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A recent TechCrunch article about the launch of Floodgate, a seed-stage investment company run by Mike Maples and Ann Miura-ko, highlighted Maples’ approach to investing: he looks for ideas that are “non-consensus right.”  While every investment has to be “right” otherwise it won’t work out (pretty logical…), not every investment firm/VC looks to be non-consensus.  Indeed, the stories of VCs asking entrepreneurs what other VCs are saying abound.  It’s widely believed that a herd mentality prevails in the VC community.  As Ann Miura-ko notes in the video below, the number of Groupon and Gilt Groupe copies are staggering.

I wrote a few months about a talk by Reid Hoffman where he talks about the nature of early-stage investing.  He comes to the same conclusion (with only slightly different vocabulary): one needs to be an “accurate contrarian theorist” to be a successful entrepreneur or venture capital investor.  I wrote then:

Reid posits that an entrepreneur (and therefore venture capitalists who back them) need to pick something others don’t think is viable, that is unique – in other words one needs to have a contrarian theory.  It helps if the theory is correct at first (lucky!), but accuracy can be honed through iteration on the idea as the entrepreneur finds product/market fit.

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Mark Gerson, founder of Gerson Lehrman Group (possibly the most successful financial services start up of the decade), spoke Sunday at the Harvard Business School Entrepreneurship Conference.  Having been familiar with (and jealous of) the disruptive nature of GLG since my days in equity research, I awaited the talk with eager anticipation.  His talk did not disappoint, but he didn’t speak about his effort in creating GLG.  Instead, he spoke about the 15 common mistakes he sees entrepreneurs make or misconceptions they tend to have.

He caveated (is that a verb?) the talk by referring to an essay by George Orwell “Politics and the English Language” which lays out simple rules for clear writing but then states: “Break any of these rules sooner than say anything outright barbarous.”  The outright admission that any of the rules should be broken underlay a theme from the conference that there is no clear roadmap for being a successful entrepreneur… but coupling tried-and-true practices with a little bit of wisdom sure can help.

The 15 Misconceptions (with some commentary)

1. “We have no competitors.” Don’t be too narrow in the definition of competition. Gerson stated that competition is any entity that is fighting for the dollar spend from your customer.  By the same token, don’t worry too much about competition early on if you have a differentiated idea, just make it happen.
2. “Our idea is complicated but it’ll work anyways.” A technical idea often takes much longer and requires more cash to commercialize than initially thought. Be aware of this common bias.
3. “My advisory board/investors matter.” All that matters is that customers like and then pay for your product or service. This is one that can really be debated — in terms of garnering credibility to help sign customers, it often helps to have reputable investors, but I get the gist of what he’s saying.
4. “Our company may not be profitable but it’ll be of great strategic importance to acquirers.” Always try to build your company with a revenue model in mind.  It should be able to stand on its own, why put the success of your company
5. “My friends all think it’s a great business idea.” People tend to be polite, particularly if they’re a good friend.  Gone are the days of ‘true friends stab you in the front.’  Your friends would rather just tell you its great than risk you being upset from a negative review.
6. “We have great technology that is patented.” But can it be sold commercially?
7. “It may take us a long time to raise money, but it’s worth it to get great investors.” A corollary to #3, Gerson stressed that starting a company creates a tension between time and money.  Many ideas will work with infinite time.  The trick is getting a sustaining company going before you run out of cash.
8. “If 1 out of every ‘x’ buys our product, the company will be huge.” Beware the claims that a huge market makes your company success rate higher.  This is the refrain of many businesses hoping to make it big in large markets like China. Oftentimes, narrowing the market focus and mastering a niche leads to great adjacent opportunities and that can be a better way to build a company.
9. “We don’t want to share our idea because someone may steal it.” I (and many others) have already posted on this topic.
10. “I can hire someone else to make the early sales of our product.” Gerson stressed that the founders need to be the evangelizers of the product. Hiring someone to make the early sales usually doesn’t cut it.
11. “We can give away the product now and charge our users later once they’re already using it.” While freemium is widely considered a viable business model option, Gerson lobbed a tongue-in-cheek joke at the idea.  But the fundamental idea is sound, in my opinion, as this is what investment banks have grappled with in terms of what to do with equity research for the past ten years.  Giving away a product trains your customers to think its free, and they won’t change their behavior easily (newspapers introducing paywalls take note).  Ironically, Gerson’s fortune was made by carving out a significant role many research analysts played and building an incredibly lucrative business around it.
12. “The idea is working for another company, we can do it and charge less.” Being the first with an idea has significant benefits, so try to build something that hasn’t been done before.
13. “We’re going to keep working on our business plan.” Using a Steve Jobs line – “Real artists ship” – Gerson emphasized that spending time with customers is far more important than writing an extensive business plan.  Another way of saying what Steve Blank teaches and espouses.
14. “It’s less risky to join a large corporation than start my own.” If there is anything that the recent financial crisis and ensuing recession can teach us, it’s that large corporations are not necessarily less risky.  Sure, you can get away with more (and probably not work as hard) at a large corporation, but in many cases you aren’t in charge of your own destiny and can be fired on a whim or after a single poor quarter.  Is that really less risky?
15. “We’ll work on this idea at night and keep our day jobs.” Starting a company requires a full-time commitment, so if you’re serious: make that commitment.

“Everything should be made as simple as possible, but not simpler.”  Albert Einstein

I recently attended a talk by a LinkedIn executive where he quickly summarized the company’s business model and hit on a common theme with most “Web 2.0″ companies.   Almost all activities performed by the company were oriented around optimizing 3 things on the LinkedIn system: people, activities, and content.

Each of these elements worked to feed into the other two and increase the overall value of the platform.

The more people on the platform, the more activity (status updates, connections) and the more valuable content (posts, job information).  The more content, the more people will be attracted to the platform and the more activity will be generated. The more activity, the more content… and on and on.

And it all acts like a virtuous circle. Those familiar with the technology industry probably already know everything about “network effects” and how web 2.0 companies utilize them as a competitive advantage.

The revenue generators – advertisements, job postings, mail contact, etc – were all built on top of the platform, and seemed almost secondary.  They sit at the periphery and attempt to segregate the customers with a higher willingness to pay while not diluting the core user experience.  Although it’s clear these services keep the lights on, they did not appear to be the core of what the company focused its efforts on.

However, the really fascinating aspect of the talk centered on the fact that this exec was able to encapsulate everything one needed to know about the company in a simple chart he drew on the chalk board (replicated above).

I think there is real power in being able to articulate a business model as a simple diagram with even simpler variables to optimize. Having everyone in the company using it as a guide, it makes the decision-making process very easy. It really points out what matters, what doesn’t, and what will drive decisions going forward.  Every LinkedIn employee knows it just needs to increase the size of the core box by optimizing the 3 important elements – the rest will take care of itself.

This reminds me of a story – which could just be the stuff of start-up legend – of when Jeff Bezos first described his vision for Amazon.com.  He simply drew the following diagram on a napkin:

It seems to me he stayed true to his original vision and – $50 billion in market cap later – the company is still focused on those initial elements.

When that first idea pops in your head, it’s easy to be a wild-eyed optimist as an aspiring entrepreneur.  Of course you’re going to change the world – whether that be in search, education, or the music industry.

But what are the real odds that your idea becomes a complete success – that you get to be the next Chad Hurley with your own F-1 racing team?

The answer?  Not very good.

I culled these odds from informal conversations with a few VCs and think they are approximately accurate (but could be wrong).  Now the pathway from idea to a successful company may be a stretch so the 0.01% chance is too low (but it does make for a good headline).  However, even the odds of creating a company that reaches a market value of greater than $50 million after being funded by a venture capitalist is very low – approximately 5.3% (80/1,500).

With such a low expected value, why do so many entrepreneurs take the shot?

MBA’s sometimes get a bad rap in the start up world – and the negative perception may be worsening.

The debate has been raging the last two days after my friend Rafael penned a response to Charlie O’Donnell’s post about MBAs who want to work at start ups.  While his post had a bit of a negative tone, many of Charlie’s points held great advice and I think every MBA should read it.  A measured response was posted by Rob Go with some details as to how business schools should improve their programs to better prepare students to work at a start up (I especially agree with his comment on teaching sales).

Entrepreneurship – as defined by Howard Stevenson - is the pursuit of opportunity without regard for resources currently controlled.  Implictly, the entrepreneur needs a specific set of behavioral characteristics to be successful at this, the same characteristics VCs consistently say they look for in a founder and entrepreneurs look for in early hires: scrappy, resourceful, intuitive, adaptable, etc.  It only makes sense that when looking for a job at a start up, one needs to display these attributes in order to impress someone attempting to make something out of nothing.

Unfortunately, MBA programs are loaded with resources. Every top MBA program has a small army of ‘career services’ employees working to attract top-notch companies to campus to recruit and fill their ranks with students who just underwent a ‘transformational experience’.  In order to apply for one of these jobs, a student literally needs to just log in to an online database and click their mouse (at most) five times to submit a resume. If they get an interview, they traipse five minutes away to the career center and sit down with an interviewer.  The process is institutionalized, much like processes at large companies, and it is easy to utilize the resources.

Start ups are different, and the process for finding a job at them is as well.  Some may fail to realize this at first, but – lo and behold – they do figure it out. Much like figuring out what needs to be done to make payroll next week when cash is running low, the process for finding a start up job probably can’t be taught in a classroom.  Umair, in the comment section of Rafael’s post, said it best:

It’s important to remember that MBA programs are still schools in which people, surprisingly, are *learning*. As such, many students are still learning to make a transition from big corporate life to a start-up world. They are still going to be a bit rough around the edges when it comes to seeking start-up opportunities. Now that doesn’t mean that this group should be coddled, but it doesn’t make sense to write off MBAs as a whole based on this group.

While it seems unfair to bucket a whole group based on the actions of a few, it’s human nature to do so.  Those who are really dedicated will figure it out, the perception doesn’t matter.  So I guess my approach is to think: who cares?

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On a related note: Interestingly enough, the advice a few clever HBS entrepreneurial management professors give to students is two-fold: either start a company right out of school, or join a medium-sized, growing company and try your luck a few years later as you build skills, identify talent, and become an industry expert.  What’s not said is important.  They do not give the advice to join an early-stage start-up if you’re not starting it yourself.  Upside (at least financially) is limited and all the downside risk that comes with failure is present.  Just some fodder for thought.

On a semi-related note: I find it interesting that the term ‘start up’ has become synonymous with technology companies securing venture capital funding.  Every year there are upwards of a million new companies formed, but only 1,000 to 1,500 companies per year are backed by traditional venture capitalists. There are literally hundreds of thousands of entrepreneurs out there securing resources through other means, experimenting and trying to make things happen. I think there’s a lot to be learned by looking at some of these entrepreneurs – stay tuned for another post on this topic later.

I once sat in on a talk given by an entrepreneur who, in the early 2000s, dropped his steady (and extremely high) paycheck from an investment bank, moved to India, and opened up an outsourcing firm.  The highlight of the talk came when he described the bureaucratic hoops he needed to jump through to start the company in India, particularly given he was an American.

The amount of time it would have taken to receive the necessary regulatory approvals from the local government just to put a sign on the door would have left them far behind competitors and low on cash. His response was, in his own words, sheer “force of character.” He wouldn’t take ‘no’ for an answer and often found people surprised when he revealed his determination. They acquiesced and he was able to get accelerated approval.

I am coming to believe that force of character or will is the number one determinant of success in life and business.  In most cases, many businesses appear to succeed on acts of will alone, most of the time from (but not limited to) the founding entrepreneur.

And one can’t listen to this success story as told by Tony Robbins and not acknowledge the power of force of character.

Just getting a potential customer to your site is half the battle; the other half is getting them to stay.  If you’re lucky enough to get someone to sign up, you need to keep them engaged. Churn can be a pain to most young start ups.

I recently came across two clever ways to reel delinquent users back in.

First, Groupon – the hot collective buying coupon site – has a clever page meant to draw you back with a laugh before you make the final decision to unsubscribe from their email newsletter.

Unsubscribe from Groupon.

Second, Weebly – a simple web creation application – just sent me a simple email that reads like a mother wondering what happened to her derelict son.

While they both are clever – definitely got my attention -I wonder how effective they are at changing people’s decisions.  In the second instance, my delinquency on the site was because I lost interest and then actually forgot about it, which I suspect happens with many web sites.  I’m definitely going to go back and check it out again. Besides, the detail of how long ago I was there and what I did really makes me think they care (nice touch despite knowing its an automated system).

However, with Groupon, I have to imagine  someone going out of their way to unsubscribe hasn’t been happy with the service. A funny video likely won’t do much to change that.  But I could be wrong.

I finally got around to checking out some of the amazing content on iTunes U and came across a talk by Reid Hoffman, founder of LinkedIn and member of the PayPal mafia, addressing the general idea of entrepreneurship and providing a narrative of how he came to build LinkedIn (see link at the end of the post).

In the course of the talk, he made the assertion that there are three approaches to investing:

1. “Sure-bets”.  This is the style of investing that is attempted by hedge funds and other opportunistic (activists, PE, etc) investors.  The ability to generate a sure-thing profit is the goal, usually characterized by having some form of “edge” versus other investors whether that be in the form of access to resources, information, or analysis that others just simply do not have.
2. “Diversified, low-risk portfolios”.  A former Professor of mine divided the investing world into two camps: wolves and sheep.  The wolves were those out there who understood the workings of a security – be it a stock or a bond – and sought to take advantage of those who didn’t: the sheep.  However, one can be a sheep and still earn a nice return. The investor who knows what they can’t do (knows the limit of their circle of competence as Buffett would say), can just spread their bets through diversification or buying index tracking vehicles.
3. “Accurate contrarian theorists”.  This is an interesting term that I hadn’t heard before.  Reid posits that an entrepreneur (and therefore venture capitalists who back them) need to pick something others don’t think is viable, that is unique – in other words one needs to have a contrarian theory.  It helps if the theory is correct at first (lucky!), but accuracy can be honed through iteration on the idea as the entrepreneur finds product/market fit.  This is viewed as the highest risk, highest reward of the three.

I think of these three approaches as the only intelligent ways to earn return on investment.  Effectively, they encompass three strategies to systematically lower risk (whether perceived or real) while generating decent returns.

The idea of “accurate contrarian theorists” provides a helpful framework to think about the process, in my opinion.  Scientific theories are rarely correct at first.  They are tested against the mettle of peer review, re-analyzed, and re-theorized. The peer review system of the “market” can work in a similar way. The low probability of success leads one to conclude that getting the theory out there and shifting hypotheses as feedback comes in increases the chances of success greatly.

Additional note:  Reid also makes an interesting comment toward the beginning about how raising money from a top VC is not a sign of success although many act like it is.  I once asked the founder of a top East Coast, seed-stage VC firm the same thing and he scoffed saying, “nobody is that blind.”  I’m not so sure…

iTunes: Reid Hoffman at the Stanford Technology Ventures Program

As the healthcare reform debate rages on in DC, Massachusetts has suddenly been thrust into the spotlight with the special senate election on Tuesday becoming a deciding congressional vote on reform.  Unfortunately, I haven’t had a chance to closely follow the debate but I do know that the proposed legislation to offer universal healthcare is massive in scope and will shake the foundation of the current system.

To be honest, the legislation is probably so convoluted and confusing that nobody in the country knows exactly what the Frankenstein-like system will be like after implementation.

But it all got me thinking back to a class this past semester when a Professor performed a quick analysis of the incentives provided by the current healthcare system in the United States:

• During World War 2, the US government placed caps on wages for labor.  Companies subsequently competed for the best employees by offering health plans.
• The government instituted tax benefits – healthcare costs are deductible for companies, but NOT for individuals.
• Healthcare providers are paid per test or procedure.
• The government subsidizes sugar and corn (high fructose corn syrup).
• Insurance providers aren’t allowed to charge rates to those covered on any behavior besides smoking.
• Government proposes to mandate universal insurance coverage.
• Government will pay for universal insurance coverage with savings (which it doesn’t have) and increased taxes.

While a very generalized, 50,000-foot view of the subject, the exercise helped to put things into perspective. I get cheap sugar coupled with all-I-can-eat (no pun intended) healthcare provided by my employer.  I don’t smoke, so I (or my company) don’t have to pay any more than the other, similar-aged person.  Obesity, here I come!

Lay nine cards out on the table numbered one through nine face up.  Find a willing (or even better, unwilling) participant to play against.  Now alternating turns, attempt to pick up a single card in each turn with the intent to hold three cards that add up to 15.

It seems simple but invariably someone gets the numbers tangled up in their head as they think both offensively and defensively, leaving an opportunity for the opponent to win.

But is there an easier way to look at this?

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