I Have all the Problems I Want

Several years ago there was an entrepreneur that I’d meet with regularly. As is custom, I’d ask the standard meeting intro, “How are things going?” Now, with 99% of the people I talk to I get something along the lines of “Good. How are things with you?” Instead, with this entrepreneur, I’d always get the same answer, “I have all the problems I want.”

Hmm, “I have all the problems I want” is an unusual answer and I’ve never heard it from anyone else. At the time, I didn’t think much of it. Yet, here I am, years later, thinking about that answer to the most common of questions.

That answer prompts several questions:

  • What problems do I want?
  • What problems don’t I want?
  • Do I want a life with no problems?
  • What’s the value of having problems?

This makes me think the entrepreneur has a strong locus of control and works to manage his life around “good” problems and attempts to eliminate most “bad” problems.

From here, I go to a saying I heard last year:

Humans feel most alive when experiencing, creating, or problem solving.

That resonates with me. If most “bad” problems are removed, more flexible time is available and can be devoted to experiencing, creating, or problem solving.

Do you have all the problems you want?

6 Business Value Creation Questions in 10 Words

Lately, I’ve been thinking more about David Friedberg’s Rubric for Business Value Creation. I’m always searching for ideas that capture an important concept with broad applicability. After working on it a bit, I’ve distilled the six value creation questions into simpler phrasing and tweaked them slightly.

Six questions for business value creation in 10 words:

  1. Makable?
  2. Desirable?
  3. Customer profitable?
  4. Customer profitably acquirable?
  5. Investment scalable?
  6. Platformable?

Makable?

Can you actually make the product or service? Is it possible? Some categories are easier, like a mobile app, while other categories are significantly harder, like a solar panel with dramatically more efficiency.

Desirable?

Do people want what you’re offering? Is there authentic demand? Most new ideas suffer from a lack of demand — no one wants the product — ultimately resulting in failure.

Customer profitable?

Can you make a positive gross margin on each unit you sell? For software, this is easier, while other categories, like more complicated physical products, becomes much harder.

Customer profitably acquirable?

Can you make a positive gross margin on each unit you sell after adding in the sales and marketing costs to acquire the customer? Acquiring customers is often expensive, making it challenging to both produce the product and sell it with a positive gross margin.

Investment scalable?

Can you continue to invest in the business and earn a high ROI as the business grows by improving gross margins, economies of scale, etc.? Some businesses, like software, have high ROI from continued investment whereas others don’t see an improvement in their business.

Platformable?

Can you add more products and services to upsell and cross-sell customers thereby taking advantage of your scale and infrastructure? Also known as a multi-product strategy, the main idea is being able to scale beyond the initial product in a way that creates additional enterprise value.

Conclusion

Now, in 10 words, we have six questions for business value creation that are universally applicable and readily understandable. Use these ideas the next time you’re contemplating a new business or working with an entrepreneur on her business. Creating value is challenging, but not impossible. Good luck!

Entrepreneurs as Probabilistic Thinkers

Last week I was talking to an accomplished entrepreneur and I asked what trait he saw in another entrepreneur that made her successful. Without missing a beat, he said she was a probabilistic thinker. Hmm, that’s interesting. I hadn’t heard anyone use that characteristic when describing someone else.

Now, several days later, that idea is still resonating with me. Growing up in the traditional K-12 and higher education world, most things were black and white — grades, test scores, etc. Only, the real world is dramatically different. Perfect information isn’t a thing. Decisions are made using the best available information and outcomes are much more nuanced. Then, layer in entrepreneurship and the quantity of decisions that have to made with limited information goes up even higher.

A probabilistic thinker is someone who thinks through chance variations. What’s the likelihood A, B, or C happen? What can we do to change those probabilities? What decision do we make based on the probabilities? Whether they realize it or not, entrepreneurs are constantly assessing the chance variations and picking a path.

Layer in chance variations across so many facets of a startup like sales, marketing, product development, customer success, operations, and more, and the overall complexity is intimidating. Yet, an entrepreneur that’s a strong probabilistic thinker is making better decisions repeatedly that compound over time. Similar to the idea that if you’re 1% better per day, that equates to a 37x improvement over a year, better decision making on a daily basis results in remarkably better outcomes over longer periods of time.

The next time the topic of successful entrepreneur traits comes up, add probabilistic thinker to the list.

Search Funds Eyeing SaaS Startups

Lately, I’ve heard of new search funds eyeing Software-as-a-Service (SaaS) startups as their acquisition target. A search fund is typically an individual that’s raised a specific amount of capital with the sole purpose of acquiring and running a company. Think of it like a private equity firm with a solo partner that only buys one company and the partner becomes the CEO of the company. Search funds have been around for decades but ebb and flow in popularity.

From a search fund perspective, the target is usually a “good business” with the potential to grow into something significantly larger, often exiting in 7-10 years, just like a standard investment fund. In addition, they have a set of criteria of what they’re looking for in an acquisition:

  • Strong management team
  • Consistent growth and profitability
  • Recurring or re-occurring revenue
  • High gross margins or maintainable gross margins
  • Industry growth or opportunity to grow market share

Looking at this list of criteria, it becomes clear why search funds are eyeing SaaS startups. Save for the profitability component, many SaaS startups check all the boxes:

  • Consistent growth
  • Recurring revenue
  • High gross margins
  • Industry growth

While a strong management team is critical, it’s slightly less so in the search fund example where the search fund leader is going to be the CEO of the acquired company.

In addition, a huge number of SaaS startups have raised a large amount of money over the last few years, yet a meaningful percentage haven’t been able to grow into their valuations. The clock is ticking for these angel and VC-backed startups to find a home as ones that aren’t growing fast are having a harder time raising money. Search funds, much like private equity, are a perfect exit opportunity.

Look for search funds targeting SaaS startups as a growing trend.

7 Lessons from 15 Years of Angel Investing

Last week I was talking to a potential angel investor and he was asking a number of questions. My first comment to him was how it’s dramatically more difficult than it seems. Yes, it’s easy to write a check. No, it’s not easy to be good at it and/or make money at it. As with anything, there’s a tremendous amount of survivorship bias. People only talk about the winners and rarely talk about the losers. And, most investments don’t work out (the loser investment bucket overfloweth with non-existent startups).

Thinking more about it, here are seven lessons learned from 15 years of angel investing.

Every Deal Looks Great at Time of Investing

When an angel investment is doing well people like to ask, “What did you see in the opportunity?” Of course, it’s always a great team, TAM (total addressable market), and timing. Only, every consummated investment is believed to have those. When making an investment, it’s hard to tell which one is actually going to succeed.

Winners Take Time, Losers Lose Fast

One observation I didn’t expect is that winners cruise along with the usual ups and downs, but don’t die, and then eventually something clicks where growth takes off. For the ones that don’t work out, it’s obvious right away, usually within 3-6 months. They don’t close down that fast, rather they flounder and don’t show authentic signs of forward progress.

Find a Lead Angel Investor

Someone has to care and want to help the entrepreneurs. Today, it’s far too common to have a big party round with dozens of investors putting relatively small amounts of money in the round such that no one takes the lead. Signs of a lead investor include issuing a term sheet (not a SAFE/convertible note), joining the board, holding a weekly call with the entrepreneur, etc. Startups are messy and complicated, even more so for first-time founders. Someone needs to step up and pro-actively help the entrepreneur.

Ask Why You’re Getting a Look at this Deal

When a deal falls in the lap of a potential angel investor, the very first questions that should be asked is, “Why am I getting the chance to see this amazing investment opportunity?” Rarely is the answer the investor tells him or herself a good one. In reality, it’s likely been looked at by professional investors and people with relevant expertise such that they’ve passed on it. Go seek the professional investors and ask why they passed before writing your own check.

Think Investing in a Minimum of 20 Startups

An old startup adage that’s incorrect goes something like this: out of 10 investments, one makes a ton of money, 2-3 make some money, and most lose some or all the money. I don’t believe this is true. I actually think the odds are dramatically worse. At a minimum, if angel investing for a financial return, plan on 20+ investments and budget appropriately. Maybe, if all goes well, one out of the 20 will be a homerun and return 50x+ while most will not be successful. Investing in five or 10 startups isn’t enough. Plan accordingly.

Reserve 4x+ in Follow-On Capital for the Winners

When a startup does well it almost always raises more capital, and in today’s world, significantly more capital. As an angel investor, the best investment is always doubling down on the winners by investing more capital in subsequent rounds. Put another way, instead of planning on investing in 20+ startups, plan on investing in however many startups it takes to get a homerun, and once you have a homerun, stop investing in new ones and put everything you can into the winner. Startups are power laws where the winnings are so massive that they make up for all the losses. Plan for investing at least four times more than the original investment in the outliers.

Expect 10 Years to See a Return

After 15 years of angel investing I’ve invested in 50+ companies and it takes significantly longer than expected to see financial returns. Ones that are doing well readily show strong returns on paper, but converting those paper returns to cash returns is a different story. Plan for a minimum of seven years to see financial returns for the ones that do well and expect it to often take 10+ years. And, for the ones that are doing well, there’s a conundrum that you typically have the opportunity to sell early because there’s strong demand from new/existing investors, but know that even greater returns often accrue in the later years as the business is growing fast at scale.

Conclusion

Angel investing is a strange activity that’s equally fun and energizing while most likely not financially rational without a unique edge. As an investment strategy, it should be viewed as part giving back (charity work) and part paying it forward recognizing the success in life that afforded you the opportunity. Regardless, go into angel investing eyes wide open knowing that it’s much more challenging than it looks. Good luck!

Post Entrepreneurial Exit —Bias Towards Action

Over the last couple weeks I’ve had the opportunity to talk with multiple entrepreneurs that have had nice exits and are thinking about what’s next. After putting thousands of hours into a venture and going through so many low lows and high highs, it makes sense that an entrepreneur would be thoughtful about what’s next. Building a company is incredibly taxing, both mentally and physically. Now, with financial freedom, a good deal of urgency and ambition is often tempered.

When talking to these entrepreneurs, my main point always stays the same: don’t lose your bias towards actions.

Keep moving.

Keep pushing yourself.

Keep exploring.

Keep tinkering.

Many years ago, I was on the other side of the table after we sold Pardot. I was talking to a successful entrepreneur, seeking advice as to what to think about now that it was time for the next chapter in life. He said something that has always stuck with me, “Your skills will immediately start atrophying if you don’t stay in the game.”

Figure out what game you want to play next.

Join/buy an existing business?

Invest in startups?

Do board work?

Do nothing?

Most of the time, the entrepreneurs I talk with want to do something. Rarely do they want to jump in and grind out another startup from scratch. For me, I think of it like the parent vs grandparent analogy.

As a parent, you always have to be on. You have a deep responsibility that’ll likely last a lifetime, but often at least 18+ years. It’s an experience that’s immensely rewording and challenging at the same time.

As a grandparent, you don’t always have to be on. You care deeply but can come and go with no day-to-day responsibility. The highs aren’t as high and the lows aren’t as low, yet the joy is still there.

Entrepreneurs post exit would do well to maintain their bias towards action, figure out what game they want to play, and what level of responsibility they desire. While there’s no right answer, it’s important to be thoughtful and keep moving forward.

Equity Strategy for Late Co-Founders

Last week I was talking to an entrepreneur and he asked about equity compensation for late co-founders. Late co-founders are senior team members given the co-founder title after the company has already been started. Also called a junior co-founder, these people are key recruits early in the life of the business. Once a late co-founder has been engaged and is interested, inevitability the topic of compensation and equity comes up.

Here are some initial compensation questions to answer for a late co-founder:

  • What was their W-2 compensation (or equivalent) for the last two years?
  • What’s the cash component of the compensation in this new co-founder role?
  • What is the company worth now based on the last (or next financing round)?
  • What will the company be worth in three years (subjective!)?
  • What’s the equity target value multiplier for taking the risk (e.g. by joining as a co-founder, how much should the equity hopefully be worth in three years to take a pay cut)?

Now, let’s run through a hypothetical scenario:

  • Average W-2 compensation for the last two years of $150,000
  • Cash compensation as a co-founder of $100,000/year
  • Company valued at $5M in the last round
  • Plan to be valued at $50M in three years (10x increase from today)
  • 50x multiplier for each $1 of cash pay cut (e.g. make $1,000 less, get $50,000 in equity)
  • Formula: $50,000 pay cut times 50x multiplier = $2,500,000 of year three equity, which equals 5% of the company’s overall equity (assumes a $50M valuation)

Of course, this doesn’t take into account items like salary increases to get to market rate and other potential compensation enhancements. This also only looks out three years for the valuation — if everything goes well, the equity will appreciate even more dramatically in future years.

Equity for a late co-founder is always a subjective negotiation. This example provides a framework for thinking through different elements and coming up with a value based on a combination of pay cut and future company valuation.

I Don’t Know, But Let Me Get Back to You

Meeting with entrepreneurs is incredibly fun as there’s always something new to learn. Tell me about the team, the market, the product, and the raison d’être — plus 100 more questions that come up along the way. During this exploration process, inevitably there’s something the entrepreneur doesn’t know yet or hasn’t thought through.

While some entrepreneurs are more confident than others, it’s often apparent when the entrepreneur is just making something up or saying what he or she thinks you want to hear. Instead, the best answer is as follows:

I don’t know, but let me get back to you.

On the surface it seems so simple and obvious, yet few entrepreneurs do it. First, it shows a level of humility and honesty that’s not common. Entrepreneurs aren’t expected to know it all. With that said, entrepreneurs should be curious and have an innate desire to learn and grow. Second, it provides a next action giving the entrepreneur a chance to show how they follow through and execute on a commitment. Again, small on the surface but powerful in the context of potentially working together over a long period of time.

The next time you ask an entrepreneur a question where they don’t have the answer, listen to the response and see what they do with it. The type of response and potential follow through tells a great deal about the person.

More Capital Often Needed for Exit Opportunities

Years ago I was much more averse to startups raising capital. I believed, naively, that the best businesses grew at the natural rate of customer acquisition and needed that governor to scale elegantly and cohesively. With time, and more varied experiences, I’ve seen hypergrowth, fueled by substantial amounts of capital and customer demand, scale in a quality manner while maintaining a strong culture.

Now, knowing there’s more math around when it makes financial sense to raise capital, I’ve also come to believe that if you’re going to get on the fundraising train, it’s important to plan for enough capital to get to a scale that provides for some exit opportunities in the event the business doesn’t achieve hypergrowth. Translation: the business needs to get to $10M of annual recurring revenue growing 30% or more for potential acquirers, especially private equity, to get interested.

Over the years, I’ve talked to a number of entrepreneurs that raised some money, achieved single digit millions in recurring revenue, and stalled. The startup had enough gross margin to keep the lights on indefinitely, but didn’t have enough scale or growth to find a home that made everyone happy. Herein lies the land of zombie startups. Too big to die, too small to matter.

Often, the solution is to manufacture growth with more capital. While not always efficient, more capital allows the startup to get to more scale which provides more outcome options. Scale matters to potential acquirers much more than entrepreneurs realize.

The next time an entrepreneur is on the fundraising train, make sure they know that getting to scale is one of the most important things needed to have options, so raise a bit more money than needed, or plan for another round sooner than desired. More capital is often needed for exit opportunities, so plan accordingly.

7 Recent Entrepreneurial Books

As part of my personal rhythm, I read for 30 minutes daily on a physical Kindle Paperwhite next to my bed and keep my phone on the other side of the house. My approach is mostly that of snacking on books — reading a chapter here or there based on what’s resonating with me at that moment in time. I like to jump around different books and look for new ideas or concepts.

Here are some recent entrepreneurial books I’ve snacked on:

  • Amp It Up: Leading for Hypergrowth by Raising Expectations, Increasing Urgency, and Elevating Intensity
    Frank Slootman brings the heat sharing stories from his incredible career, with a focus on expecting more from the team
  • Endurance: Shackleton’s Incredible Voyage
    Alfred Lansing tells one of the all-time great stories of perseverance and resilience in the face of unimaginable difficulty.
  • Leadership and Self-Deception: Getting Out of the Box
    The Arbinger Institute’s classic managerial story about leadership being defined by who we are, not what we do.
  • Be Where Your Feet Are: Seven Principles to Keep You Present, Grounded, and Thriving
    Scott O’Neil shares a number of excellent life stories from the world of professional sports, family, business, and life in general.
  • The End of Jobs: Money, Meaning and Freedom Without the 9-to-5
    Taylor Pearson makes the case for entrepreneurship, entrepreneurship, and more entrepreneurship. The best future is to create your own.
  • Becoming Trader Joe: How I Did Business My Way and Still Beat the Big Guys
    Joe Coulombe shares his amazing journey creating Trader Joe’s from scratch and building what we know it for today.
  • The Innovation Stack: Building an Unbeatable Business One Crazy Idea at a Time
    Jim McKelvey, founder of Square, unpacks his theory of innovation and lessons learned along the way.

I’ve enjoyed this list of books and I’m always looking for new ones.

What should be added that you’ve read recently?