Launch: Silicon Valley 2008 is now accepting executive summaries. The deadline is May 9th. This conference is a very inexpensive way to get your startup in front of a highly-qualified audience of venture capitalists and journalists. It takes place on June 10th at the Microsoft campus in Mountain View, California. For more information, click here.
I hope you can join me at Envision’08 in San Antonio, Texas. The conference runs from April 23-25. Texas A&M's Center for New Ventures and Entrepreneurship created this conference for entrepreneurs. It features these keynote speakers: Stephen Covey, Peter Schutz, Ray Rothrock, Marcus Buckingham, and yours truly plus power-packed workshops. Click here to register. It's BBQ time since I didn't much at SXSW!
This is a video of the winner of Stanford's Entrepreneurship Week innovation tournament. The challenge for the tournament was to use an everyday object to create as much value as possible. The "RubberBandTogether" team's goal is to sell the ball and donate the proceeds to the Susan G. Komen Breast Cancer Foundation. Cost? $1/band or $3,056. To give these students a "liquidity event" by buying the ball, send an email.
Read a great little piece about placing ads "above the fold"—that is, before readers have to click or scroll. Most people believe that's the best place for ads. This article, called "Demystifying 'Above the Fold'" is important to read for its contrarian approach to this belief. It states that people are often so intent on reading content may not notice any ads above the fold. Better places to insert them are at "action points" like Comments or Links.
Entrepreneurship Week starts on Friday, February 22nd. The events are free and open to the "greater Stanford community" (which I would define as anyone who can get to the campus). Here is the agenda that features a bunch of great workshops and sessions. I can't imagine you could a better way to spend a few hours or days if you're an entrepreneur than attending this event.
My friend Anastasia Goodstein is running the Ypulse College Mashup conference for companies who are trying to reach the college-student market. The conference is running from January 31 to February 1 in Santa Monica, California. Speakers include: Jake Sasseville, host, The Edge With Jake Sasseville; Jessica Barron, director, Front Page Programming, Yahoo!; Chip Ross, director of PlayboyU.com, Playboy; Stephen Friedman, general manager, mtvU, MTV Networks; Ricky Van Veen, cofounder of CollegeHumor.com,; and Rafat Ali, editor and publisher, ContentNext Media. The keynote speakers include Dr. Jean Twenge, author of Generation Me, and Penelope Trunk, author of Brazen Careerist. Readers of my blog can enter "KAWASAKI" and receive a 15% discount when registering. If you want to learn how to reach college students, this conference is the one to attend.
This is a guest post by Scott Shane as a follow up to his entrepreneurship test. He is the A. Malachi Mixon Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of seven books, the latest of which is The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By
It takes a lot of money to finance a new business. Not true. The typical start-up only requires about $25,000 to get going. The successful entrepreneurs who don’t believe the myth design their businesses to work with little cash. They borrow instead of paying for things. They rent instead of buy. And they turn fixed costs into variable costs by, say, paying people commissions instead of salaries.
Venture capitalists are a good place to go for start-up money. Not unless you start a computer or biotech company. Computer hardware and software, semiconductors, communication, and biotechnology account for 81 percent of all venture capital dollars, and seventy-two percent of the companies that got VC money over the past fifteen or so years. VCs only fund about 3,000 companies per year and only about one quarter of those companies are in the seed or start-up stage. In fact, the odds that a start-up company will get VC money are about one in 4,000. That’s worse than the odds that you will die from a fall in the shower.
Most business angels are rich. If rich means being an accredited investor –a person with a net worth of more than $1 million or an annual income of $200,000 per year if single and $300,000 if married – then the answer is “no.” Almost three quarters of the people who provide capital to fund the start-ups of other people who are not friends, neighbors, co-workers, or family don’t meet SEC accreditation requirements. In fact, thirty-two percent have a household income of $40,000 per year or less and seventeen percent have a negative net worth.
Start-ups can’t be financed with debt. Actually, debt is more common than equity. According to the Federal Reserve’s Survey of Small Business Finances, fifty-three percent of the financing of companies that are two years old or younger comes from debt and only forty-seven percent comes from equity. So a lot of entrepreneurs out there are using debt rather than equity to fund their companies.
Banks don’t lend money to start-ups. This is another myth. Again, the Federal Reserve data shows that banks account for sixteen percent of all the financing provided to companies that are two years old or younger. While sixteen percent might not seem that high, it is three percent higher than the amount of money provided by the next highest source – trade creditors – and is higher than a bunch of other sources that everyone talks about going to: friends and family, business angels, venture capitalists, strategic investors, and government agencies.
Most entrepreneurs start businesses in attractive industries. Sadly, the opposite is true. Most entrepreneurs head right for the worst industries for start-ups. The correlation between the number of entrepreneurs starting businesses in an industry and the number of companies failing in the industry is 0.77. That means that most entrepreneurs are picking industries in which they are mostlikely to fail.
The growth of a start-up depends more on an entrepreneur’s talent than on the business he chooses. Sorry to deflate some egos here, but the industry you choose to start your company has a huge effect on the odds that it will grow. Over the past twenty years or so, about 4.2 percent of all start-ups in the computer and office equipment industry made the Inc 500 list of the fastest growing private companies in the U.S. 0.005 percent of start-ups in the hotel and motel industry and 0.007 percent of start-up eating and drinking establishments made the Inc. 500. That means the odds that you will make the Inc 500 are 840 times higher if you start a computer company than if you start a hotel or motel. There is nothing anyone has discovered about the effects of entrepreneurial talent that has a similar magnitude effect on the growth of new businesses.
Most entrepreneurs are successful financially. Sorry, this is another myth. Entrepreneurship creates a lot of wealth, but it is very unevenly distributed. The typical profit of an owner-managed business is $39,000 per year. Only the top ten percent of entrepreneurs earn more money than employees. And the typical entrepreneur earns less money than he otherwise would have earned working for someone else.
Many start-ups achieve the sales growth projections that equity investors are looking for. Not even close. Of the 590,000 or so new businesses with at least one employee founded in this country every year, data from the U.S. Census shows that less than 200 reach the $100 million in sales in six years that venture capitalists talk about looking for. About 500 firms reach the $50 million in sales that the sophisticated angels, like the ones at Tech Coast Angels and the Band of Angels talk about. In fact, only about 9,500 companies reach $5 million in sales in that amount of time.
Starting a business is easy. Actually it isn’t, and most people who begin the process of starting a company fail to get one up and running. Seven years after beginning the process of starting a business, only one-third of people have a new company with positive cash flow greater than the salary and expenses of the owner for more than three consecutive months.
A site's signup page is the second most important page on a site (the most important is the home page itself) because this is where you're asking for committment. Everyone worries about the home page (and still don't do a good job), but most companies do a poor job with the signup page. For example, HAMweather's is aesthetically-challenged, and Last.fm's doesn't convey enough information. This article about signup pages by Tim Bednar is a good read. His list of important signup-page elements is:
Logo
Elevator pitch
Descriptive copy
List of key features
List of key benefits
Call to action
Testimonials
Tours
Examples of users
Screen shots
Life-style images
Link to more information
However, you can clearly be successful without a great signup page.
Scott Shane of Case Western recently published The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By
I used to take an adult hockey class. Each session started with all of us facing the boards and skating backwards on the instructor’s whistle. We were all supposed to stop on a second whistle; then the instructor grouped students by how far they had skated in the limited time.
(This is a picture of Bret Hedican of the Carolina Hurricanes. Arguably, one of the best skaters in the NHL, Macintosh user, and heckuva nice guy.)
The instructor was trying to group people of similar skill levels for a more efficient learning environment. However, I made the case to him that by grouping people in this way, the folks in the slower groups (like me) learned that we sucked, and our heads got filled with negative thoughts. As a result, we performed worse than we (theoretically) could have for the rest of the class. Of course the instructor ignored my brilliant insight—after all, he’s from Minnesota and I’m from Hawaii.
Recently I read “The Choke Factor: How Stereotypes Affect Performance” which analyzes how stereotypes compromise performance—particularly of negatively stereotyped groups. For example if female students are told that women are stereotypically worse in math immediate before a math test, then they score lower in the test.
The theory is that by making a group aware of their stereotype, you can introduce “enhanced cognitive load.” Instrusive and negative thoughts cause a load that interrupts and harms performance. What do you think will happen when (not if) you are told that you don’t know how to run a company? Entrepreneurs—like wannabe hockey players and female math-test takers—should heed the scientific underpinnings of choking and the impact of negative stereotypes.
Here’s what you can do to avoid choking:
Avoid negative people. This refers to the folks who are likely to express the negative stereotype that first-time entrepreneurs don’t know what to do. (This doesn’t necessarily mean that you have to avoid venture capitalists because they never tell you what they really think.) Certainly you should avoid “proven” older entrepreneurs who don’t remember how clueless they were when they were “your age” and now consider themselves experts.
Ignore the people you cannot avoid. As George Orwell should have said, “Ignoring is bliss.” If you think about what they said, it could lead to what they said, so figuring out what to ignore is as important as what to listen to. The best way to ignore negative people is to bury yourself in your work—to prototype like hell. When I’m writing, nothing enters my brain but the need to eat and pee—and sometimes not even that.
Invoke positive stereotypes. Positivity can enhance performance according to the article—it’s “fighting fire with fire” as the saying goes. For example, entrepreneurs could invoke the positive stereotype that a couple of guys/gals who love technology and aren’t “proven” entrepreneurs can start companies like Apple, Yahoo!, Google, YouTube, and Facebook. Perhaps this is one reason that Silicon Valley rocks as a place for young people to start companies: the wunderkind stereotype is a very positive one here.
Frame, or reframe, yourself. Finally, you can control how strongly you identify with any social group. For example, you don’t have to identify with “first-time entrepreneurs.” You could more strongly define yourself in terms of being a mom, dad, wife, husband, scholar, programmer, marketer, or whatever works for you. Or, in my hockey experience, not as a lousy beginning skater, but a 53-year-old guy from Hawaii whose peers are mostly playing golf if they are exercising at all.
Addendum: Several readers have pointed out the work of Carol Dweck regarding how one’s mindset can affect performance. Duh, I wrote about her and linked to a video of her. And here is a Scientific American piece that she authored. (Thanks to Mitch and Luke Burton.)
Google announced the winner of the Adsense Story Contest today: Hometips. This is a site that features free content concerning home improvement, remodeling, repair, redecorating, and do-it-yourself projects. For example, here are tips for hanging Christmas lights.
According to the owner, Don Vandervort, the revenues generated by Google Adsense went from paying for coffee to paying for lunches to paying for all salaries, overhead, and business development. The site's traffic is moderate--something like one million visitors a month or less if you believe Compete. I love this kind of story:
The company started in a backyard clubhouse. Don converted the bottom floor of his sons' two-story treehouse. "Two-story" treehouse? How cool is that?
The site has a clear focus: content for homeowners. There's nothing that I can find that smacks of "Web 2.0 social media" at all. This is just so refreshing: All you can do is find information, you don't need to bond with any strangers.
Don added Adsense to his site by himself. He said it took twenty minutes. He probably didn't do any market research, focus groups, or 2x2 McKinsey-esque matrix analysis.
He probably didn't even raise a dime of venture capital. He probably didn't even try to raise venture capital. He probably didn't even boot PowerPoint. He certainly didn't present at Demo or TechCrunch40.
Yes sir, there's a lot to like about Don's story: do what you love, focus on a niche, find a viable business model, and work for yourself.
Stanford Magazine has a terrific article about Kiva called “Small Change, Big Payoff” by Cynthia Haven. This is the story of how Matt and Jessica Jackely Flannery created it to enable people to make micro loans to entrepreneurs around the world.
The results are awesome: more than 123,000 people have loaned more than $12.4 million to 18,000 entrepreneurs. In fact, there so many lenders that there’s are individual limits so that everyone can make a loan. The process involves reading a short profile about each entrepreneur and then deciding which to fund. From beginning to end, you can make a loan in under five minutes if you’re a slow typist. Lenders do not earn interest though the micro-finance organizations that helped Kiva find the entrepreneur does. Entrepreneurs pay 99.67 percent of the loans.
Here are some lessons that any entrepreneur can learn from the Kiva phenomenon:
Create meaningful partnerships. Most entrepreneurs create partnerships to impress investors, journalists, customers, and parents. Hence, most partnership as bull shiitake. The best test of a partnership is whether its existence requires that you change numbers in a spreadsheet. No changes = b.s. partnership. In the case of Kiva, it has sixty seven partnerships with micro-finance organizations. It is these organizations that provide the “leads” for lenders to fund.
Also, Kiva has partnerships with PayPal (free transactions), Google (free traffic) as well as with Yahoo!, Micorosft, MySpace, and YouTube. As you can imagine, these kinds of partnerships do make you reboot Excel.
Catalyze and support evangelism. Like Apple, Harley-Davidson, and Tivo, evangelism starts with a great product, and Kiva has one. When you have a great product, then evangelists will appear, and Kiva has 250 active volunteers—what I would label “evangelists.” Kiva has really institutionalized evangelism if you ask me.
Find a business model. You’d be surprised how many people wave their hands or avoid the topic of business model completely. Kiva’s model is a minimum $2.50 voluntary fee that lenders pay when checking out their “shopping cart.” If I understand this right: lenders receive no interest and pay a voluntary fee to Kiva in order to loan money. And you thought Google had a great business model—wow, as Wayne and Garth said, “We’re not worthy.”
“Bank” on unproven people. What would the ideal background be of the founder of Kiva? Investment banker from Goldman, Sachs? Vice president of the World Bank? Vice president of the Peace Corp? Vice president of the Rockefeller Foundation? Partner at McKinsey? How about temporary administrative assistant at the Stanford Business School? Because that’s how Jessica started her quest. The spark that lit the fire was a speech by Muhammed Yunus, founder of the Grameen Bank and Nobel Peace Prize winner.
Focus on free marketing. Kiva launched in 2005 with seven businesses in Uganda. The first “marketing” was sending out an email to the wedding invitation list of Jessica and Matt. All seven businesses were funded in a weekend. Then the Daily Kos picked up their story from a hacked together press release. Then PBS’s Frontline covered the organization and loan volume went from $3,000 to $30,000 over night. No road show. No Demo. No TechCrunch 40.
Ignore the naysayers. The Flannerys got a lot of advice that you can’t send money around the Internet without government approval; that Kiva couldn’t scale beyond a few African villages; that a non-profit couldn’t offer an investment product; and that it would violate SEC regulations as well as the Patriot Act. Besides this, Kiva was a no-brainer. :-)
Yup, there’s a lot any entrepreneur can learn from the Kiva story. More importantly, why don’t you go to its web site and make a loan? You could co-invest with me in Chhorn Yan, mother of six in Cambodia, who needs capital to expand her home-based, offline grocery store. One way to look at this is we could fund one Webvan or 800,000 Chhorn Yans.
TechCrunch published a great guest post by Glenn Kelman, the CEO of Redfin, called “Entrepreneur 2.0.” It inspired me to piggyback on his idea that investing in “serial entrepeneurs” who have already been successful might not be all that it’s cracked up to be and write this post.
Both our posts run counter to the theory that many entrepreneurs, wealthy from their previous smashing success but restless and too young to die (or become venture capitalists, which is roughly the same thing) are the best bets for the next big thing.
Superficially, it’s hard to fault this ”back the proven entrepreneur“ theory. For one thing, from a venture capitalist’s point of view, if you fund a serial entrepreneur and she succeeds, you “knew” that she was proven. If she fails, at least you backed someone for a good reason—that is, she was proven—so your limited partners shouldn’t get too bent out of shape.
That’s a lot better than backing a first-time entrepreneur who fails—then you are just stupid. (Also, if you back a first-time entrepeneur, and she’s successful, you take the credit: “It’s because of my hands-on coaching and guidance.”) But, just as Glenn wrote, if you think about it, great, world-changing companies such as Hewlett-Packard, Apple, eBay, Microsoft, Google, Yahoo!, and YouTube were zero for three according to the official venture-capitalist spec sheet: Proven team, proven technology, and proven business model.
Hence, I would like to declare my support for Glenn’s perspective and help him make the case that second-time entrepreneurs are not necessarily the be-alls and end-alls.
Serial entrepreneurs try to prove that their first success wasn’t a fluke. Rather than starting from the basis of technology (“isn’t this cool?”) or customers (“there must be a better way”), the reason for existence is “I’m going to prove that I’m talented.” This is a bull shiitake reason for starting company compared to solving people’s problems or changing the world.
Serial entrepreneurs cannot distinguish between causation and correlation. The root cause of earlier success may have simply been blind, dumb luck, but few people realize this and even fewer will admit. Thus, they have the hollow arrogance of people who just got lucky instead of people who have been truly tested, and arrogance is a bad thing in entrepreneurs.
Serial entrepreneurs are likely to use the same methods again. How can you fault them for using the same methods that made the successful the first time? For example, if they built a high-end computer the first time, they build a high-end computer the NeXt time. If they used dealers the first time, they use dealers the second time. If they gave everything away to get eyeballs and sold the company to a bigger, dumber, richer company, they try try that “business model again.”
Serial entrepreneurs don’t (or can’t) work as hard. When you have a 5,000 square foot house, a second house in Montana, a car made by a company whose name ends in “i,” a spouse, and kids, attitudes change. Indeed, attitudes should change or people never grow up. However, it’s one thing to work to survive and another to work for fulfillment. They can say they’re just as hungry this time, but the point is that no one had to ask if they were hungry the first time.
Serial entrepreneurs don’t get smacked around enough. Life is good as a serial entrepreneur: they walk in, tell people that their last company was sold for a bazillion dollars, and now they’re starting another one, and it’s a privilege and honor to invest. Who’s going to poke holes in their strategy when Sequioia, Kleiner Perkins, et al are issuing term sheets and ever lesser venture capitalist is sucking up? No one. And that’s too bad because they won’t get anyone checking their sanity.
Serial entrepreneurs fill new, unfamiliar roles in their next companies. For example, in the first company the person was an engineer who became the vice-president of engineering who became the CTO. Just because you were good at writing designing chips doesn’t mean you’re CEO material in your next fabulous fabless chip company. As Glenn says in his post, “This means that what I used to be really good at — designing software — I don’t do as much of anymore, and what I never had to learn how to do — manage people – I now do all the time.”
Serial entrepreneurs hire their buddies who were with them the first time. Thus, the entire founding team suffers from all the problems listed above. People who don’t know what they don’t know are few and far between, but a startup needs this kind of people to push the boundaries of what’s possible in what ways. Ignorance is not only bliss; it’s also empowering.
I once heard Mike Moritz of Sequoia explain what kind of entrepreneurs he wanted to invest in. I’m paraphrasing: “Guys under thirty who are building a product that they themselves want to use.” Amen, baby! I vote for two guys or gals in a garage who are an unproven team, unproven technology, and unproven market.
All hail Carleen Hawn because she has written a fabulously funny analysis of the management style of (Fake) Steve Jobs. It’s called the “Ten Commandments of Fake Steve Jobs”
Never let people know where they stand.
You don’t have to hire the best people.
Only promote stupid people.
Never tell people what is expected of them.
A manager should be inconsistent and unpredictable.
No praise. Ever.
Keep people’s spirits broken.
Throw tantrums.
Don’t speak to employees in elevators.
Start with the ad campaign.
I haven’t provided all the text that goes with each commandment so that you have to click through and read the whole posting in all its glory. Trust me, it’s worth it.
Here’s the place to get video clips from my interview with Dan Lyons, aka “Fake Steve Jobs.” This is one of the funniest interviews I’ve ever done—if I do say so myself. There are a boatload of inside jokes going on, though. If you need joke support, just post a comment.
I found this interview of Mohammad Yunus of Grameen Bank. His idea to provide “micro loans” to poor people to jumpstart their entrepreneurship truly is changing the world. In fact, Yunus won the 2006 Nobel Peace Prize for his work.
Here are some key quotes from the interview:
“Women have a long-term vision, she wants to move up to something”
“It’s not Grameen Bank came and told them to do that; it is in their hearts”
“We developed a system which doesn’t need collateral, guarantee, legal”
“We citizens, we individuals, are capable people addressing social issues”
The interview is a must-read for anyone who wants to change the world—via a profit or not-for-profit company.
After posting "Financial Models for Underachievers: Two Years of the Real Numbers of a Startup" about the two years of actual costs of Redfin, many people asked for a generic version of the financial model that Redfin used to project costs. Here it is! Redfin used this model over the past two years, but beyond the costs already disclosed, the numbers are all fictitious. Also, unlike last week, the values aren’t actual data-points but formulas and formats that calculate them.
Glenn’s point isn’t to make a statement one way or the other about Redfin’s business or to even give you a crystal ball for seeing whether you’ll succeed. A model, after all, doesn’t drive demand or serve customers; it only helps you count up the beans if you do. We’re posting this model because its basic structure might help other entrepreneurs who don’t know where to start.
Here’s what you’ll find in the model:
Earnings, capital expenses and cash balance summarized on a single page.
Ratios of revenue and profits to employees and program expenses.
Assumptions called out so investors can easily evaluate dependencies.
Assumption-driven formulas, so changes to the assumptions propagate through financial statements.
Unit economics isolated on a separate page: for Redfin, this is how much profit each real estate market can generate.
Charts of headcount growth, cash balance, earnings segmentation, revenue segmentation.
Hiring detail with headcount and salary sums for each department.
The model also contains a few Redfin-built, custom Excel functions:
Counting the number of employees in a department, by counting the number of times a department value like “Engineering” appears in a column.
Summing the salaries of employees in a department, by adding up salaries for each employee where the department value for that employee equals a value like “Engineering.”
Calculating how a Redfin market grows in revenue-capacity to reach maturity, and then grows more slowly thereafter.
Calculating the number of support personnel needed to accommodate demand, and when those support personnel start. This allows us to update the staffing projection automatically when we change demand assumptions.
To get the custom functions to accommodate changes in the assumptions, you will have to set Excel’s macro security to “Low” (Tools | Macro | Security | Low). The file does not contain any malicious macros.
Fred Greguras is a partner at the Silicon Valley law firm of Fenwick and West. He is also a buddy of mine, and I asked him to answer the most common questions of newbie entrepreneurs. His clients have included BioMarker Pharmaceuticals, Excite, Kintana, and Speedera Networks. It’s very important to make the right decisions in these areas at the start of a company, so I hope you’ll heed his answers.
Question: Can I start a technology company in the same business as my current employer?
Answer: Working completely outside of an employer’s premises and not using an employer’s trade secrets or other resources may not be enough to avoid a taint on your technology and intellectual property (“IP”) for the new business. Investors will examine the creation of IP very carefully in such a situation as they don’t want to buy into a law suit. While California law favors employee mobility it also protects employers in Labor Code Section 2870 which is part of most employee invention assignment and confidentiality agreements you sign before you begin employment with a company.
Basically, 2870 states that an employee owns an invention that he/she developed entirely on his or her own time without using the employer’s equipment, supplies, facilities, or trade secret information except for those inventions that either relate at the time of conception or reduction to practice of the invention to the employer’s business, or actual or demonstrably anticipated research or development of the employer; or result from any work performed by the employee for the employer.
The taint to the new business can come from the founder who is trying to continue work with his/her current employer while trying to create technology and IP for a new business or from a consultant who is “moonlighting” from a business in the same space. Some business sectors such as EDA software are notorious for litigation against departed employees who try to start a new business in the same space.
Question: When should I incorporate?
Answer: The first step in starting a business is to test the business concept with prospective customers and to look carefully at potential market size to see if there really is a business opportunity. Timing of incorporation will be driven by the need to document the founders’ ownership of the business, to secure ownership of pre-existing intellectual property, to enter into contracts with customers, to grant stock options and to accept investment. You usually don’t want to delay incorporating until just before a Series A financing round because such timing could cause tax problems for founders who want to buy their shares at a nominal price as compared to the valuation of the corporation at the time of the financing.
Question: Why don’t I use a Limited Liability Company (“LLC”) since it is cheaper to start?
Answer: An LLC is often used for consulting and smaller businesses, but not often for an operating business that will seek venture capital. You can decide whether to be taxed as a corporation or partnership when your business organization is an LLC. Losses and gains of the business flow through to the shareholders individual 1040 tax return when taxed as a partnership. Venture capitalists won’t invest in an LLC, you can’t grant stock options to employees and other service providers in an LLC, and an LLC can’t be acquired tax-free in a stock acquisition exit.
Question: Why does everyone incorporate in Delaware?
Answer: I still see some entrepreneurs use California corporations because they want to keep their costs as low as possible. Delaware incorporation advantages are venture capitalist preference, ease of dealing with regulatory authorities, flexibility in the law (such as the number of board members) and more helpful precedent on corporate law. Disadvantages are the corporation being taxed by and subject to two states regulatory requirements.
You can’t avoid California taxes if the corporation is operating in California. California advantages are lower cost and being subject to only one state’s regulatory requirements, if the corporation is operating here. One major disadvantage of using California is the difficulty of dealing with regulatory authorities on corporate filings in a financing or other situation when articles of incorporation need to be amended. If a business has been incorporated in California, the VCs will often want it to be reincorporated in Delaware as part of a round of financing.
Question: Should we incorporate as an S corp or C corp?
Answer: “S corp” and “C corp” are tax statuses rather than a type of corporation you would form in California or Delaware. An S corporation is taxed like a partnership. Gains and losses flow through to the shareholders so it can provide tax advantages if, for example, there is a long product development period with significant expenses that would flow through to individual tax returns.
There are restrictions on the number (100) and types of shareholders in an S corp. Shareholders must be U.S. citizens or residents and natural persons not entities. Also, while you can make a decision at the end of a calendar year to switch to a C corp, you can’t decide to turn S corp status off when ever you want to do so. A preferred stock financing will terminate S corp status because an S corp may not have more than one class of shares outstanding.
Question: Should I incorporate offshore since my business will focus on China/India?
Answer: This decision is driven by the likely exit strategy and the type of investors most interested in your business. Exit alternatives such as an IPO on the Indian or Hong Kong stock exchanges are not possible if you are a U.S. corporation. Some global investors will invest only in an offshore corporation such as a Cayman Islands exempted company while some domestic U.S. venture capitalists will still only invest in a U.S. corporation.
You can reincorporate from one state to another, i.e., California to Delaware, on a tax-free basis but you can’t reincorporate outside the U.S. without tax consequences. Reincorporation offshore almost always will cause the corporation to remain subject to U.S. taxes under Internal Revenue Code Section 7874. If you initially incorporate offshore you can reincorporate into the U.S. on a tax free basis so if in doubt, start offshore at the outset.
Question: Can I have everyone in my startup be contractors or consultants (“1099 services”) rather than employees?
Answer: Many startups label and engage service providers as consultants rather than employees prior to a round of financing to try to avoid employer obligations such as income tax withholding and unemployment taxes. This status depends on facts, however, not a label in an agreement. The basic test is the degree of control over the individual.
If he/she is tightly supervised and on the company’s premises during regular working hours, the individual is really an employee. It is very hard for a startup to properly structure a contractor relationship in a startup because of the way the company must operate. For example, many times the company provides a “contractor” with business cards identifying them in an employee position such as “VP, Sales” which is not the right thing to do legally but is what the company believes it needs to do to be successful.
Question: How can I grant stock options to employees and consultants?
Answer: Your start-up should adopt a stock option plan at the time of incorporation that satisfies federal and state tax and securities laws requirements. In California, the plan is often referred to as a “25102(0) plan” based on the California Corporations Code provision. Adopting such a plan will enable the corporation to grant tax favorable options (“incentive stock options”) and avoid securities law violations because the plan will have a securities law exemption under state and federal law. If the plan is not created in accordance with securities laws, granting an option to an employee or other service provider requires the individual to qualify for the same type of securities law exemption as for an investor (“accredited investor”).
Question: How does the corporation obtain ownership of the technology and IP from each of the founders which was developed before we incorporated?
Answer: Founders will usually assign ownership of technology and IP as payment for their shares of common stock of the corporation. This is documented in their founders stock purchase agreement. Investors will almost always want technology and IP to be a transfer of ownership rather than a license in which the founders “hedge” on their commitment to the new business. Ownership provides more value to the business than a mere license. Ownership of technology and IP created after the corporation is established occurs through invention assignment agreement or consulting agreements.
Question: Can I hire people away from my former employer?
Answer: Your employee invention assignment agreement with your former employer will likely have a restriction on soliciting employees, usually for a period of 12 months. The restriction usually doesn’t cover non-solicited hiring of your former employer’s employees but proving who solicited whom may be difficult. Even if the non-solicitation period has expired, you still need to be careful to make sure the new hire does not use trade secrets of your former employer while working for you.
Question: Can I file a provisional patent application myself?
Answer: You can but you need to be very careful to describe the invention and the best mode of practice as required by patent law. A patent attorney may be needed to help draft “claims language” because of increasing litigation over whether a provisional application covered these elements. The provisional patent application must contain a written description of the invention, and “of the manner and process of making and using it, in such full, clear, concise, and exact terms as to enable any person skilled in the art to which it pertains, or which it is most nearly connected, to make and use the same.”
Question: If we have been issued a patent, won’t that stop a Microsoft from copying us?
Answer: You cannot enforce a patent until and if it is issued and the costs to enforce a patent can be staggering – literally millions of dollars. Whether someone is infringing your patent usually isn’t a 1 or 0 case. The other party may claim it is not infringing your patent or that your patent is invalid, for example, because it is based on a defective provisional application. There may be good arguments on both sides that require a court to make a decision after a lengthy and expensive trial.
Question: Shouldn’t prospective investors sign non-disclosure agreements (NDAs) so that they don’t rip off our ideas?
Answer: Venture capitalists won’t sign NDAs before hearing your pitch because they see so many companies that may be in the same business segment and overlap in what they are doing. NDAs with investors patent counsel are usually feasible later during IP due diligence for a financing when, for example, investors counsel needs to review an unpublished patent application. I recommend “peeling the onion” in making disclosures to investors and others whenever feasible. This means disclosing only as much as you need to for the purpose of the meeting. This isn’t helpful in many businesses such as Internet where what you are doing may be obvious.
Question: If my buddies and I own more than 50% of the corporation, don’t we control it?
Answer: You may if it is prior to a VC financing and you also control the Board of Directors of the corporation. Both the board of directors and shareholders have a right to approve key decisions of the corporation. Board decisions are made on the basis of one person, one vote rather than on a percentage of ownership so you need to be careful with the size and composition of the board. The preferred stock holders in a VC financing will have what are called protective provisions which give them “veto rights” over key decisions like a new round of financing or selling the corporation without regard for their percentage of ownership of the corporation.
Question: Why should founders vest—we’ve already been working on the business for two years?
Answer: Vesting among founders avoids the “free rider” problem, where a founder gets shares and then leaves the corporation and the other founders continue to make contributions. I recommend vesting schedules whenever there is more than one founder to try to make sure all founders continue to contribute. While the investors may renegotiate vesting schedules for founders at the time of a financing, providing some upfront vesting is appropriate when founders have been working on the business for a while. The balance is between maintaining the “stickiness” of the founder and recognizing prior contributions. I usually tell founders to err on the side of more stickiness.
Question: Why does it cost $50,000 or more to do a round of financing?
Answer: The corporation receiving investment pays the legal fees of both its legal counsel and the investors counsel. The total tends to be higher than $50,000 in most Series A financings because of the number and complexity of the financing documents and the rate structures of the large law firms that tend to represent both sides in these deals.
You can manage these costs to a certain extent by having a clear and complete financing term sheet that covers all key points. The business people on each side should address the “tough” issues (such as founders vesting and option pool size) at the term sheet stage and make decisions on such issues rather than have lawyers argue over business issues which increases legal fees. A vague term sheet may avoid confrontation for the moment but it is likely to cause larger legal fees.
My buddy at Redfin, Glenn Kelman, decided he wanted to bare his financial soul so that other entrepreneurs could get greater insight into the witchcraft called financial modeling. In this two-part posting, he reveals his numbers and his lessons. They are eye-opening for most entrepreneurs.
Part I: Numbers
Startups face one primary challenge: To never run out of cash. So when projecting costs, we heeded Guy’s advice that “the three most powerful words you can utter at a board meeting are, ‘We beat projections.’” This convinced us to develop the worst possible financial model that could still be used to raise money.
We’re glad we did. True underachievers, we’ve performed at or just a bit better than this worst-possible plan almost every month, raising revenue projections only when forced to in December 2006. We’ve been able to stick to our plan mostly because absurd assumptions in opposite directions cancelled one another out. As the real estate market tanks, we may not be so lucky in the future.
When first putting together our financial model, we looked online to calibrate spending assumptions. So many people have blown venture capital, we thought, there must be a manual somewhere on how to do it, at what rate, avoiding which follies. We couldn’t find anything. So we took some wild guesses and figured we’d see how they turned out. And now two years later to the day that we built our first model, here are the projections and actual results. Hopefully, you can learn from our experiences.
Rent, Per Employee, Per Month
Redfin Model: $250. Actual Redfin Cost (Last Month): $336
Our actual costs are high because we just moved last month into an office with room to grow, which seems to happen every eighteen months. When people were sitting in hallways at the old space, we were paying about $200 per employee, per month. Class B space on well-traveled mass transit lines is roughly $20 per square foot per year in Seattle, $30 in the Bay Area. You need 165-200 square feet per person or more.
At the extremes, Adobe supposedly allocates 435 square feet per person while Yahoo! allocates 220 square feet per person. The startup cult of cramming people into small spaces is counter-productive: people are what’s really expensive, not space. The cost Redfin really didn’t anticipate was for tenant improvements which you mostly have to fund yourself when signing sub-three-year leases. In September, we spent more than $100,000 to add private offices for our engineers on the hope that our current office will last us longer. It was probably too much money.
Initial Per-Employee Equipment Cost
Redfin Model: $6,500. Actual Redfin Cost: $5,700
Computers, 20” monitors, Ikea desk, decent chair, VOIP telephone, and cell phones for field employees. Our first phone system came from Craigslist, and we had to upgrade after a year.
Monthly Benefits, Per-Employee
Redfin Model: $600. Actual Redfin Cost: $471
Redfin benefits are competitive, but many employees are Seattle-based. Costs are 10% higher in California.
Annual Payroll Tax
Redfin Model: 12.5%. Actual Cost: 8.5%
We added 4% here to our plan, just to pad per-employee costs. In ways you can’t anticipate, people cost money. Payroll taxes are the same nationwide. California’s state payroll tax is, for example, negligible.
Quarterly Bonus Payout, as a % of the Total Possible
Redfin Model: 85%. Actual Cost: ~85%
We pay quarterly bonuses, mostly based on customer satisfaction objectives. Maintaining discipline on bonus payouts has been difficult. When business booms, everyone wants to be paid for it, even if you haven’t yet turned a profit.
Annual Payroll Increase for Existing Employees
Redfin Model: 6%. Actual Cost: ——-
We can’t disclose actual costs here, but they were higher than planned. When we set the plan, many employees were being paid below-market rates, which is not uncommon for startups; as a startup raises more capital and people go into their second year of sucking it up, you have to pay the piper at the employees’ annual review.
Percentage of Candidates for Which Redfin Paid a Recruiting Fee
Redfin Model: 35%. Actual Percentage: 20%
If you can’t build an engineering team through your own network, recruiting fees can become a significant expense at an early stage. Most of the folks Redfin paid a recruiting fee to hire still came through our own employees who got a $2,000 bonus for every recruit they bring on board.
I assumed colleagues would encourage friends to apply to Redfin without a fee, but for $2,000, people start nagging their cousin’s friend’s wife to apply. We saw an immediate increase in candidates. The occasional party, done on the cheap with kegs and pizza, has also worked well for us.
For Employees Recruited for a Fee, the Recruiting Fee as Percentage of Annual Salary
Redfin Model: 20%. Actual Cost: 4.5%
Because we want top-of-the-stack candidates, we do pay 20% to professional headhunters, but most recruits only required a $2,000 employee referral bonus. We’ve also experimented with in-house recruiters working on an hourly wage, but they tend to focus on managing the hiring process rather than adding candidates to the pipeline.
What really wrecks the budget is a retained search for executives ($30,000 - $50,000), a cost we didn’t even include in our calculations above. A retained search as an agreement to work exclusively with one search firm is reasonable, but we recommend negotiating aggressively to defer most payment until placement.
Incremental Amount Paid to Contractors, as Percentage of Payroll
Redfin Model: 5%. Actual Redfin Costs: 3%
Our contractors have mostly been an in-house recruiter, a graphic designer, and a web programmer; no big-shot consultants.
Monthly Travel Costs, Per Field Employee
Redfin Model: $300. Actual Redfin Costs: $369
The $369 includes mileage for field agents who drive clients to listings as well as travel between our San Francisco and Seattle engineering offices. Your costs may be lower. Or not: on the road, some of us still stay with friends.
Monthly Telephone Costs per Field Employee
Redfin Model: $125. Actual Redfin Costs: $261
We’ve started equipping real estate agents with cellular modems, so costs are unusually high here, too.
Monthly Legal Costs
Redfin Model: $12,500. Actual Redfin Costs: $9,406
The $9,406 per month excludes legal costs for a round of financing, usually about $50,000 for company counsel and investors’ counsel (more late stage, less early stage). We have saved money by dividing the monthly work between a more-expensive tech-focused firm (Orrick, very good) for board resolutions, minutes and stock administration and a general corporate practice (Lasher, also quite good) for employment and real estate law.
We also handle on our own most of the repetitive paperwork like option grants and, perhaps unwisely, vendor contracts. We don’t spend much on patents. Incidentally, we pay a service $14,000 per year to set a quarterly price for our stock options. This is a cost that we didn’t anticipate and didn’t project as part of our legal costs.
Annual Accounting Costs
Redfin Model: $45,000. Actual Redfin Costs: $32,912
Once you’ve raised money, your investors will want a year-end audit of financial statements. This can be done for less money when the business is small and if you keep your books in good order, but we commissioned our first audit only after Redfin had generated over $1 million in revenues. Your accounting expenses will also be a bit higher (and your payroll significantly lower) if you can hire a book-keeper to come in twice a month to pay your bills, which makes sense for the first year or two until you need someone permanent.
All-Company Meeting Cost, Per-Meeting, Per-Employee
Redfin Model: $350. Actual Redfin Cost: $560
Almost half of Redfin works outside of Seattle, so our meeting costs are unusually high. But we can't avoid meeting at least once a year, which is a significant expense that we forgot to plan for in our original model.
There are of course all sorts of other costs that are unique to our business as an online real estate broker: how much we spend to attract a home-buyer to our site, for example, or what it costs to sell a listing. What you see here are just the costs common to every startup.
And now, looking this over, I worry at every turn that we've spent too much money. When I first worked at a venture-backed company, someone told me that Sequoia liked to see entrepreneurs "dive in the toilet for nickels." I'm not even sure that's true, but it was an image that always stayed with me. At the time it was actually comforting. I couldn't do anything else right but, thinking about the toilet and the nickels, I said to myself, "This, I can do."
Part II: Lessons
Here are a few other tips for building a financial model:
Focus on headcount. Outside of marketing programs, the basis for all cost in Internet software is headcount. Just figure out whom you'll hire and how much you'll pay and you can't go far wrong.
Plan slow, run fast. The most likely scenario is that you won't be able to hire engineers fast enough, and that revenues will come more slowly too. Investors expect their money to drive artificially accelerated growth rates, but signing up for that sometimes just blows a company up before you've had a chance to figure everything out. At least in the financial model, give yourself as much time to grow as you can.
Run top-down sanity-checks. To estimate what a company is likely to spend each year, try doubling the average salary and multiplying it by the number of employees. A 100-person company might spend as much as $15 million per year.
Forget economies of scale. The biggest whopper is that a business will magically become more efficient as it grows. If you really believe this, just walk into the headquarters of Amazon or eBay. Bureaucracies grow. Salaries float away. Straining to make a model work, I always forget that per-employee costs rise every year.
Admit that revenues are a mystery. If you don't have any revenues yet, you can't say what they'll be. The point of a model is to prove you can make money if people buy your product, not to insist that they will. By developing different scenarios based on different levels of demand, you can later calibrate hiring and spending according to which scenario fits reality best.
Build from building blocks. Nearly every model is the sum of smaller units. In Redfin's case, our unit is a market like the San Diego real estate market, which we plan to grow to a certain size in a certain number of months, hopefully returning a certain amount of profit to the overall business. We can then gauge whether the model works by just looking at whether San Diego works, and then asking, "Now what if we had twenty San Diegos?" For another company, it may be a user-created website, with so many page-views and so many ads, or it may be the productivity of a single salesperson, with a million dollars in quota per year.
Take out "hope." Think about what is most likely to happen, so that a bookie would say you're as likely to out-perform the plan as under-perform it. Generally speaking, "hope" is not a strategy.
Flag your assumptions. Rather than burying your assumptions in Excel formulae, call them out in a separate tab of the workbook, so that you have a control panel for adjusting the model. This is especially important if you plan to share your model with potential investors.
Hit $100 million in revenues within five years. The premise of most venture investments is the possibility of generating ten-fold returns in five to seven years, which is hard to do if you spend $5 million to build a $25 million company.
Keep market-share under 20%. Most startups reach a jillion in projected revenues by assuming that the business grows by leaps and bounds for five years. Since there's a natural limit on growth, be ready for the question: "What would your market-share be in year five?" If it's over 20%, take the jillion-dollar projection down a notch. Even a hit like iPod doesn't have 20% market-share. You'll be lucky to come close to 20% of any market.
So these are our costs, and that's our advice. What's your take? We'd love to see how our costs compare to other startups'; please leave a comment and let us know where your numbers differ from ours, especially in markets outside the U.S. We could also post a sanitized version of our financial model, if enough people ask for it to make it worth the trouble.
(Thanks to Redfin's Chris Roske, Chris Neitzert, Matt Goyer and Angela Cough for their help with the numbers in this post.)
David Bornstein is the author of
How to Change the World: Social Entrepreneurs and the Power of New Ideas.
He recently updated this book, and it’s now available for the first time in paperback. No less than Nelson Mandela said the book is “wonderfully hopeful and enlightening.” David is also the author of The Price of a Dream: The Story of the Grameen Bank, which chronicles the worldwide growth of the anti-poverty strategy “micro-credit.” The Price of a Dream, which drew on ten months of research in villages in Bangladesh, won second prize in the Harry Chapin Media Awards, was a finalist for the Helen Bernstein New York Public Library Book Award for Excellence in Journalism, and was selected by the San Francisco Chronicle as one of the best business books of 1996.
Bornstein’s articles have appeared in The Atlantic Monthly, The New York Times, New York Newsday, Il Mundo (Italy), Defis Sud (Belgium) and other publications. He co-wrote the two-hour PBS documentary series “To Our Credit,” which focuses on “micro-credit” programs in five countries. Bornstein received a Bachelor of Commerce degree from McGill University in Montreal and a Masters of Arts from New York University.
Question: Are there fundamental differences between a social and for-profit founders?
Answer: Depends what you mean by fundamental. In terms of temperament, skills, drive, the way they ask questions and think about problems—social and business founders are very much the same creatures. Increasingly we see more and more social founders who are using a business format to achieve their objectives. So a social founder doesn’t have to run a nonprofit, and in the future you will see a lot more for-profit social entrepreneurship as well as a lot of blending of legal formats.
The difference is really in terms of what the founder seeks to maximize. What is the primary motivation behind building your organization—whatever form it takes? Are you trying to develop drugs for diseases that afflict large numbers of poor people in the developing world as Victoria Hale is doing with One World Health or are you trying to dominate the world market for sneakers or fashionable jockey shorts? For-profit entrepreneurs build all kinds of things. Social entrepreneurs are primarily motivated by an ethical imperative. They seek to respond to urgent needs. The question of why is paramount.
Question: Are there fundamental differences in the people who go to work for a social versus not-for-profit startup?
Answer: The big difference is that the folks who go work for a start up focusing on creating a social change are less motivated to make a lot of money since that usually isn’t the “upside.” If you are phenomenally successful, you don’t get rich—you change the world. That difference must somehow relate to the hierarchy of values that govern that person’s decisions—and what they feel they “need” to accomplish to be happy and feel good about themselves or, alternatively, whose esteem and admiration they are seeking.
Answer: It is very tough since it is all apples and oranges and plums. In business you can compare the financial performance of companies whether they sell coffee or cars. How do you compare the success of an organization that helps disabled people to live more independent and dignified lives with an organization that provides after school enrichment to low-income children? There is no single yardstick that is comparable to revenues or profits in business, but within “sub-industries”—say college access or health care access or environmental advocacy—there are clearly some organizations that achieve more impact per dollar spent than other organizations.
It isn’t as simple as putting the data on a spreadsheet and doing a calculation. But by combining some well-thought-through metrics or proxies, which relate to impact with other forms of non-numeric evidence or analysis, it is possible to make reasoned, reliable judgments about which organizations are doing the best work and which ones should, accordingly, have greater access at a lower cost to growth capital.
In the end, it’s really not that different from what many investors and rating agencies do intuitively in business. Investors look at many intangibles—the team, the enthusiasm, the quality of the problem solving, the drive, the goodwill, the potential for growth—when they make decisions. You can do the same with social entrepreneurs.
Answer: By offering people employment opportunities that align with their talents, interests, and values. By inspiring them with a vision of changing the world, of being part of something bigger than themselves. We have to think about an assumption behind this question—namely the notion that people seek to maximize how much money they make. Certainly, we all care about making money. But choices that people make every day—becoming teachers, having children, giving money to charity—indicate that we are complex creatures motivated by many different things.
We are also at an interesting point in America’s history. With all our wealth and freedom of choice, we seem to be obsessed with finding happiness. Everyday it seems another book is published focusing on how we can make ourselves happy. Most Americans today are phenomenally wealthy compared to their grandparents, yet many studies show we are no happier, and we actually may be less so. At the very top of the list of things that make people feel happy and fulfilled are doing work that you find challenging and deeply meaningful with colleagues whom you respect and care for. Social entrepreneurship offers this.
Question: Is this why many prominent business people move into social entrepreneurship?
Answer: Business people are moving into social entrepreneurship for the same reasons that so many other people across society are moving into this field: They see new opportunities to solve problems in creative ways; as individuals, they have far more power to understand and address problems at scale than in the past; they see enormous needs to solve problems that aren’t being addressed by traditional institutions, whether businesses, governments or nonprofits; they have lived through what may be described as the “failure of success”—the extraordinary accumulation of wealth and possessions over the past fifty years that has left people feeling dissatisfied and often empty.
When Bill Gates announced that he would be stepping down from Microsoft to run his foundation, he made it clear that he was not retiring, but rather “reordering” his priorities. Why? It was through his research trips in the developing world that he came face to face with people suffering and dying—and he couldn’t shake it. He saw that he could be more valuable to the world helping to develop AIDS or malaria vaccines, or expanding access to health care systems, than helping to create more software tools, as valuable as those tools may be. Lots of people are coming to similar conclusions. It is like a global awakening.
Question: People celebrate when a corporate mogul ditches the big bucks and goes to work for a not-for-profit, but has the opposite occurred too?
Answer: What we’re seeing today is much more interflow between business and social entrepreneurship. It’s increasingly common to find people who have been working on social or enviromental issues for many years who discover a business opportunity that will augment their impact.
The surge of entrepreneurship in CleanTech is a perfect example. It’s driven by many people who cut their teeth working in the environmental field who see business as a powerful engine to achieve their environmental goals. In the health arena, we are beginning to see more health professionals or people from public health careers starting businesses that are aimed at solving problems well suited to a business model. More and more people are growing sector agnostic; they are seeking impact and looking for the best tools to do the job. This trend looks likely to continue.
Question: What makes some people take action and others to just cogitate?
Answer: It’s hard to say. Why do people who are procrastinating for months suddenly kick in gear and get their taxes done on April 14? At a certain point the pain of not acting—getting hit with a penalty—overtakes the pain of actually doing your taxes. The same may apply to other aspects of life. There is emotional pain associated with inaction, especially if we care about something. So to the degree that we help people gain more and more exposures to problems in ways that make it more difficult to emotionally accept those problems, we will see more action.
On the other hand, there is the upside of action—the anticipated pleasure and satisfaction. So, to take the tax example again, if you know you’re in for a big refund, you may be motivated to get your taxes done in January—so you can collect as soon as possible. The upside of taking action—the pleasure of collaboration, the feeling of satisfaction and thrill of making a change happen, the joy in giving—are all potentially great motivators. But often we forget to talk about these aspect of change.
The bottom line is that we focus on the “doing good” aspects, on the sacrifice, and ethical components, but we often forget to mention how wonderful it feels to take meaningful action in line with your core beliefs. Finally people often delay because they just don’t know where to go, what to do, or how to take the first step. So there is a big need for tools that help people find their place in the field of social entrepreneurship and social innovation. That is actually the subject of the current book I am working on.
Question: What are the things that keep potential social entrepreneurs from succeeding to fulfilling their potential?
Answer: The major blockages are lack of rationally allocated growth funding that would allow people to build world class institutions. Most of our major businesses are able to raise hundreds of millions of dollars in capital markets—through debt or by issuing stock. But social entrepreneurs, who typically run nonprofit organizations, usually have to raise considerable grant funding from foundations, which usually comes in small, short term installments. Because the funding is so fragmented, social entrepreneurs end up spending 80% of their time fundraising, rather than spending 80% of their time focusing on running their organizations.
This is a huge bottleneck. Social entrepreneurs who run “social enterprises” have a similar problem—which is the difficulty in finding patient growth capital targeted at businesses that seek to maximize social, environmental and economic returns at once. A corollary of this problem is the difficulty in recruiting and retaining highly talented people. Another blockage are the lack of two-way bridges between social entrepreneurs and both business entrepreneurs and governments.
Question: Then what could government or society do to encourage more social entrepreneurship?
Answer: There are many levels at which social entrepreneurship can and should be encouraged. At its essence, the goal is to help build a society in which many, many people have the confidence, skill and desire to solve problems they see around them. The most important qualities in social entrepreneurship are empathy, the ability to collaborate well with others and the stubborn belief that it’s possible to make a difference—which motivates and stimulates people to act.
There are many ways to improve the education system so that young people have experiences that build these qualities, and give them a sense of agency, a sense of their own power connected to an ethical framework. I would argue that this should be one of the fundamental goals of education. Once a child has had this experience, that child will never go back to being a passive actor in society. She will always be asking the question—Why don’t we fix this problem?—and causing waves of creative destruction wherever she goes.
We could build into the curriculum of every school and college such experiences. We could use our powerful media to make the field of social entrepreneurship more visible. At more advanced levels, social entrepreneurs need a variety of financial and structural supports—new laws, less fragmented and more rational capital markets and stronger bridges with governments, business and academia. Lots of work for anyone who has some creativity and likes to be a positive deviant.
Question: Who is the “Steve Jobs” of social entrepreneurship?
Answer: The most famous social entrepreneur would be Muhammad Yunus, the founder of the Grameen Bank. Like Jobs, Yunus took a product—“credit”—that was once an exclusive item (like the early PCs) and brought it to a mass audience. In so doing, his bank helped to democratize access to capital in a way that is similar to the way that Apple Computer democratized access to information. The effect is similar: more choice and self-determination in the hands of more people globally.
Question: Is the entrepreneur in the middle of Africa who gets a micro-loan and supports his or her family much different from Bill Gates or Steve Jobs?
Answer: Yes and no. In terms of vision and aspiration, the Bill Gates and Steve Jobs of the world are pretty rare. Forget about Africa, there are many people born into the heart of privilege, with the best education, broad exposures, lots of confidence, and they don’t become entrepreneurs. It’s just not what draws them. Entrepreneurs are most excited by making their visions real. Other people derive their greatest satisfaction from different things—interpersonal relations, perhaps, or teaching or healing or making beautiful music.
There is not much difference between leading business entrepreneurs like Bill Gates and Steve Jobs, and leading social entrepreneurs like Jim Grant, Muhammad Yunus, Fazle Abed, or Bill Drayton. But clearly not everyone has the temperament and desire to be a for-profit entrepreneur—thank goodness!
There are also entrepreneurs at many different levels. Some people build small organizations, some build medium ones, some build large ones. The difference is what’s most important to them in life, how big they allow themselves to dream and where they come to rest along the way. Without a doubt, millions of micro-entrepreneurs in Africa and Bangladesh and all around the developing world have massive pools of untapped and underutilized potential.
Given the right structural supports and exposures, including capital, many of them would go on to build very successful companies or social organizations; a subset of them would go on to build world-class firms, just like in the United States. But, lest we overemphasize the role of entrepreneurs, it’s important to realize that they are only one ingredient in the change process.
Entrepreneurs are successful only to the degree that they can bring together other people with different talents and abilities who can, as a team, build things they could never do apart. Entrepreneurs are hubs or magnets: organizing forces. It takes many hands working together to produce any significant change.
I blew it. Two weeks ago I was supposed to offer discount tickets to Jeffrey Pfeffer’s Stanford talk called “What Were They Thinking?: Unconventional Wisdom About Management.” It’s on Wednesday, Sept. 12th. Here’s the link to the discount. Sorry that this is so last minute.
This is a guest posting by Glenn Kelman, CEO of Redfin, a company that enables people to buy homes online. He offers a counterpoint to my posting about how easy it is to make millions of dollars with "user-generated, long-tail, Web 2.0, social-networking, open-source content."
Last month, Guy called James Hong and Markus Frind heroes for running multi-million dollar websites like Hot or Not and Plenty of Fish in their underwear. Their stats are jaw-dropping: twelve billion page views, 380 hits per second, two hours of work a day.
Lately I've been thinking how hard, not how easy, it is to build a new company. Hard has gone out of fashion. Like college students bragging about how they barely studied, start-ups today take care to project a sense of ease. Wherever I’ve worked, we’ve secretly felt just the opposite. We’re assailed by doubts, mortified by our own shortcomings, surrounded by freaks, testy over silly details. Trying to be like James or Markus has only been counterproductive.
And now, having been through a few startups, I’m not even sure I’d want it to be that easy. Working two hours a day on my own wasn’t my goal when I came to Silicon Valley. Does anybody remember the old video of Steve Jobs launching the Mac? He had tears in his eyes. And even though Jobs is Jobs and I am nobody, I knew how he felt. I'd had the same reaction--absurdly--to portal software and more recently to a Redfin, a fledgling real estate website.
“The megalomaniac pleasure of creation,” the psychoanalyst Edmund Berger wrote, “produces a type of elation which cannot be compared with that experienced by other mortals.” Jobs wasn’t just crying from simple happiness but from all the tinkering, kvetching, nitpicking, wholesale reworking, and spasms of self-loathing that go into a beautiful product. It was all being paid back in a rush.
Like the souls in Dostoevsky who are admitted to heaven because they never thought themselves worthy of it, successful entrepreneurs can’t be convinced that any other startup has their troubles, because they constantly compare the triumphant launch parties and revisionist histories of successful companies to their own daily struggles. Just so you know you’re not alone, here’s a top-ten list of the ways a startup can feel deeply screwed up without really being that screwed up at all.
True believers go nuts at the slightest provocation. The best people at a start-up care too much. They stay up late writing Jerry Maguire memos, eavesdropping on support calls, snapping at bureaucracy, citing Joel Spolsky on Aerons, and Paul Graham on cubes. They are your heart and bones, so you have to give them what they need, which is a lot. The only way to get them on your side is to put them in charge.
Big projects attract good people. If you aren’t doing something worthwhile, you can’t get anyone worthwhile to work on it. I often think about what Ezra Pound once said of his epic poem, that "if it's a failure, it's a failure worth all the successes of its age.” We’re not writing poetry, but it matters to us that we’re trying to compete with real estate agents rather than just running their ads. You need a big mission to recruit people who care about what you’re doing.
Start-ups are freak-catchers. You have to be fundamentally unhappy with the way things are to leave Microsoft, and yet unrealistic enough to believe the world can change to join a start-up. This is a volatile combination which can result in group mood swings and a somewhat motley crew. Thus, don’t worry if your start-up seems to have more than its fair share of oddballs.
Good code takes time. One great engineer can do more than ten mediocre ones especially when starting a project. But great engineers still need time: whenever we’ve thought our talent, sprinkled with the fairy dust of some new engineering paradigm, would free us from having to schedule time for design and testing, we’ve paid for it. To make something elegant takes time, and the cult of speed sometimes works against that. "Make haste slowly."
Everybody has to re-build. The short-cuts you have to take and the problems you couldn’t anticipate when building version 1.0 of your product always mean you’ll have to rebuild some of it in version 2.0 or 3.0. Don’t get discouraged or short-sighted. Just rebuild it. This is just how things work.
Fearless leaders are often terrified. The CEO of the most promising start-up I know of recently used Hikkup to anonymously ask his Facebook friends if we thought his idea was any good. Just because you're worried doesn't mean you have a bad idea; the best ideas are often the ones that scare you the most. And for sure don't believe the after-the-fact statements from entrepreneurs about how they "knew" what to do.
It'll always be hard work. Most start-ups find an interesting problem to solve, then just keep working on it. At a recent awards ceremony, Microsoft CEO Steve Ballmer tried to think of the secret to Microsoft’s success and could only come up with “hard, hard, hard, hard, hard, work.” This is an obvious cliche, but most entrepreneurs remain fixated on the Eureka! moment. If you don't believe you have any reliable competitive advantage, you're the kind of insecure person who will work your competition into the ground, so keep working.
It isn't going to get better--it already is. In the early days, start-ups focus on how great it’s going to be when they succeed; but the moment they do, they start talking about how great it was before they did. Whenever I get this way, I remember the Venerable Bede’s complaint that his eighth century contemporaries had lost the fervor of seventh century monks. Even in the darkest of the Dark Ages, people were nostalgic for...the Dark Ages. Start-ups are like medieval monasteries: always convinced that paradise is just ahead or that things only recently got worse. If you can begin to enjoy the process of building a start-up rather than the outcome, you'll be a better leader.
Truth is our only currency. At lunch last week, an engineer said the only thing he remembered from his interview was our saying the most likely outcome for Redfin--or any startup--was bankruptcy, but that he should join us anyway. It’s odd but the more we've tried to warn people about the risks, the more they seem to ignore them. And since you have to keep taking risks, you have to keep telling people about them. You don't want to be like Saddam Hussein, who never prepared his generals for invasion because he couldn’t admit he didn't have nuclear weapons.
Competition starts at $100 million. A Sequoia partner once told me that competition only starts when you hit $100 million in revenues. Maybe that number is lower now. But if you do something worthwhile, someone else will do it too. Since you can’t see what’s going on behind a competitor’s pretty website, it’s natural to assume that all the challenges we just went over only apply to your company. They don’t, so keep the faith.
I work in the surreal world of Silicon Valley where venture capitalists fund companies based on PowerPoint pitches and executive summaries. My friend Tim Berry rightfully pointed that business plans still serve an important role in "the rest of the world." He's right, and he should know because he's the president of Palo Alto Software, the principal creator of Business Plan Pro, and the author of a blog called Planning, Startups, Stories. He was recently named the US Association of Small Business & Entrepreneurship (USASBE) Corporate Entrepreneur of the Year for 2007.
Question: Who even reads business plans anymore?
Answer: How about “Who should read a business plan”? It’s not about whether venture capitalists read plans, it’s about planning to make your business better. So here’s who should read a plan:
First, you the owner, manager, author of the plan--and you’d better be the owner of the plan too—not some consultant. The plan is by you and for you and if tracking it, reviewing it, managing and executing it aren’t important to you, then you don’t understood planning. Planning isn’t about the document; it’s about controlling your destiny, running your business better, setting goals and tracking progress, and keeping your eyes on the horizon while not tripping over potholes in front of you. If you’re not going to read it regularly, then don’t ask anybody else to.
Second, team members, boards of directors, and collaborators. A business plan is a way to coordinate, communicate, and collaborate with accountability and tracking. It should get all the key people on the same page. Nobody can execute a plan they don’t know about.
Third, relevant outsiders. Banks, investors, boards of advisors, key consultants, and even occasionally—but only with caution—vendors or prospective new high-level employees.
Question: What’s the most important qualities of a plan?
Answer: First, a plan should set priorities with the understanding that you can’t do everything. After all the buzzwords and analysis, strategy is focus. What can you do better than anyone else? What’s your core competence?
Second, specifics. What’s going to happen, when, how much it’s going to cost, and who’s responsible for it.
Third, cash flow. Growth spurts in a company are good things, meaning more sales, and presumably more profits, but unplanned growth can suddenly sucks up liquidity and in the worst cases kill the company. Growth without prior planning can be as fun a hard kick in the stomach.
Here’s a story to illustrate the concept growth versus cash flow: Willamette River runs through Eugene where I live. Mo