Editor’s Note: This is a guest post by Mark Suster (@msuster) a VC at GRP Partners. He blogs at BothSidesoftheTable
I’m a very big proponent of the “lean startup movement” as espoused by Steve Blank & Eric Ries. The part of the movement that resonates the most with me (in my words) is that entrepreneurs should keep their capital expenditures really low while they’re experimenting with their product and determining whether there is a large market for what they do.
In the initial phases of any new market you’re developing a product (hopefully with a minimal set of features), getting feedback from customers, refining your product based on user feedback and then re-launching your product. Rinse & repeat. Nobody really knows whether or not the idea is yet going to be big, so I believe in not over capitalizing too early. This benefits you, the entrepreneur. It’s the whole basis of my investment philosophy, which I call “The Entrepreneur Thesis.”
I believe that over capitalizing companies too early often favors the VC. It takes options off of the table. It produces only one kind of outcome. It drives perverse incentives. If you’re creating truly innovative products, you often have no idea whether the proverbial dog will eat the dog food. You have a hunch. Testing is what helps determine whether you’re really on to something.
In the late 90’s I saw a dangerous trend creeping into the startup world, which was that companies were suddenly raising huge amounts of money too early in their existence. It seemed to be purely speculative. It’s not clear that there was big customer demand for some of these products yet entrepreneurs were egged on by VCs to “take the money” and try and push the market. I was a victim of this kind of thinking. “If my competitors have raised $40 million then I need to in order to keep up.” This is total bullshit.
Here’s what those VCs (and us entrepreneurs, myself included) didn’t understand: 9 women can’t make a baby in a month.
Markets develop for a complex set of factors that are often beyond all of our control. It is often the fortuitous mixture of new technologies, customer awareness and then acceptance of the technology and then the slow adoption into our daily lives that leads to markets exploding.
Often the timing of this is luck. And one of my favorite sayings is that “being too early in a market is the same thing as being wrong.” Throwing more money to speed up market adoption very seldom produces results. Yet it tempts us all. And it seems to be creeping back into startup culture of late in a worrying way. Great product ideas (and even potentially great companies) are being thrust at us in an attempt to go more quickly. I recently read this anecdote in the press (I won’t mention the company name because I actually really love the concept, but it’s not too hard to figure out). Talking about whether to raise more money or not, their VC allegedly said to them:
“If you had more capital, could you get to the future faster? Will (many more) millions help you get five years into one?”
9 women. Baby. Month. You can’t get 5 years into one. That’s falling prey to the “mythical man month” line of thinking.
Over funding often produces bad behavior in early-stage companies. You hire people too fast, you over build your products, you try to force market adoption and you do PR blitzes before your product is really ready for prime time. And having too much money certainly raises board expectations that you will do big things quickly. No board is going to give you $25 million up front and then expect your year-one staff expenditures to be $2 million.
I would argue that the father of the lean startup movement might actually be Bill Gross as he talked about in this interview I did with him on “why your company needs to be 10x better than your competitors to win” in your market. And I believe that strength of the Y Combinator movement in America has been exactly this: take incredibly talented technologist who have a passion for an idea, let them launch it and let’s see what they produce and what the market reaction to this product will be. It’s interesting to me that two of the most talented tech leaders of our era – Bill Gross & Paul Graham – have both opted for a model of incubation to encourage young tech entrepreneurs to build disruptive businesses.
The moment that you have a product that seems to satisfy the needs of a large enough market you enter what startup people like to call “product / market fit” characterized by the rapid acceleration of customer demand and therefore adoption. This is the so-called “tipping point.” It is at this point that your startup needs to consider “going fat.” In fact, not going fat at this stage can also cause problems. Once you’ve woken up the sleeping lions (e.g. Facebook, Google) to a large market opportunity then you had better have enough resources to compete.
Some of the best new companies of the past several years seem to stay lean until they figure out their product / market fit. Twitter took a few years until people (or the company) really understood how to use it effectively. I’d hate to see what Twitter would have become if they had started with $50 million. Quora is one of the better designed new products of the past few years in my opinion. And they seem to have been going really slow in building out the team and you certainly don’t see a ton of too-early PR blitzes from them.
Those of us that espouse “lean startups” often do so from personal experience. We made mistakes ourselves that proved to us that you can’t make markets move faster than they inherently want to just by throwing more resources at them. Those of us that are willing to admit that we fawked things up in the first dot-com explosion and learned from our mistakes have the battle wounds to make more pragmatic decisions in 2011. It is encapsulated in one of my favorite quotes that I first heard from Bruce Dunlevie of Benchmark Captial,
“Good judgment comes from experience, but experience comes from bad judgment”
I loved the quote so much I wrote an entire blog post on the topic. That’s why when you hear Steve Blank talk about lean startups you can hear his experiences ooze out of him in real-life examples of 8 startups. He knows that in the earliest phases of your businesses you’re trying to discover whether there is actually a large market for your product. If you’re a startup or product person and haven’t read his book Four Steps to Epiphany please do.
And let’s be clear. “9 women behavior” is not restricted to just fund raising. We technology leaders also make this mistake. I certainly did in my first company. I continually felt the market pressure to get new product releases out the door. I had my sales teams telling me we needed certain features to be competitive. I had my dev team asking for us to work through new architectural components to improve performance. I had my operations team telling me it was too hard for them to run analytics unless we built in our new BI platform.
It was so tempting for me to throw extra resources at our technology debt for a couple of quarters. And that’s exactly what I did. Our lead architect argued against it. He said that they were in a tight, small, very productive team and if we left them alone he felt they could be incredibly productive. As we added more resources we added more strain on his high-calibre core team. They had to spend time training our new resources, reviewing code, refactoring where mistakes were made, attending meetings, etc. He argued that in some cases less was more.
What did he know? He was tech. I was management. He didn’t feel my pressures on sales, marketing and ops. I had built computer systems before. I had been part of large, multidisciplinary teams. So I added a third-party developer in Bulgaria to increase output on one of our products. I added a dev team in India to spearhead new initiatives and design our future UI. The former was outsourced, the latter was our own team.
In the end, of course, our productivity actually suffered. It is he who first taught me this lesson. It was Ryan Lissack, now senior director in tech at Salesforce.com. He understood “the mythical man month” long before I did. The beauty of working with uber talented teams is that no matter how experienced you are as a leader you’re always learning from your team if you’re willing to listen. Eventually I did. And ever since then I have been reluctant to over-resource tech projects. Ever since then I have been in favor of smaller teams focused on core tasks. I have been in favor of lean development.
I hope this phase of the economy – the 9 Women phase – doesn’t last too long. And I hope that entrepreneurs will have the confidence to resist VCs who are pressuring them to over-fund too early. I know how it feels when the “siren calls” of money. It’s tempting. Just know how the end game often plays out …
** Image courtesy of Fotolia. Check ’em out.