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Commandment #9: Be Like Goldilocks

Any VC who doesn’t grill you on “the competition”, either in the initial meeting or during due diligence, fails the VC IQ test.  Understanding how to think about – and present -- the competition, therefore, is important to getting VC funding.  Here are some thoughts.

Competition is, what I call, a “Goldilocks” phenomenon.  You don’t want too much (no surprise here) and you don’t want too little (hmm, surprise?) – you want it just right.

It’s probably easy for entrepreneurs to understand why too much competition is a bad thing:

·        Competition for Funding.  By this, I don’t mean that there isn’t literally “enough” money to fund multiple startups in a single niche (on the contrary, one of the problems of the current early stage venture capital ecosystem is that there’s too much money chasing early stage deals). It’s more nuanced than that (and not as self-serving as it always sounds on first blush to entrepreneurs).  Several actual reasons:

o       because most top-tier VC firms don’t invest in companies that compete too closely (longer discussion in a future post), a startup that has numerous existing startup competitors actually may actually have a much shorter list of top-tier VC’s to approach;  given the odds of any particular VC firm funding any particular startup, this can have a dramatic adverse effect

o       Though apostasy to entrepreneurs, it’s actually quite hard to distinguish among startups going after the same space, if there are a lot of them.  When this occurs, every startup suffers from the “least common denominator” effect -- and inevitably seems less interesting; and

o       Many VC’s simply won’t fund the 4^th or 5^th company in a space.

·        Competition for Talent:  Pretty straightforward.  Commandment #8 asserts that “it’s all about the team”.  Where talent is concerned, two bad things happen when there are too many competitors:

o       talent gets spread too thin; and

o       good talent stays away because the space is too “crowded”.

·        Competition for “Market” Attention:  In a market with numerous competitors, any single startup will have a tough time gaining the attention of important consultants, analysts, pundits, columnists, reviewers, press, etc.  Partly, it’s the confusion (and the extra effort required to make sense of the competitive dynamic), and partly it’s the “least common denominator” problem mentioned above.

·        Customer Confusion:  Much the same thing.  Quite often, customers faced with numerous competing products or services find it too costly and confusing to differentiate.  Remember:  purchase decisions have costs.  When the costs are too high (because of confusion about what product or service is the best fit or value), it’s always bad news.  At best, the purchasing decision is delayed (as the competitors confuse the customer base by bashing each other).  At worst, the customer makes the “safe” choice and buys the product or service from the “most trusted” vendor – usually a large, established competitor with a vaporware or highly inferior product or service. 

·        Customer Leverage:  Smart customers also play off startups against each other to get the best deal.   Since the value of an early, marquee, reference customer is so important to a startup, the customer has all the leverage here.

·        IPO Opportunity:  For established companies, public markets don’t like markets with too many competitors because competition drives down margins and earnings.  For startups trying to go public, that’s also true, but another concern also comes into play.  To go public and achieve an efficient market for its stock, a startup needs coverage by sell-side analysts.  Even in the “good old days” when there were lots of analysts, it was not easy for startups going public to obtain broad analyst coverage (other than from the underwriters).  Nowadays, it’s much worse, given the dramatic decrease in the number of sell-side analysts.

·        M&A Opportunity:  In many markets (e.g., “core” enterprise ERP applications, or, increasingly, consumer internet businesses), the dominant players provide the main liquidity option through mergers and acquisitions.  While actual strategies differ, often the dominant players in a market will buy the 2^nd or 3^rd leading startup, rather than the leader.  Leaders often think they can go public as an alternative, and therefore demand a premium acquisition price.  Startups in the 2^nd or 3^rd position feel more vulnerable, and therefore feel pressure to sell for a lower price.  Once each of the dominant players has made an acquisition in a market, it’s often “game over” for the other competitors who remain independent, even the market leader.  Why?  Even for companies selling a technology-based product or service, the marketing, distribution and sales (or in consumer internet parlance, “customer acquisition”) muscle of a larger company is often more important than any particular technology.  A cheaper, inferior product or service in the hands of a powerful distribution system often defeats a better product or service being sold by a startup, even the (pre-acquisition) leader.  So, in a crowded market with dominant incumbents, if you’re not acquired, you’re toast.  Smart acquirers use this leverage to their advantage.  The more startups to play off against each other, the better.

[Quick sidebar

:  Having said all this, however, the history of venture capital is replete with instances where promising markets are imprudently (and even stupidly) over-funded.  VC’s (like entrepreneurs and other people) don’t always do the smart thing.]

Given all the bad things I just wrote about too much competition, one might assume (some entrepreneurs do) that “…if having a lot’s bad, then having none must be great…”.  This is wrong for a couple of reasons:

• Though I’ve never seen it, I suppose that there may be cases, very rarely, in which a startup has a truly unique and original business idea – and therefore has no competition.  Most startups, however (no matter how innovative), do.  Given the inefficiencies in the information marketplace about startups, entrepreneurs may not know about all their competitors, but they’re almost always out there.   I know, from my entrepreneur friends, that this is painful for entrepreneurs to hear – and understandably so.  Because they’re human beings, and therefore subject to the same motivations (and foibles) as the rest of us, it’s hard for entrepreneurs to make the enormous sacrifices necessary for success if some little corner of their mind doesn’t think that they have a deep, fundamental insight into a market that no one else does.

• Given this, if a startup asserts that they don’t have many (any) competitors, they hurt their case, no matter what.  Either:  (1) the VC won’t believe them, and will think that they simply haven’t done enough competitive due diligence (and are therefore not worth backing) or (2) the VC will believe them and conclude that, if there aren’t any competitors, it must not be that large or interesting a market.

So, if too much competition is bad and too little (or any) competition is bad, what’s the entrepreneur to do?

Couple of things:

• Do your competitive due diligence.  By dint of their position in the deal flow, VC’s in the top-tier firms often know a lot about who the startup competitors are in a given market.  VC’s expect (and reasonably so) that good entrepreneurs, even though they’re usually not as deep in the deal flow, will be very well informed about their competitors, and to have thoughtful, balanced analyses of their strengths and weaknesses.

• Don’t be Afraid to List Your Competitors:  From the VC’s perspective, it’s much more impressive to hear a thoughtful, careful, balanced analysis of a crowded competitive landscape, than it is to hear one that omits many of the competitors (the worst) or naively concludes that all the competitors are “losers” (for one reason or another).  VC’s will fund startups that have competitors.  Don’t be afraid to point them out.

In summary, as you develop your business ideas, and begin to think through your investment pitch to the VC’s, remember the following; it’ll help: 

• Having too many competitors is always bad.  If you have too many, consider another startup idea, painful as that is.

• Having too few competitors is usually bad.  If you have too few, consider whether the market’s that interesting.

• Having some competitors is good.  It validates the market opportunity.  BUT,  know who the competiors are and understand their weaknesses AS WELL AS their strengths.  VC’s are most impressed by entrepreneurs who know who their competitors are and know a lot about them -- and have a healthy respect for them.

Commandment #8: Know What You Don’t Know – and Admit It

If all questions about your startup had well-known, easy answers, you’d be on your IPO roadshow, not meeting with early stage VC’s.  Most good, early-stage VC’s don’t expect entrepreneurs to know everything, but they do expect entrepreneurs to know what they don’t know and to be upfront about it.  This Commandment gives advice on how to handle this.

To set the stage:  VC’s invest in people.  You’ve all heard the old saw: “To a VC, what are the three most important things about a startup?”  Answer:  “(1) the team, (2) the team and, (3) most of all, the team.”

By and large, it’s true.

Now, if you followed Commandment #1, you’re meeting with VCs who know something about your area. I know it seems hard for entrepreneurs to believe (especially given some of the comments I’ve gotten), but VC’s are generally smart people (present company excluded).  They can have lots of other unattractive attributes (just like entrepreneurs and other people), but they are, on average, reasonably smart.  Thus, your jaw shouldn’t drop if you find yourself in a VC meeting and you get a question about your business to which you don’t know the answer.  Believe it or not, this sometimes happens.

Here’s some really important advice. 

When this does happen:

            DO: admit (with confidence) that you don’t know the answer

            DO: make a note of the question

            DO: quickly find out the answer to the question

            DO: promptly follow up offline with the VC who asked the question

DO NOT, REPEAT, DO NOT: fake your way through an evasive, oblique, or indirect attempt at an answer.

I know from comments to my blog that some readers reject my proposition that VC’s are, more or less, smart folks.  That’s OK.  Everyone’s entitled to their own view on this matter, and, who knows, they may even be right.  But, even to those doubters (if they want to raise VC money), I implore you to believe that VC’s (smart or not) do have good bullshit detectors – even in areas where they’re not necessarily domain experts.  Often, of course, it’s not even that hard.  Human beings are generally pretty good at reading body language, and body language usually gives away evasive behavior.

To put this in a more positive light, from the VC’s perspective (no VC actually thinks about it this “formalistically”), I offer this little “algorithm”:

·        There’s a “list” of the important questions about any new business idea, some of which are not currently “answerable” (e.g., will the market develop as predicted by the entrepreneur);

·        The entrepreneur should have answers to most of the currently “answerable” questions on this “list” (e.g., why a large incumbent vendor with major brand recognition and a huge cash hoard can’t easily move into the market); and

·        If the entrepreneur doesn’t, he should admit it, and quickly heed the aforementioned advice about follow-up.

Again, VC’s don’t expect entrepreneurs to have all the answers.  As mentioned, if you did, you’d be on your IPO roadshow.  VC’s do, however, expect entrepreneurs to know the “list” of important questions. Failure on this front is the real confidence deflator (though, to say the least, it also doesn’t inspire confidence if an entrepreneur doesn’t know the answers to questions that he should). 

Failure to heed this advice can hurt an entrepreneur in a way that might come as something of a surprise.  VC’s ultimately cannot know nearly as much about your particular business as you do (see numerous references in prior Commandments).  After lots of due diligence meetings, reference checks, customer calls, etc., many funding decisions more or less rest on VC intuitions about the “character” of the entrepreneurs.  This is why VC’s are so much more comfortable backing entrepreneurs they already know. 

Keep in mind, many important questions about a startup are not answerable until the startup answers them (positively or negatively) by executing its business plan.  VC’s, at least the good ones, know this. Thus, if the entrepreneur exhibits evasive behavior when answering a question, the “trustworthiness meter” starts running in reverse.  Believe me, every startup will encounter situations in which the entrepreneur will have to report to the Board of Directors on a tense, critical situation, with highly imperfect information – and, after lots of analysis, the Board’s decision will often rest on beliefs about “character”.

So, for any entrepreneur who wants to raise VC funding, following Commandment #8 -- (1) know a lot, (2) know what you don’t know and (3) admit it when asked -- will get you a lot farther down the road.

Commandment #7: Limit Yourself to the Baker's Dozen

Loyal readers who’ve slogged it out with me so far will know that, partly by “tradition”, and partly due to the Hard Stop (Commandment #2), entrepreneurs usually have about an hour to get their message across in the first meeting with a VC (subsequent meetings vary in length).

Loyal readers also will know that entrepreneurs have lots to do to prepare for that first meeting (Commandments #1 and #2) and make it productive (Commandments #3- #10 (#8, #9 and #10 aren’t posted (or written) yet)).

Now, more bad news: entrepreneurs have to do all this in 13 (or fewer) slides.

I know, I know…..sounds impossible, but do the math:  You have (roughly) an hour.  According to Commandment #2, you should use a few precious minutes to find out “who are all those people”.  Let’s say 5 minutes. That leaves 55 minutes, more or less. 13 slides = <5 minutes/slide.  Not much time.

Plus, you’ll get questions (in fact, 9 times out of 10, it’s a bad sign if you don’t).  This uses up even more of your precious air time (BTW, Commandment #10 (forthcoming) dishes on how to handle questions).

Now, in reality, actual mileage may vary. The “optimal” number of slides in your presentation may not be exactly 13, but the truth is that it can’t be much more than that or bad things happen: (1) you run out of time, (2) you look disorganized or (3) you end up handling the last few slides like one of those radio announcers at the end of a drug ad – speeding through 10 pages of fine print about possible side-effects in 3 seconds.  Hard to follow, right?

More constraints:  you don’t even really have all 13 slides to explain your business. In every first presentation to a VC, a few slides on stuff other than explaining the business are mandatory: (1) the team, (2) the competition (more on this in forthcoming Commandment #9) and (3) the financial projections. So, you really have about 10 slides to do your thing.

Remember, in the “religion” of getting VC financing, simplicity is a cardinal virtue. Keep this – as well as Commandment #3: Tease, Don’t Overwhelm – in mind.

All this said, we’ve done deals at Mayfield where, despite a lousy initial presentation (takes one to know one; I’m a lousy presenter myself), it was nevertheless clear that the entrepreneur had a great idea.  But, is it ever helpful to meet a startup team that has clearly, cleanly and crisply distilled a complicated message down to 13 slides (or fewer). 

Following Ten Commandments in only 13 slides is really hard.  If you can do it, however, you’ve helped yourself more than you probably know.

Commandment #6: Explain Your New Idea by Analogy To, or Contrast With, Old Ideas

To date, I’ve tried to couch the ideas in the “Ten Commandments” as objectively as possible.  No doubt, I’ve only partly succeeded, but in this post I’m admitting upfront that the following advice is likely to be idiosyncratic to me, and may not apply to every VC you ever pitch to.  So, use it only if it feels good in your own “voice”.

In Commandment # 5, I urged entrepreneurs to describe the “It” early (and explained why).  I suggested that a way to do this was frame the description as an answer to the question: “What problem are you trying to solve?”.  Commandment #6 is, sort of, the next step in that process of making clear to the audience how your “It” solves the problem. 

One way to describe “It” quickly and cogently, I find, is to analogize to, or contrast your “It” with, the other, existing “It’s” out there.  Sometimes (most likely, the “contrast” situation), the other “It” is a product or service that you’re going to kill off, replace, compete with, complement, or relate to in some direct way because your “It” and the other “It’s” are solving problems in the same or similar markets.

Sometimes, however, it’s useful to analogize your “It” to an “It” from an unrelated market.   This works best when the other “It” is a popular “social artifact” – such as Blog, Google, TiVo, Podcast, etc. (good way to tell this is when the “social artifact” formerly just a noun, has morphed into a verb due to its popularity).

An example:  One of my companies, Pluck (www.pluck.com) has a very interesting set of capabilities, in some ways structured around the core application of an RSS newsreader.  Among a bunch of other features and functionality, Pluck enables (I promise this advertisement will be brief) users to save, store and file web content in ways that allow groups of collaborators to access, over extended periods, the data stored in a collectively accessible place.  This, plus the other features of the product, is a complex set of capabilities to explain quickly.  When the team pitched Mayfield on their deal, they described this unique ability to “time shift” access by groups to stored web content as “Tivo for the Web”, and that phrase turned out to be a great way to initially place Pluck in an already understood mental category for my partners and me. 

Needless to say, “TiVo for the Web” is not a complete description of Pluck, and, like all figures of speech that seek to explain by emphasizing analogies between otherwise different things, you can push it too far.  Care should also be taken not to fall into, what I call, the “Hollywood trap”.  According to friends in the film business, the spoofs of Hollywood in which the principal way of pitching a new movie idea is to describe it as the mélange of two (or more) earlier films (e.g., “Son of Dracula meets Bride of Frankenstein”) is actually fairly accurate.  As the foregoing parenthetical shows, it’s easy for this to slide downhill into farce, so use discretion.

Think about this technique, however, as a potentially useful way to help you get to the point fast.  I recently met with a startup that pitched their wares as: “podcasting for cell phones”.  For a bunch of reasons, I didn’t think the business was a good one, but, nevertheless, I immediately had a sense for what they were trying to do.

Another interesting application of this that I recently saw was described as “eBay meets CNN”, a sort of “a news site (portal) for amateur (newsworthy) videos where viewers rate the videos to move them up or down in the popularity queue”.  Here, the entrepreneur (a Mayfield EIR) decided for various reasons not to pursue the idea, but it was easy to quickly see what he had in mind – and start to frame some of the due diligence questions one would want to ask.

I’d actually be interested in hearing from readers other examples of this type of thing – and whether they find it useful as either an “elevator pitch” technique (if they’re entrepreneurs) or as a quick way to categorize the new “It” (if they’re VC’s).

Intermission

Halfway home…..and I’ve gotten tons more input from readers than I ever thought.  As I round the horn, and start on the last five Commandments, I wanted to reflect a little on the comments that readers have left.  I promise a more thoughtful perspective when the entire 10 are finished.

It’s been almost a couple of months since I’ve posted, which several readers have pointed out to me (embarrassingly, but truth be told, also slightly gratifyingly – you mean someone is actually reading it??!!).  I’ve been busy at work and home, but aim to pick back up the pace.  As partial recompense, I thought I’d offer a snippet of a conversation I had down at the DEMO conference a couple of weeks ago with Walt Mossberg, who writes the Personal Technology column for the WSJ.

Walt and I were having lunch, and, the talk eventually turned to blogs -- and then to my blog (which Walt hadn’t read).  He asked me about it, plus a bunch of other questions about blogging.  I told him that I was in trouble because I’d made several rookie blogger mistakes. 

They included doing a series of numerically-related posts (the “Ten” Commandments for Entrepreneurs) that hadn’t taken into account the “reverse” chronological order in which one’s posts appear in a blog. What I should’ve done, like David Letterman’s Top 10 Lists, is to have started with Commandment #10 and worked down to Commandment #1.  That way, readers new to the blog could read the posts in a more natural way, from Commandment #1 “down” to Commandment #10, instead of seemingly backwards.

But the bigger, MUCH bigger, mistake, I said, had been to promise readers TEN Commandments instead of, say, “Several” Commandments, or “A Few” Commandments – in case (as happened) I got too busy to post, got writer’s block, stepped in front of a bus, etc., etc. 

Walt then looked at me with his patented “you’re an idiot” look….Why?  Because, he said, experienced journalists never, NEVER, announce a multi-part series (especially one that has an explicit number of installments) before they’ve written all of them.  In fact, it turns out that most of the leading newspapers and magazines won’t even print the first of a multi-part article until all installments have been turned in, edited and finalized for printing. They’ve learned from past mistakes, I guess.

Wish I’d thought of that before launching into something called the Ten Commandments.

Anyway, onward and upward.

I’ve received a number of suggestions on my blog, mostly on the Ten Commandments, some of which I’ve listed (and commented on) below.

One of the most interesting, from a pseudonymous VC whom I know of, is that I write a companion series:  “Ten Commandments for VC’s”.  I will seriously consider this.  To help, I invite suggestions from any reader on what they’d include on the list.  I’m sure there are lots of entrepreneurs out there with stories they’d like to share back to the VC community.

Another suggestion was to respond to comments to my posts.  One regular reader/commentator, Vanilla Chin, takes me to task on this.  I assume “Vanilla Chin” is a pseudonym since I can’t find that name (except in connection with other comments on blogs) on Google, in the Internet Archive or at Yahoo People (yes, I know there are other, even free, sites but, at some point, it’s not worth it).  In any event, I plead guilty to Mr. or Ms. Chin’s charge, but also plead the extenuating circumstances of being very busy at work and home.

Vanilla Chin has been a very interesting reader:  sometimes scolding and sometimes supportive (in the face of attacks by Harry Kiwi (see below)).  He’s also one of the more thoughtful respondents to posts, frequently raising concerns about my advice from the entrepreneur’s perspective.  I’m tempted to respond to him or her, but I’ve decided to adopt a rule proposed by Dan Gillmor (which I’m not sure he, himself, always follows), which is:  don’t respond to comments from anyone using a pseudonym.  So, please identify yourself if you want to start a dialogue; otherwise, especially given the time it consumes, I can’t do it.

Throughout the first Five Commandments, I’ve tried to make clear that I’m not defending VC behavior in any way.  Most readers who’ve given me any feedback (either in comments to a post or in a direct email to me), seem to have, more or less, gotten that point, although several have accused me of arrogance (some pseudonymously, some using their real names).  This has made me realize that, despite a lot of effort, it’s hard to describe (sometimes) arrogant behavior without readers, some at least, thinking the writer is, himself, arrogant.

In this regard, it's important to remember that the game, "Raising Venture Capital", is not played on a level playing field.  In some ways that’s not “fair” to the entrepreneur, and I’ve never pretended it is.  But it is a fact of life.  In writing the Commandments, what I’ve tried to do is give “little”, helpful suggestions to entrepreneurs about how to optimize their chances for winning the game on this unlevel playing field.  I sometimes wonder whether – instead of the "Ten Commandments" -- I should have called them “Several Small Suggestions to Help Entrepreneurs Do Their Best When Interacting With VC’s in the Unfair Game of Raising Money”.

Finally, one reader, whose screen name is Harry Kiwi, really has it in for the VC community, and me as a representative of it (not that there aren’t occasional good reasons).  You can read his comments next to the related posts.  I have to say that I found his comments to be ad hominem and entirely off the mark, at least relative to my intended message.  I’ve also searched for “Harry Kiwi” in Google, Internet Archive and Yahoo People, but, likewise, come up empty-handed.  Dan Gillmor also warns of “trolls”, like Harry, and it is amazing how one person, especially one who only comments pseudonymously, can really lessen the whole experience, at least for the blogger.

In any event, Harry’s been the only commentator who’s tested my initial (and still standing) resolve to not block (or delete) posts from anyone unless they’re really over the top.  On a couple of occasions, he’s come close, but I consider the “open-ness” of the blog one of its most important attributes, so, for now, I’m hanging in there with the resolve intact.

Anyway, I never expected even to have to think about rules like this for my blog, because I never expected anyone to read it.  So, thanks to all of you, except Harry, who have.

Commandment #6 coming up tomorrow.