them you don’t and can’t possibly know yet), give them enough equity in the venture to make it material for them and get them to help you push it along however they can. For both investors and founders, success comes from creating a great business—not by screwing every last cent out of a funding round.

Whatever you do, don’t be a want‑repreneur, sitting around waiting for investment before you even get started. Chasing money from outsiders before you have a working product is probably not a good use of your time anyway: the valuation you’ll be able to get at this stage is far less than if you fund yourself to at least the point where you have something you can demonstrate that shows the potential, and allows you to understand the likely demand. Investors are mostly impressed by scrappy execution.

This often creates a catch-22: you need investment before you can afford to leave your job, but you need to leave your job before investors will take you seriously. I don’t have an easy solution, I’m afraid, but know that the best founders somehow find a way to make it happen.

Mojito Island

“Ridiculous yachts and private planes and big limousines don’t make people enjoy life more”
–Richard Branson, Virgin Group founder: his number one life lesson

Kiwi business people are often criticised for a lack of ambition—selling out once they have a bach, a boat and a BMW. I agree we should all aim higher than this, but I don’t think this means aiming for a private jet or super yacht instead.

If you measure yourself based on how many expensive toys you can buy, you’re never going to be satisfied.

The reason is simple: there is always another level. As soon as you have achieved something, you quickly normalise it and start to take it for granted. Then you start to compare yourself to those who are slightly ahead of you. Your appetite is always slightly bigger than your wallet.

To make this worse, if you’re lucky enough to be part of something that is successful, the first thing people ask afterwards is, “What are you going to do next?” That can weigh you down, take my word for it!

So it pays to think about what you really enjoy. Consider this formula, from hotelier Chip Conley’s TED talk:

Happiness = Wanting What You Have
Having What You Want

How much time do you spend on each part of that equation? Those who understand how fractions work realise that the idea is to focus on increasing the numerator (on the top) not the denominator.

It’s hard to describe how much better it is to work on something that you care about, unless you’ve experienced it yourself. It’s not a factor of two or three times better, it’s more like 100 or 1,000 times.

If you don’t understand this, go and work for a large corporate for a while.

Likewise, once you’ve been part of something as exciting as a startup that has momentum, and the rewards that come from that, sitting on the sidelines is going to feel like a step backwards. Even the biggest boat you can buy probably won’t compensate.

So, enjoy the walk. Think about why you’re doing all of this in the first place. If you’re lucky enough to work on a new venture and create your own job, appreciate the opportunity and try to enjoy it.

Financial rewards are a way to keep score, but don’t get too hung up on them. Even if you do all of the above, it still may not work out the way you hope.

All together now

“Success is throwing yourself at failure and missing”
–Richard Taylor, Weta Workshop

So, in summary:

• Build a team—probably generalists to begin with.
• Prepare for lots of the initial assumptions you make to be wrong.
• Listen carefully and respond quickly with changes where needed.
• Be brave and talk to everybody who can help you shape the idea.
• Spend your limited time and money on increasing the chances that you’ll actually succeed, rather than wasting them on preparing for success which may never eventuate.
• Work out what actually fuels your growth and how to tell your story in a way that spreads.
• Build a business that makes money.
• Be realistic about the value of what you’ve created, and honest with those that you’re bringing along for the ride.
• Have the right end in mind.
• Get started!

When you describe a startup like this it doesn’t sound like so much of a fairytale. But better, I think, that you go into this sort of thing with your eyes open.

Good luck!

Comments

Richard Francis

May 6, 2011 @ 12:01 pm

As someone who started a successful services business 10 years ago and now has a fledgling tech start-up underway, I think Rowan's advice should be required reading, irrespective of what type of start-up venture you are launching.

Useful, practical insight - pin it to the wall above your desk.

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