Crash Dev

Money, Power + the Culture of Innovation

2012-05-22T16:49:00.000-07:00

The concept of acquired situational narcissism has been in my head since 2001, when the New York Times Magazine included it in their annual "Year In Ideas" issue.

The phrase describes the lack of empathy -- and resulting self-serving behavior -- that the rich and powerful tend towards when they mistakenly interpret their own success as evidence of their innate superiority, and not just a happy confluence of of birth, luck, environment, hard work and timing.

Living in Seattle, I (thankfully) don't cross paths with many investment bankers, heads of state or Hollywood celebrities, and the per-capita incidence of the condition is probably lower here than in LA, DC or New York.

But as our culture increasingly looks to technology for its heroes (think Mark Zuckerberg or Steve Jobs) this pathology is starting to seep into in the nominally egalitarian world of software innovation.

This change is already visible in the national discussion -- tech founder stories that used to be told with a light-hearted "revenge of the nerds" angle now have a darker tone, lamenting the billion-dollar valuations ascribed to "trivial" companies like Facebook, Twitter and Instagram, and claiming that the current easy-money culture of Silicon Valley signals the death of innovation.

Unsurprisingly, the attacks are most often launched from the East Coast, long the center of American money and power.

The New Yorker recently waded into this bi-coastal culture battle with Ken Auletta's piece on Stanford's abrupt withdrawal from the New York Tech Campus project, ominously titled "Get Rich U. : There are no walls between Stanford and Silicon Valley. Should there be?"

The tone of the article veered wildly, beginning with a celebration of Stanford's remarkable success as the intellectual heart of Silicon Valley, then shifting to a vague but unmistakably critical profile of Stanford President John Hennessy and his handling of the negotiation with Mayor Bloomberg's office over the project.

One particular pair of quotes from the article jumped out at me:

"Mayor Bloomberg, in a speech at M.I.T., in November, had said of two of the applicants, 'Stanford is desperate to do it. Cornell is desperate to do it. . . . We can go back and try to renegotiate with each' university. Out of the blue, Hennessy says, the city introduced the new demands.

To Hennessy, these demands illustrated a shocking difference between the cultures of Silicon Valley and of the city. 'I’ve cut billion-dollar deals in the Valley with a handshake,' Hennessy says. 'It was a very different approach'—and, he says, the city was acting 'not exactly like a partner.'"

Taken together, Bloomberg's and Hennessy's comments cut to the heart of the massive cultural gap between the dominant values of the technology innovation community and those of traditional industries like financial services:

The "heroic" cultural action in the software innovation community is creating, making something from nothing, growing the pie, and giving everyone who helps a slice of the gains. In this mode, negotiations tend to be friendly, focused on achieving mutual gain and equitable outcomes.

By contrast, the "heroic" action in financial services (or politics, for that matter) is winning, "being on the right side of the trade". The pie is finite, the game is effectively zero sum, and each players' share of the gains tend to come at the expense of the other players.

Facebook's IPO this week offered an even starker example of this dichotomy, with commenters from the trading economy lamenting the "failure" of the offering, while those from the "maker" side celebrated the lack of trading gains delivered to Wall Street on the back of the maker's efforts.

The roots of this cultural difference aren't easy to pin down, but both the New Yorker article and a thoughtful recent book-length analysis (The Rainforest: The Secret to Building the Next Silicon Valley) see its historical antecedents in the egalitarian, cross-cultural and community-centric values of Western pioneer culture.

But whatever its origins, the collaborative and gains-sharing ethos of the innovation community acts as critically important grease on the wheels of the system, reducing legal and deal-making overhead and fostering trust and agility among players at every layer.

From where I sit, it's not hard to read the current cultural moment as a long-cycle power shift from East to West -- from traders to makers. This is probably bad news for Wall Street, but good news for the long-term economic competitiveness of the U.S. as the driver of global technology innovation.

The single greatest risk to this this future isn't technological, but cultural -- allowing the short-term focus on wealth creation and extraction to erode the bedrock values of collaborative invention.

Steve Blank summed this up nicely with his recent (and widely-republished) article, "Why Facebook is Killing Silicon Valley":

"[W]hat’s great for making tons of money may not be the same as what’s great for innovation or for our country"

Acquired situational narcissism is the cultural cancer -- fed by wealth and power -- that kills empathy and celebrates extraction over creation.

The current frothy climate in Silicon Valley is tilting the table towards extraction once again, but I believe the culture of innovation is stronger than the culture of extraction -- and that even as the battle rages in Silicon Valley, maker culture is spreading too far and fast for the forces of extraction to catch it.

Unwritten Rules

2012-05-14T10:31:00.000-07:00

Last week I had several different conversation with entrepreneurs who are on the verge of setting up operations for their new startup. The topics we covered included:

Should I self-fund / bootstrap or raise angel money?
Should I accept an EIR / incubation offer from a VC firm?
Should I keep looking for a technical co-founder or outsource early development?
How much of my founder's equity should I expect to share with co-founders and early hires?
What would being accepted at a top-tier accelerator do for me that I can't do myself?

There are no "right" answers to any of these questions. Hugely successful businesses have been built at all points on the spectrum, and -- since companies are fundamentally a reflection of their founders' values -- the most important question is "what feels right to you?"

But founders also need to be aware that their answers to these (and other) questions have huge significance to prospective investors. I know I have a "right" answer to each of these, some of which I''ll outline below. That doesn't mean that I'll never invest in a company that chooses the "wrong" path, but it's a significant hurdle for me to overcome in making a decision to invest.

I'm not the only investor who rules investments in or out based on early choices made by startup founders.

I've hugely enjoyed Blake Masters notes from Peter Thiel's CS183 lectures at Stanford -- if you haven't read them I can't recommend them more highly -- and the notes for Class 6: Thiel's Law cover this topic well.

A few examples of Peter Thiel's investment heuristics (from that same lecture) are:

Founders should be full-time / all-in
Never hire consultants or contractors for important work
No startup CEO should ever make more than $150K a year
Every startup should be a Delaware C-corp

Again, many successful businesses have been built that violate some or all of these rules, but in Peter Thiel's estimation, every decision you make that runs counter to this framework is a signal that your thinking and his are at odds. If you want his money, that should matter to you.

I'm sure there are skilled investors who disagree with Peter Thiel, but you can be sure that every investor has a set of heuristics and biases that she uses to filter investment opportunities, even if she's not entirely aware of or explicit about them.

If you're out looking for capital for your startup, you need to be aware of these biases and make decisions that are congruent with the kind of capital you hope to raise.

If you want to raise money from Founders Co-op, here are some of our biases that you should be aware of before you come in to pitch:

We're "maker-centric" -- we're heavily biased toward founding teams that are more engineers + designers than businesspeople, with a track record of building beautiful, useful software both within and outside their day jobs.

We're wary of solo founders -- the atomic founding team is at least two people, ideally a hacker and a hustler. Both can be devs, and three or more is OK, but one is a worrying number.

We don't believe winning products get built by outsourcing / offshoring -- makers who listen to customers and improve at lightning speed will always beat spec-driven development, and all the selling in the world can't fix a shit product.

We like founders with huge dreams + the skills to back them up -- building any company is brutally hard work, so pick a fight worth winning and build the best team you can -- investors included -- to play in the big game.
We view attending a tier-one accelerator as a no-brainer based on signaling value alone -- even before you get to the mentorship, the alumni network or the investor intros, being selected by Y Combinator or TechStars is such a powerful positive signal to the market that you'd be crazy not to take it, especially in a world of near-perfect competition for software ideas.

These aren't rules, they're biases -- we always reserve the right to break them if we find something else about the deal to love -- but they're a hurdle to jump over. And there are plenty of other things we take into consideration when we're evaluating a company for investment.

But for founders with an interest in raising money -- never forget that *everything* you do has signal in it for investors. In the investing world the default answer is always "no", so try not to make choice that will get you a "no" before you've even opened your mouth.

Don't be a grinder

2012-05-09T22:51:00.000-07:00

Lots of chatter lately about how Seattle investors aren't stepping up to back promising local entrepreneurs, which in turn is driving the best + most ambitious teams to decamp for Silicon Valley (e.g., GeekWire on Tony Wright's departure, or Trevor Gilbert's PandoDaily piece on local funding weakness).

This is a big and complex topic that I won't attempt to unwind in a single post, but I had a couple of different exchanges with local investors and entrepreneurs just today that drove home just how real and how damaging this problem is.

Here's a quick rant on just one of the many issues in play here:

The behavior that triggered my frustration today is what I call "grinding" -- when an early-stage investor spends little to no time on team and opportunity, but centers the conversation around price.

Don't get me wrong -- purchase price has a direct bearing on expected return, and is a very real consideration in any deal. I've passed on plenty of opportunities because I felt the price was out of whack with the returns profile of the investment (and the current Bay Area fashion of uncapped notes or double-digit caps for "companies" that barely exist strikes me as absolute lunacy from an investor perspective).

But all too often an investor conversation that pivots around price instead of the intrinsic merits of the opportunity leads quickly to the next ask, the "special" price this investor believes they should receive because they're... umm... special.

This is what I call "grinding", and it's one of the most short-sighted and damaging behaviors an investor can engage in if they want to build trust with entrepreneurs -- and help those entrepreneurs maximize long-term value for founders and investors alike.

When good entrepreneurs ask for money, they aren't *just* asking for money. They're inviting you into their extended family and asking you to join them on a long and difficult journey into the future.

Your investment will be highly illiquid, so you'll be stuck with them -- and they with you -- for as long as it takes to succeed or fail. Every investor that comes along for that ride is now a partner in the business -- for better and for worse.

Entrepreneurs are at their most vulnerable when they need money, and "grinding" -- taking advantage of that vulnerability to try to eke out a little more return for yourself -- is the worst kind of relationship-poisoning, short-sighted behavior you can engage in -- if you believe that the really big gains in enterprise value are still ahead of you (and if you don't believe that, why the fuck are you investing at all?!).

I know, because I have been guilty of this myself.

I am still learning how to be a good investor, and when I started this journey I was under the mistaken impression that money mattered more than talent, and that the terms under which I invested were a private matter between me and the entrepreneur.

Both of those assumptions turned out to be badly, dangerously wrong.

When I approached an investment with a "grinder" mentality, one of two bad things happened: either I lost the deal and permanently damaged my relationship with a quality entrepreneur, or I won the deal and entered into a long-term relationship with an underperforming team and company, with strained relations between myself, the other investors and the company founders -- all based on a lack of trust.

So grinders have not one but two different ways to fail. They lose in both cases, but at least in the first one they don't also saddle good founders with bad investors.

I still have a ton to learn as an investor, but I'm trying hard not to keep on making the same mistakes. At this point, the only optimizing behavior that makes sense to me in early-stage investing is around two things:

Team -- are these the most talented, relentless, creative and ambitious people I've ever come across?

Opportunity -- is this team's vision so valuable and so exciting that if they pull it off it will be a massive win for everyone involved?

If the answer to both questions is yes then price is just a binary:

If the price offered is fair given the stage and goals for the raise, I invest as much as I can.

If I have conviction in the team and their vision but don't believe the price is fair, I offer that feedback respectfully and decline to invest -- or better yet, let them know at what price I would invest, alongside others on the same terms, and leave it up to them do with that information what they will.

If I don't believe in the entrepreneur or the opportunity they've chosen to pursue, price and terms are irrelevant -- the answer is always no.

Putting an end to grinding won't fix all the problems with the Seattle startup scene, but it will go a long way towards focusing the conversation on the right questions:

Are we fielding increasing numbers of amazing teams with huge visions?

Are we doing everything in our power as a community to help those teams win?

Only when the answer to those questions is an unqualified 'YES!' will Seattle have a shot at the big leagues. Until then, it's chop wood, carry water.

More Turtles: "Freemium" Investing

2012-05-04T10:18:00.000-07:00

I've written before about the fractal relationship between running a startup and running a venture fund -- here's another example:

Freemium pricing is one of the most powerful customer acquisition strategies in the software business. Many billion-dollar businesses have been built (think Dropbox or Evernote) by giving away a significant chunk of their overall value proposition completely free, no strings attached.

This model has more or less won the day in mobile app marketing as well -- most top-grossing apps are "free to play", relying on in-app transactions for premium services to drive lifetime value.

I've been reflecting lately on what I've learned over the past four years as a "professional" venture investor, and the freemium parallel strikes me as pretty accurate description of how VCs invest their most precious resource -- their time.

Most of my calendar slots are filled by people I've never met -- first-time meetings with entrepreneurs, co-investors, or other folks (academics, enterprise leaders, city and state government officials) who share my passion for early-stage innovation and community development. Most of these meetings don't "go anywhere" -- meaning they don't lead to investments, close working relationships or other obvious outcomes -- at least not in the short-term.

But every one of these meetings is an opportunity to forge a connection that may lead to a positive outcome in the future. And nearly every meeting results in additional connections -- each of us acting as a "human switch" and offering introductions from within our networks that might help the other along their journey.

This kind of no-strings-attached relationship-building and connection-sharing is the "freemium" part of my working life. And it's a very big part of what I do. The benefits of it aren't always obvious in the short term, but it's easy to look back over the past four years and see how powerfully this investment in people and relationships has become the foundation of my ability to create value as an investor.

Last night I was honored to receive the "Investor of the Year" award at the annual Seattle Startup Awards (created by Marcelo Calbucci and now hosted by the amazing team at GeekWire). It's definitely not awarded based on financial success -- I still have much to prove on that front -- but as Rebecca Lovell said in her introduction of the award, it's really for being the "believer of the year."

I *do* believe -- with all my heart --in founders, in entrepreneurship, and in the capacity of digital innovation to make a better life for people in our community and around the world. And if that's what the award is really for I'm even more grateful to receive it.

Don't get me wrong: "Freemium" investing is still investing -- it serves the the capitalist master of turning money into money. But the more I learn about my journey as an investor, the more I appreciate the wisdom of Yvon Choiunard's parable about Zen archery -- hitting the target is just a by-product, not the work itself.

Education Selling

2012-04-30T16:13:00.000-07:00

Pop quiz -- is it easier to:

(a) close a sale with a customer who already wants what you're selling, or

(b) sell to someone who's not even aware they might want a product like yours, much less why they should buy it from you?

Easy, right?

Every day I meet entrepreneurs who beat their heads against the brick wall of (b) while giving little or no time to (a).

Here are just a few examples:

1. Raising Money

Andy and I make every effort to be transparent about our approach to early-stage investing. We're both active bloggers and social media users. We list most of our existing investments on our website. We have a "what we do" page that tries to spell out in very simple terms what we look for as investors. We're on AngelList, LinkedIn and a dozen other places besides.

In addition to many the well-crafted + thoughtful investment inquiries we receive at Founders Co-op, we also get silly amounts of unsolicited financing requests -- promoters of South American gold mines, Chinese import/export deals and similar "once-in-a-lifetime" investment opportunities seem to think their "to whom it may concern" inquiries will spark our imaginations and open our wallets.

These unsolicited funding appeals are laughably off target, but I see inexperienced entrepreneurs do the exact same thing with their investing outreach all the time.

Whether you're raising angel or VC money, the single most important thing to remember is that investors are actually just people. A fund is nothing more than a legal wrapper for the human beings behind it, and those humans make decisions based on a very personal set of patterns, heuristics and habits developed over a lifetime of experience.

The shortest path to a successful fundraise is to show how your company is leveraging patterns of success that relate directly to those that made your target investor money in the past, and/or fit their current worldview on what's coming next.

If your business touches themes they love and markets they understand, and your team has the mix of business- and product-building skills they've seen win in the past, your job is (relatively) easy:

All you have to do is convince them that you're going to fucking own the market you're tackling -- and that it's a market worth owning -- and they might write you a check (as long as they don't have a conflicting investment already in their portfolio).

If you make the mistake of thinking of investors generically as fat, flapping wallets that will open for any risky bet if you just say the right magic words, you'll waste a ton of both your time and theirs. Raising money is hard enough, but it's practically impossible if you have to educate investors about your market and why they should care before you even get a chance to pitch.

Product-market fit it as important in raising capital as it is in building your business, which brings us to the second example...

2. Finding Product-Market Fit

There's not much to say here that Eric Ries and the Lean Startup community haven't already beaten in to entrepreneurs' collective consciousness, but I'll add a few comments from my own experience.

Like investors, entrepreneurs' actions are informed by a very personal history of views, habits and lessons learned, acquired over their lifetime of experience. By definition, entrepreneurs seek opportunity -- often using analytical frameworks that take them far beyond their personal experience base.

The error happens when entrepreneurs extrapolate patterns from their personal experience base to domains where there is no data to suggest that they apply.

Many, many times, I see entrepreneurs fall in love with an "opportunity" in a market that has no demonstrated appetite for their solution. (My own personal Waterloo along these lines was Andy's and my experience at Judy's Book, about which I have written at length).

Because they love their own idea so much -- and are so convinced it is the right thing for the market -- they take on the "education selling" challenge with the zeal of an evangelist, despite a demonstrated lack of interest on the part of their target customers.

Markets change, innovation happens and disruption ensues -- some level of market education is often required for a new service to thrive -- but evangelical selling is a brutally hard way to build a business. The classic investor cliche -- "be a pain pill, not a vitamin" -- is a good place to start:

When you talk to prospective customers about your offering, do you have to first educate them about what problem of theirs you solve before you get to the part about why your solution is the right one?

If the answer is "yes", you're either talking to the wrong customers, or you have a huge uphill climb in front of you.

Raising money and building a successful business are both brutally hard. Make your life easier by:

solving problems that actually need solving
selling to customers who would happily pay you *right now* for a solution, and
building a team -- investors included -- that shares your passion for solving those problems better than anyone else in the world.

Invert, always invert

2012-04-23T22:52:00.000-07:00

Charlie Munger (Warren Buffet's long-time partner) is full of pithy maxims for investors, but one in particular has been ringing in my ears lately:

"Think forwards and backwards -- invert, always invert"

By "inverting", he means coming at any problem from (at least) two different and opposing angles. This is good advice in any situation, but especially for entrepreneurs who are wrestling with hard strategic decisions.

Here are three specific examples:

1. Fundraising

Every startup business idea I've ever seen looks great in Year Five -- with massive revenues, fat margins and negligible selling costs. But it's the rare team that can tell a convincing story about how that massive success gets built brick-by-brick, with just three guys (or gals) nobody's ever heard of and a little bit of running code that doesn't look anything like the snazzy version in the mockups.

On the flip side, sometimes I come across incredibly disciplined operators who can tell me with astounding accuracy what their Customer Acquisition Cost (CAC), Lifetime Value (LTV) and Monthly Recurring Revenue (MRR) will be next month, but fail completely to paint a convincing picture of the big exciting future that awaits them (and their investors) as they grow.

The right answer -- "invert, always invert" -- is that you have to do both.

The most successful fundraising pitches are able to convey the kind of long-term, strategic future for the business that gets greedy investors drooling, while at the same time demonstrating that the team has the insight, discipline and skills to build that business from the ground up. Either one or the other isn't enough -- you have to tell both stories together.

2. Go-to-Market Strategy

In a world of costless software innovation -- and resulting hypercompetition -- building a great product that solves a problem for your customers is less than half the battle. Winning teams know how to apply the same level of creativity and passion to their sales and distribution efforts as they do to product development.

All too often I come across teams that have just one trick in their distribution bag, and it's usually the kind of Hail Mary strategy that's both rare and exceedingly difficult to pull off ("we're gonna go viral man!").

Very few teams are able to articulate a credible distribution approach that includes both "bottom up", one-customer-at-a-time cultivation of loyal users, and "top down" market development approaches like channel sales, content marketing, and partner-based cross-selling.

The need to "invert, always invert" your go-to-market strategy is particularly acute in enterprise software.

The great equalizers for enterprise startups -- consumerization and self-provisioning -- have opened the door to consumer-style "freemium" selling approaches that target individual users rather than CTOs and procurement officers. But that doesn't mean that top-down selling isn't still a good idea: the best enterprise tools deliver significant value to end-users and workgroups, but also create accelerating cost, transparency and business intelligence gains when rolled out company-wide.

The smartest enterprise startups find a way to "invert" their sales efforts, complementing single-user freemium offerings with strategic sales outreach higher up the organizational stack to clear the way for faster, more profitable rollouts across the enterprise.

3. Exit Strategy

In the weird, coded world of investor / entrepreneur communications, exit is a loaded topic.

If the founding team seems too focused on it, investors worry that the team is greedy and short-sighted, with unrealistic expectations about how hard and long the journey of business-building really is. But if the founders don't come in with a wild-eyed vision for massive strategic impact in their chosen industry, investors worry that the founders are just building a "lifestyle business" that will never pay off.

Since most angel and venture liquidity comes via M&A, this little dance always strikes me as an elaborate zen archery ritual. The truth of the matter is that every entrepreneur -- and every investor who backs high-risk ventures -- lives the Stockdale Paradox every day:

"You must never confuse faith that you will prevail in the end – which you can never afford to lose – with the discipline to confront the most brutal facts of your current reality, whatever they might be."

The Goliaths may vary by industry, but there is a little bit of David in every startup founder. The day-to-day grind of shipping code and delighting customers is the bedrock of startup success, but it never hurts to remind yourself -- and your team -- which lumbering behemoth you aim to scare the pants off as you travel the bumpy road to startup success.

---------------------------

As it turns out, Charlie Munger's maxim -- "invert, always invert" -- is the rule, not the exception for startup founders. Every day, many times a day, you will be whipsawed between the extremes of love and fear, elation and despair, bottom up and top down.

Learning how to invert like a master while keeping your own equilibrium is one of the most difficult and powerful Jedi mind tricks a founder can learn.

Human Empowerment

2012-04-18T16:58:00.002-07:00

I'm too fired up right now to do the topic justice, but I just read this pair of tweets from Alex Payne (someone I don't know personally but have huge respect for by reputation) and the article / blog post he links out to, I and just couldn't fit my reply into 140 characters.

I think both of these pieces -- but the Atlantic article in particular -- are kind of missing the point.

The lament that "technology" or "startups" have failed to deliver on their social promise contains a latent assumption -- that the tools of digital creation are wielded by an elite few on behalf of the unlettered many. By extension, it's the responsibility of the wizarding class to deliver innovations worthy of their exalted role in society.

This assumption was certainly true when the microprocessor was first invented, and the erosion of the condition has been so slow that it has largely escaped notice or commentary. But the transformation is accelerating now and no amount of ridiculous, me-too startups or silly valuations can undermine my belief that the best that technology has to offer society is still to come.

Why do I believe that? Because...

The wizard's magic wand is now being mass-produced in a 3D printer and handed out free to every smart kid on the planet.

The tools of digital production have become so accessible, and so cheap, that it no longer matters what Silicon Valley startups or venture capitalists do with their time and money.

Technology is nothing but an enabler of human empowerment, and we have reached a global tipping point in the democratization of access to the wizard's spell-book.

This is why I love the investment strategy of people like Fred Wilson and Brad Burnham at Union Square Ventures -- they don't just back pretty services that make it easier for rich people to live their happy lives, but invest in platform technologies that are animated by the most powerful and inspiring vision there is:

To unlock the creative potential that exists in all of us, with the wired world as a geometric force multiplier for the positive impact we each can have on our fellow human beings.

I'm no Fred Wilson, but I *am* on a mission to find entrepreneurs who share this goal of empowering others through technology and will do anything in my power to speed them on their way.

The best is yet to come, and this time we all get to play.

Request for Startups: An open 'federation layer' for enterprise SaaS users + data

2012-04-16T22:08:00.000-07:00

I love Y Combinator founder Paul Graham's "Request for Startup" meme. In that spirit, here's an idea I've been kicking around with a few folks and would love to see happen.

The traditional enterprise software business is crumbling. Once-dominant vendors like HP, SAP and Oracle aren't going away anytime soon, but their iron grip on the minds and wallets of Fortune 100 C-suite residents is weakening daily.

When the New York Times -- not exactly the center of the tech reporting universe -- runs a piece like this one, you can be pretty sure the writing is on the wall.

What's driving this change?

Salesforce gets a ton of credit for setting the pace -- Force.com is the biggest and most vibrant platform and marketplace for cloud-based enterprise apps, and they've made bold acquisitions (e.g,. Heroku) and invested heavily in internal innovation projects (e.g., Chatter) to accelerate their leadership.

But really, monolithic, top-down enterprise software is dying the death of a thousand cuts -- with literally hundreds of agile SaaS vendors targeting thin slices of enterprise functionality, winning over end-users one at a time without ever paying a call on central procurement officers or IT gatekeepers.

This trend has only accelerated with the rise of "smart" mobile devices and the app store model of software distribution. Employees love their iPhones and iPads, and they expect to be able to use them at work as well as at home. BYOD (bring your own device) policies are slowly making their way from consumer-centric enterprises to the most security-conscious strongholds like financial services, cracking open another path into the enterprise for agile software entrepreneurs to wiggle through.

Individual enterprise users love all this beautiful, functional software -- and most SaaS vendors are smart enough to price their services so low that "official" approval channels can't block the purchase. You can expect this trend not just to continue, but to accelerate, in coming years.

But even the most open-minded and forward-thinking enterprise technology managers have a few very legitimate beefs with the atomized, self-serve future of enterprise IT, including...

Data Fragmentation

More than ever, data is the lifeblood of any organization -- real-time intelligence about business and financial performance, supply chains and competitive environments is essential to managing cost and risk in a connected age.

What happens to that unified view of enterprise effort and productivity in a thin-sliced world of SaaS-based point solutions? You get lots of little data silos, big gaps in cross-firm visibility and a steady erosion of management insight and agility.
Security / Authorization / Permissions

Clunky as they are, monolithic legacy enterprise solutions also help companies manage employee access to sensitive business data -- sometimes just for control reasons, but often for legal/regulatory compliance and customer-facing security commitments that need to be honored.

Not only can disaggregated enterprise SaaS tools deny the organization a unified / normalized data store, they often also clutter the security and permissions landscape with isolated, opaque access control regimes that create headaches across IT user support, compliance and HR functions.
Human Performance + Innovation

The "softest" cost of fragmentation in enterprise SaaS is arguably the most important: adding friction to information flows among team members, particularly across organizational boundaries like location, department or line of control.

Maximizing performance in knowledge-work organization requires the greatest possible transparency into how people's time is being spent, who's working with whom on what, and how potential information gaps might be short-circuited by connecting individuals and teams in disparate parts of the company. Disaggregating enterprise data and workflow tools into departmental silos is virtually guaranteed to reduce total organizational effectiveness.

So, how do we get all the benefits of user-directed, flexible, functional enterprise SaaS without undermining the needs of the organization as a whole?

Microsoft and Salesforce would like enterprise buyers to believe that it can't be done -- that standardizing around Force.com or Sharepoint is the only way to get to the cloud without giving up centralized data, control and transparency.

And it's true that the alternative is both technically daunting to build and equally challenging to drive into market, but I'm not sure that means it can't be done well, and profitably.

I think the enterprise SaaS market is ready for a "T-shaped" offering (or set of offerings) -- one that nails one or two vertical use cases, but also creates a horizontal data, authentication and business intelligence framework that other vendors' tools can plug into.

Or maybe the horizontal layer can be sold as a standalone -- a "single pane of glass" for senior management to understand how effort, time and key performance data are flowing across the organization, with standardized interfaces that any SaaS vendor who wants to sell into the enterprise must comply with for the expense to be approved. Teams can still purchase any tool they want, as long as it integrates seamlessly with the shared management and data layer.

Some vendors will obviously resist this effort at standardization and -- from a customer perspective -- disintermediation, but I can imagine a group of leading, complementary SaaS vendors banding together to define an open ruleset for in-enterprise interoperability. This "co-opetition" might cost them some degree of horizontal competitive freedom, but would also increase the odds of each of them gaining a stronger foothold in their chosen vertical while also offering a more credible alternative to the dominant horizontal platforms.

Am I nuts? Does this already exist? Let me know!

Investing Capital vs. Investing Time

2012-04-12T17:27:00.000-07:00

Note: this post is one of several drill-downs on the topic of why angel investing and early-stage venture investing are not just different in scale, but different in type.

The most exciting thing to happen in software investing over the past 10 years isn't Facebook, or Twitter, or even Instagram.

It's the total collapse in the cost of innovation.

Thanks to advances in open-source tooling and cloud-based infrastructure, companies that once required millions of dollars in capital can now be built by small teams of high-performing digital creatives for just tens or hundreds of thousands of dollars.

At the same time, the world's richest people have gotten even richer, creating an ever-larger pool of returns-seeking capital. (Access to high-risk investments like venture capital is generally limited to "accredited" or "qualified" investors, the same one-percenters that have reaped the greatest economic gains over the past decade).

So, as the cost of digital innovation has collapsed, the pool of capital available to finance innovation has exploded.

This mix would be combustible enough if the world were standing still.

But -- unlike the first wave of internet innovation, when the population capable of consuming digital services was relatively small -- this cycle is feeding a massive, global user base, where 2 of the 7 billion people in the world have internet access.

Not only is there a massive addressable audience for digital innovation, but a large and growing segment of those users have the internet with them all the time -- more than half of US cellphone subscribers owns a smartphone, and mobile tablet sales are projected to outpace PC shipments in about a year.

The cost of attempting digital innovation has never been lower, the pool of capital available to fund innovation has never been larger, and the economic value of a "winning" digital innovation has never been greater.

No wonder the market for "disruptive" digital innovation is blowing up.

The current surge of software entrepreneurs will create many viable businesses, with happy customers and growing revenues. But only a tiny sliver of them will strike the magical balance of talent, insight, effort and luck that produces breakout success.

What does all this mean for the professional venture investor, and how does her view differ from that of the "typical" angel investor?

In previous posts I've asserted that:

Angel investors prefer deals where losses can be contained, while professional investors will "trade away" downside protection to maximize the potential for gains.

And

Angel investors are more likely to attain "local maxima" while professional investors are structurally driven to seek "global maxima".

The world is awash in capital and the cost of innovation is rapidly approaching zero. Financial capital -- whether angel or institutional -- no longer matters.

Today the equation for breakthrough innovation is breathtakingly simple -- it has just two variables:

Talent + Time

Angel investors -- for whom investing is a hobby but not core to their career or financial success -- rarely back up their money with significant allocations of personal time.

Professional investors are the opposite: each investment is an unrecoverable "silver bullet" fired from a finite pool of capital, and career success and compensation are directly tied to the accuracy and force of those shots.

Venture investors have three jobs: raising money, sourcing new deals, and helping portfolio companies win. Raising money is no longer the hard part (at least for investors who have a track record of producing returns). For the returns-maximizing venture investor, success boils down to outperformance in just two areas:

Talent -- Doing everything in your power to ensure that the teams you invest in are the most gifted, ambitious, relentless digital creatives on the planet.

Time -- Constantly triaging your schedule to maximize the positive impact you have on the teams and companies in your portfolio, particularly those that have the greatest odds of producing extraordinary returns for your investors.

Once a venture investment has been made, the *only* lever the investor can pull to improve the odds of a returns-generating outcome is to devote personal time to helping that company win.

Any activity that accelerates progress, neutralizes threats or otherwise removes obstacles to a portfolio company's success is an activity worth spending time on. Any activity that doesn't fit one of those descriptions is a "tax" on your odds of success as a professional investor.

There are only 24 hours in a day, and once they're gone you can't get them back. Angel investors do good by deploying capital, but professional investors produce their biggest impact by allocating time.

Local vs. Global Maxima in Early-Stage Investing

2012-04-10T08:24:00.001-07:00

Note: this post is one of several drill-downs on the topic of why angel investing and early-stage venture investing are not just different in scale, but different in type.

Venture investors who seek to maximize returns face a difficult problem: unlike publicly-traded securities, private company investments are highly illiquid -- no returns, no exchanges.

In addition, the mean time from venture investment to exit is more than five years, and any realized gains (typically) can't be reinvested by the fund because of way fund returns are treated for tax reasons.

Finally, fund managers are often contractually barred from raising a new fund until a majority of their current fund's capital is committed (i.e., via actual investments plus funds reserved for follow-on investment in existing deals).

This is why venture fund investments are like silver bullets...

Every fund investment is (essentially) a bet that:

irrevocably depletes the manager's capacity capacity to make future bets,
consumes some portion of the investor's finite time and attention (more on that later), and
either contributes to portfolio returns or doesn't.

Contrast this situation with that of the angel investor investing from personal capital.

A failed angel investment may reduce the angel's personal net worth (and require some explaining to her spouse or partner), but typically has a negligible impact on the angel's capacity for future investment, her time, and her expectations of future professional compensation.

Why do angel investors and "professional" investors behave differently?

When investment decisions...

are irrevocable,
deplete a finite pool of capital and time,
are burdened with significant legal and ethical obligations, and
have outcomes that correlate directly with the investor's future expectations of compensation...

...the manager responsible for those decisions can be expected to allocate capital with an extraordinary degree of care.

What does this mean in practice?

The raw material of any venture investment process is deal flow -- the pool of companies who are currently seeking capital and assistance in building their businesses. This market is slowly becoming more transparent and liquid (aided by high-quality enablers like Y Combinator, TechStars and AngelList), but remains an extremely localized, relationship-driven and opaque trading environment.

Under these conditions, angel investors are more likely to attain a local maximum with their investments -- participating in the best deals they see, but with fewer deals to compare against, and limited time and appetite for intensive diligence.

Why is that?

Because angel investors participate in this market part-time, they generally see only a subset of the total available deal pool.

Because they aren't as visible to the market as full-time players, they also tend to get a skewed view into the pool, with deal pipelines heavily weighted to opportunities sourced from a limited set of personal relationships.

And because -- as described above -- the personal stakes for their investment outcomes are lower, angels tend to screen their investment decisions less intensively than professional investors are both obliged and incented to.

By contrast, professional fund managers are driven by both obligation and incentives to seek the global maximum for their investments -- going to extraordinary lengths to:

see as many deals as they can;
doing the most intensive diligence on them that they can; and
only committing capital to the deals that pass the highest possible standard for long-term contribution to fund performance.

Whether the fund manager achieves this goal is up to the market -- and their LPs -- to decide. But it shouldn't come as a surprise when venture investors challenge entrepreneurs for "not thinking big enough" -- because that's exactly what what their incentives require them to do.

Loss Aversion vs. Gains Maximizing

2012-04-09T18:23:00.002-07:00

Note: this post is one of several drill-downs on the topic of why angel investing and early-stage venture investing are not just different in scale, but different in type.

Most angel investors I know don't consider their early-stage investments to be integral components of their personal investment strategy.

Instead, they're more often viewed as "off balance sheet" allocations of discretionary funds -- in effect, like (very) expensive consumer purchases, where the "thing" being consumed is both a low-cost, high-risk investment (similar to a lottery ticket), and an experience: the opportunity to participate vicariously in the entrepreneurial journey of a young company.

Because the good being purchased is both an experience and an investment asset, angel investors tend to value each of their early-stage investments intrinsically -- a significant component of the "value" to the angel investor is their ringside seat on the startup action -- and the possibility of making a significant return on their investment is a fun and exciting enhancement to the core value proposition, but often not the primary focus.

Angels with a small number of personal, discretionary and experiential angel investments will tend to be powerfully influenced by loss aversion -- a distaste for deals that have a reasonable chance of losing all their investor's capital.

A loss averse investor will tend to favor opportunities that balance a reasonable chance of producing gains with conditions likely to mitigate losses, factors like:

Conservative spend and raise plans
Near-term focus on revenue and profit
Experienced, senior leadership in sales and marketing roles
Niche opportunities less likely to attract larger competitors
Strategies that cater to the needs of wealthy incumbent players (i.e., those that have the capacity to pay more for the company's product or service)

(For more on the psychological drivers behind loss aversion, I highly recommend Daniel Kahneman's excellent book, Thinking Fast and Slow)

Contrast this with the view of the professional venture investor

When you raise a venture fund, you undertake a set of personal and professional obligations that sharply define the roles of both the fund investor (Limited Partner or "LP") and fund manager (General Partner or "GP").

In the case of the LP, the allocation of capital to a fund triggers a fundamentally different set of evaluation rules than an angel investment.

Instead of buying an experience -- the ringside seat to one team's startup journey -- the fund investor is buying a service -- financial performance within a specific asset class. The "loss" of the ringside seat and individual control over investment selection and management is traded for the anticipated "gains" of: (1) access to better deals; (2) diversification across a broader pool of deals; and (3) improved financial performance, even allowing for the fund's overhead (fees and carried interest charges).

For the GP, raising a fund means pledging to reciprocate the LPs expectations for the life of the fund (typically 10 years). As soon as the fund closes and the money hits the fund account, you are now a contracted fiduciary, legally and honor-bound to manage your LPs money with "the highest standard of care" to maximize gains and minimize losses within the parameters of the asset class you represent.

As a professional money manager, the GP's decision framing is not the experience-valuing, personal loss aversion typical of individual investors, but the risk-adjusted gains-maximizing framing of modern portfolio theory, in which each individual investment position is valued for its potential contribution to overall return.

The professional investor's focus on returns-maximizing investing is powerfully reinforced by the incentive structure of a venture capital fund.

In a traditional "2 + 20" fee structure, fund managers are authorized to draw 2% of fund capital annually to cover operations, but have a right to 20% of fund returns in excess of contributed capital. Particularly in smaller funds where basic operating expenses fully consume the 2% annual draw, a majority of the GP's expected compensation comes in the form of profit participation, commonly referred to as "carried interest".

It should come as no surprise that professional investors who...

have a legal and moral responsibility to maximize returns,
whose compensation is largely dependent on maximizing returns, and
who have made a long-term commitment to operating under these restrictions (typically a minimum of 10 years per fund raised)

...will do everything in their power to maximize returns.

Why is "returns maximizing" different from what angel investors seek to do?

In the software industry, the ability of agile, high-performing teams of digital creatives to create new product categories and / or fundamentally alter the competitive dynamics of existing industries has never been greater.

The most explosive value creation in software over the past 10 years has been wrought by companies pursuing digital disruption. And as the cost of starting a software business continues to fall, the appetite of both consumer and enterprise end-users to consume new, software-powered solutions (think iPads, smartphones, apps, etc.) has accelerated beyond most analysts' wildest expectations.

In this environment, a returns maximizing early-stage investor with the capacity to assemble a portfolio of high-quality investments will tend to seek deals with a radically different profile than those preferred by our "typical" loss-averse angel investor.

The returns-maximizing software investor will tend to favor companies that:

Have aggressive spend and raise plans
Pursue rapid growth at the expense of near-term profitability
Are led by hackers who may lack traditional business experience but possess extraordinary digital creative skills
Seek to attack major segments of the economy dominated by established players
Seek to steal share, undermine pricing power and otherwise annoy (rather than support) the incumbents in their sector

Venture investors are hired to do a very specific job: putting capital at risk with a goal of producing "asymmetric" returns -- where losses are finite but gains can be many multiples of the capital at risk. Many (perhaps most) of the investors hired to do this job will fail to deliver acceptable returns to their LPs. They will not be paid for their work, and will be unable to raise capital for future funds.

And that is as it should be.

Lesson #1: Seed-stage venture investing != angel investing

2012-04-09T18:23:00.001-07:00

Note: this is part of a series of posts unpacking what I've learned over the past four years as a professional investor.

Looking back, it seems so obvious. But the #1 lesson learned from my past four years as a "professional" venture investor has nothing to do with how I evaluate people, companies or ideas.

Instead, it's a fundamental shift in my understanding of my role as an investor.

When I first began investing on behalf of our new fund (Founders Co-op), I unconsciously viewed the world through the lens of an angel investor.

Andy and I had each been active angel investors before deciding to raise a fund together, and our positive experience as individual angels helped convince us that running a fund would be a fun way to keep working together as partners after we sold Judy's Book.

Most of our limited partners (or LPs, the investors in our fund) were active angels themselves, and their referrals helped us build our initial funnel of early-stage deals in the Pacific Northwest.

I'm proud of the deals we did in our first fund, and love spending time with the entrepreneurs we've been able to back on behalf of our LPs. But I've also noticed a steady shift over time in nearly every aspect of our fund operations -- from how we source deals, to the types of deals we tend to get excited about, to the nature of the financings we participate in, and even to the types of firms we seek to co-invest with.

It's taken me two fundraising cycles and more than 30 fund investments to get my head wrapped around it, but it's now obvious to me that...

Angel investing and venture investing aren't just different in scale, but fundamentally different in type.

Why is that so?

Let's start with a definition:

What does it mean to be an "angel investor"?

Setting aside the emerging universe of quasi-institutional "super angels" and "Micro VCs", I define the "typical" angel investor as:

an individual who invests personal capital in relatively small quantities,
based on irregular / opportunistic sources of deal flow,
with limited capacity / appetite for operational oversight of their invested companies
across a relatively small number of deals.

So why isn't venture investing just a scaled-up version of angel investing?

There are many reasons, each one requiring a blog-length post to really explain. To avoid a terminal tl;dr problem, I've listed the headlines below and will be linking out to each supporting post as I find time to take a swing at each. The first three are:

These are by no means the only differences, but they're the ones I keep coming back to when trying to explain -- to myself as well as to others in our wider Founders Co-op community -- how my thinking has been shaped by my experiences as an investor.

As always, comments and feedback help me get smarter -- please jump in below to share your experience, ask for a clarification or tell me why I'm an idiot.

Investment Thesis: Four Years Later

2012-04-03T17:44:00.001-07:00

Four years ago I began a new journey. After a 15-year career as a participant in and co-founder of various businesses, I "switched sides" and became a full-time investor in early-stage software companies.

At the time, I published a series of posts that described how I was thinking about my work, and laid out in some detail the framework I intended to use when screening and evaluating new investments.

Every day since then, I have been humbled to learn all that I don't know about being an effective venture investor, and how many miles I still have to travel on that journey.

But I have also had more fun -- and touched more lives in (what I believe to be) a positive way -- than in all my previous working years combined.

I have never been so hopelessly, happily hooked on anything, ever.

In the past four years as an investor I've:

Co-founded a new, seed-stage investment company -- Founders Co-op -- with my partner Andy Sack
Raised more than $10MM of investment capital from dozens of amazing people across two different funds
Screened literally thousands of early-stage deals on behalf of Founders Co-op, TechStars Seattle, Portland Incubation Experiment, Northwest Entrepreneur Network and the UW's Center for Innovation and Entrepreneurship
Invested in over 30 early-stage companies, of which two have been acquired, two have failed and the remainder have raised an additional $50MM+ in capital and now employ 200+ people.

Last week we hosted a portfolio review for our Founders Co-op investors. As I was putting together the deck for the meeting I realized just how much we've learned about running a fund, how much the world had changed around us in the past four years, and how our investment thesis has changed as a result.

It's time for a refresh.

Over the next few weeks I'll be revisiting the Investment Thesis topics I covered four years ago and talking about what still feels right, where I've made mistakes, and how my experiences of the past four years have shaped my ideas about the next four (and beyond).

Please join me + share your own stories and lessons learned so we can get better together.

"Why Nations Fail" + The Innovation Economy

2012-04-01T21:48:00.000-07:00

Tom Friedman's op-ed today was a riff on Why Nations Fail, a new book from MIT economist Daron Acemoglu and Harvard political scientist James Robinson. Per Friedman, the core thesis of the book is the long-term instability of "extractive" as opposed to "inclusive" political and economic systems:

"Inclusive economic institutions that enforce property rights, create a level playing field and encourage investments in new technologies and skills are more conducive to economic growth than extractive economic institutions that are structured to extract resources from the many by the few."

For anyone working in the "digital creative economy" -- the weird little tribe of engineers, designers and venture capitalists that I count myself a part of -- this thesis borders on the obvious.

Most of the people I interact with in the software innovation business take for granted the idea that the Internet is the global operating system for economic and political empowerment. No central power is viewed as unique or entitled to privileged status within this system -- over the longer-term, companies (and even governments) are *expected* to rise and fall only to the extent that they attend to the needs of their users.

I'm sure many sophisticated players in the traditional sectors of the economy -- and especially in the most extractive and politically entrenched sectors like financial services and energy -- consider this idealistic view to be hopelessly naive.

Indeed, by historical standards, our government hasn't been so in thrall to money interests -- and so uninterested in the needs of the middle class -- since the late 1890's.

But the political upheaval now underway in the Middle East is powered by the same fundamental forces as the tech investment "bubble" thats drives the startup ecosystem in Seattle and Silicon Valley. In important and far-reaching ways, money and power have never been less important in the global economy.

The power to create -- and to distribute that creation globally -- is now in the hands of every human being on the planet with Internet access, more than 2 billion of us at last count. The current innovation cycle has layered on top of that basic plumbing an astounding array of tools that make every kind of digital expression -- commercial, political or otherwise -- more accessible than ever.

How long will it be before these forces begin to weaken the hold of the financial services industry over American politics? How many more damaging leaks will spring open in the murky machinery of money politics as a generation raised on Facebook and Twitter finds itself on the inside?

Call me a dreamer, but I see the writing already on the wall. They won't go without a fight -- and we'll still have a generation of work wo do to fix the economic mess we're in -- but the distributed, transparency-seeking, individually-empowering Innovation Economy will break the stranglehold that big money has on power in America. And it will happen much faster than anyone thinks.

What does transparency buy you?

2012-03-29T21:53:00.001-07:00

I had an emotionally intense conversation with a startup CEO today about the benefits and costs of regular, transparent communication with company investors and close advisors.

My point of view -- which I articulated forcefully if not very effectively -- was that transparency within this limited set of insiders was incredibly valuable and created far more benefit than it cost in time + effort.

The CEO's view -- which he defended calmly and rationally -- was that his job was to maximize shareholder value, and that the communications effort was too costly -- not just in time away from hands-on product + coding, but even more in the randomization of effort and attention that those investor interactions often unleash.

Since I failed to express myself well in person, I figured I'd try to write it down instead...

First, what do I mean by "transparency"?

It may not be the most comprehensive sample, but among our 30+ Founders Co-op investments, the companies that have grown the fastest, and attracted the best follow-on investors, customers and team members, are all led by CEOs who practice some version of the following:

1. Frequent (weekly or monthly) written status reports to investors

Most Founders Co-op CEOs use Thinkfuse (a fellow FC portfolio company) to manage regular investor reporting. (A few have become such passionate evangelists for the product that they've virally seeded it into the portfolios of other venture funds). But the tool isn't as important as the content -- use email or carrier pigeon if you like.

Some of these weekly reports are very brief, some rival Moby Dick in length and completeness, but all of them include some version of the following:

The Numbers -- where are we on our top one or two Key Performance Indicators (KPIs) and what's the period-over-period trend?
Did -- what important things happened in the business -- good, bad or otherwise -- since the last report?
Doing -- what big projects and issues is the team focused on in the current period?
Help needed -- where could we use the kind of help investors and advisors are best-suited to offer: e.g., recruiting, fundraising, business / corporate development, strategic input?

By developing the discipline of regular, lightweight reporting, the CEO can keep her most important non-employee stakeholders current with needs and priorities of the business. Not only does this help her maintain ambient awareness among an important influencer group -- which often leads to serendipitous intros and connections for the business -- it also opens up a regular channel for specific asks that complement and leverage the internal team's efforts.

2. Automated, web-accessible performance dashboards

Since our portfolio founders are super-numerate hackers, they've all instrumented the hell out of their most important business processes. With a little extra effort, most have also built private but remotely accessible dashboards that give insiders an at-a-glance sense for how the company is performing on its KPIs. The over-achievers in the group have also spun up automated daily emails providing a 24-hour snapshot of key financial and customer metrics.

The more comfortable a CEO is with sharing these internal dashboards, the more informed their employees and stakeholders generally are about the company's vital signs and underlying trends. That can be uncomfortable when things aren't going so well, but it's hugely motivating when the business is making progress, and -- no matter how things are going -- it also serves as a daily reminder of the leadership's commitment to an organization-wide culture of trust and empowerment.

3. Regular (weekly to quarterly) phone or face-to-face meetings with key stakeholders

Emails and dashboards are great, but there's no substitute for regular, face-to-face interactions to stay on top of the complex emotional and interpersonal dynamics that exist among founding teams, employees, investors and advisors.

When you're running a growing business with limited resources, and your hair is on fire all day and deep into the night with stuff you need to deal with RIGHT NOW, it can be hard to make time for open-ended conversations with anyone who's not on that day's critical path.

But the founders who *do* make time to invest in those relationships -- who reach out proactively even when they don't need something, who show up at dinners and social events, and who get to know all the people who touch and influence their business as human beings -- those are the ones who tend to navigate the really challenging moments in their business (and personal) lives most successfully.

4. Active promotion of contributions made by other key team members

All of the traits and habits listed above are table stakes for competent startup CEOs -- if you aren't doing these things, my strong advice would be to start thinking about how, and to what degree, you want to begin adding these to your management routine.

But the biggest level-up for founder-CEOs -- especially those who haven't been in a leadership position before -- is the transition from doing to leading. An early indication of this ability is when founders begin to hire people who are clearly better than they are at something of critical importance to the business, and to trust these new hires with meaningful chunks of responsibility.

An even stronger signal is when the founder makes a point of calling attention to the performance or contributions of other team members in areas that they previously controlled. It's one thing to have the confidence to hire above yourself -- it's another to call your investors' attention to that outperformance, and know that they will value you all the more for having built a team that can carry the business to the next level.

What are the costs of transparency?

Startups are more acutely aware of opportunity cost than any other type of organization -- there is never enough time, money or manpower to do all the things that need doing, and every choice requires painful tradeoffs against the myriad other things that won't get done.

In this context of brutal, daily triage, the unstructured, open-ended activities -- which includes most of what I've described above -- are the first to go.

The argument I tried to make in my conversation today -- and am now reprising in long-form tonight -- is that small but consistent investments in transparency, relationship development and team development are the foundational work of creating scale in your organization.

None of this seems obvious in the moment, but over time, the depth of knowledge, accuracy of understanding and intensity of relationships that this kind transparency can bring will far outweigh the tactical value of the checks your investors have written to fund your business.

That doesn't mean things won't go wrong -- I can practically guarantee they will -- but when they do, the founders who have made these investments will have an army at their back, not at their throat.

A short (but important) list of things a startup accelerator is NOT

2012-03-27T20:47:00.000-07:00

I found myself ranting again in a meeting today, a sure sign that another blog post was brewing...

The topic of the conversation was startup accelerators and the do's and don'ts for starting one.

Setting aside for a minute the broader question of whether the world needs yet another accelerator, here is a short but important list of things a startup accelerator is NOT:

A startup accelerator is NOT a real estate business.

I keep meeting people who own (or at least control) big chunks of commercial real estate. Some of these folks think that a startup accelerator is just a clever form of real estate arbitrage, meaning they think they can extract a higher net yield per square foot by renting individual desks to startups than they could by striking a deal with a single tenant.

In my experience, real estate is a necessary evil in the startup business. We aim to run our Founders Co-op space at breakeven (and usually run a deficit), because we're optimizing for quality and values alignment, not economic yield. The funds and programs we work with in other cities tend to think about their space the same way.

A startup accelerator is NOT a sales channel.

I have also run into people who see accelerators as a clever way to aggregate a cluster of uncommitted prospects for sponsors to advertise to, or for vendors (consultants, accountants and laywers) to sell to more efficiently. This circle of hell also includes my least favorite people in the startup ecosystem -- the "angels with sticky fingers" who are always eager to "help" entrepreneurs as long as they can round-trip some of that "help" back into their own pockets.

I know lots of great service providers who love to work with startups and treat them with respect. They are an important part of any startup ecosystem. But they are not the customer.

A startup accelerator is NOT a fantasy sports league.

Many talented people at big companies think about quitting and starting (or joining) a startup. Very few actually do, but the number who consider it tends to increase during boom times and decrease when the shit hits the fan. Right now there are a *lot* of people peering over the edge of the precipice, so many that they actually represent an addressable market segment. I know people who believe that giving this group a safer sandbox to play in is what accelerators are all about.

Starting a business is incredibly hard and unglamorous work and *anyone* who thinks seriously about it deserves all the support they can get. But a high-quality accelerator program like TechStars or Y Combinator is actually optimized to serve the weirdos and misfits who can't imagine doing anything else -- who build companies even when everyone else is running for the exits because they just can't help themselves.

A startup accelerator is NOT a pimp for the capital markets.

Most accelerator programs end with a Demo Day -- a big show-and-tell party where graduating companies have a chance to pitch a roomful of accredited investors. And Demo Days are absolutely a good thing for both companies and investors. But -- strange as it may seem for an investor to say this -- accelerators don't exist to serve the needs of the investor community.

There was a time, not too long ago, when money mattered more than talent. Thanks to the magic of open source + cloud, those days are gone and they're not coming back. So if you're going to choose sides -- and remember, the only thing in the middle of the road is yellow stripes and dead armadillos -- it's clear what side an accelerator has to be on: your customer is the talent and no one but the talent.

OK, fine, so what IS a startup accelerator?

Like most things in life, the answer is surprisingly simple: A startup accelerator is a system for helping the most talented and ambitious entrepreneurs in the world increase their (already considerable) odds of success.

That may not sound fair, but then life isn't fair.

Accelerators only work if they attract the best possible candidates and deliver the maximum acceleration to those teams, producing the biggest wins for them and their investors. Those wins, in turn, draw new talent and money into the system, feeding the next cycle.

Any activity in this system that competes with or compromises the interests of the talent is not only a distraction from the core mission, it actually undermines the long-term health of the program.

Whether the world needs any more accelerators is a topic for another day, but if you're determined to start one in your community, do yourself a favor and post a big sign on the wall like James Carville did during Clinton's 1992 reelection campaign:

"IT'S THE TALENT, STUPID"

Wm. Shakespeare, Behavioral Psychologist

2012-03-20T16:20:00.002-07:00

There are so many examples to choose among in the collected works that I might have to turn this into a series, but the one that's been rattling around in my head this week is the following (from Hamlet, Act III, Scene II):

Hamlet. Madam, how like you this play?
Queen. The lady doth protest too much, methinks.

Every time someone answers a simple question with an overly long and self-justifying response, this exchange runs through my head.

"Over-explaining" is a common result when people are reluctant to admit they don't know something, or trying (too) hard not to accept responsibility for a mistake. I'm sure I've been guilty of this myself -- but the right answer is (almost) always to put down your shovel and stop digging.

P.S. -- I'm not much of a bible scholar, but the spirit of this is similar to Proverbs 28:

"The wicked flee when no man pursueth: but the righteous are bold as a lion."

Next time you're tempted to dig yourself out of a hole with words -- to flee when no man pursues -- remember the words of the bard and shut your mouth.

Sell your investors a ticket, but don't let them drive

2012-03-15T22:23:00.000-07:00

I've had too many conversations recently like this one:

ENTREPRENEUR: "We're raising [insert amount of money here]. As soon as our raise is complete, we plan to [insert one or more of the following: quit our day jobs; stop outsourcing and hire a real dev team; start building our product; etc.]"

ME: "So, you're asking your investors for permission to get in business?"

ENTREPRENEUR: "Ummm..."

I appreciate that this is a gross oversimplification of a complex and emotionally sensitive issue, but I feel strongly enough about it to do a little shouting anyway:

NEVER, EVER GIVE INVESTORS THE POWER TO DECIDE IF YOU GET TO BE IN BUSINESS OR NOT

Before you tell me why this isn't as easy as I'm making it sound, let me be clear: I'm talking specifically about software businesses that leverage web and / or mobile platforms for customer acquisition and service delivery.

The reason why it's absolutely the best time ever in history to be a software entrepreneur is that it LITERALLY DOES NOT REQUIRE OUTSIDE CAPITAL to get in business. If the founding team has technical skills and a credit card to put down for their AWS expenses, they can do a ton of damage without ever asking anyone for permission.

If you believe -- or your team is configured in such a way -- that this is not true, I'd strongly suggest that you consider the possibility that YOU ARE DOING IT WRONG.

There are lots of reasons why teams that ARE able to get in business without money choose to raise it anyway (more on that later), but even if you DO want to raise money for your startup, there is a fundamental principle of behavioral psychology that should stop you from ever framing your fundraising effort as a requirement to your being in business at all:

Humans -- and investors, contrary to what you may have heard, actually ARE human -- tend to want things more if they think they might not be able to have them.

If you give an investor control over whether or not you get into business, she (a) is likely to doubt that you have the skills / confidence / chutzpah to actually build a business; and (b) will tend to undervalue the opportunity to invest, because she knows you need her more than she needs you.

If, however, you demonstrate to her that you are already in business, building product, engaging with customers and figuring out where to go next, she is likelier to view her investment as a chance to empower and accelerate your team on its forward journey.

Furthermore, she knows that, if you continue to make progress at the same (or an accelerating) rate, she might not get the opportunity to invest at a later date, either because other investors will have beaten her to it, or because you'll no longer need the money.

In other words, if you can convince an investor that your train is about to leave the station -- with or without them on it -- they are much more likely to buy a ticket.

None of this is to suggest that you shouldn't seek investors for your software business. Not only would that make my life a whole lot less interesting, there are also plenty of good reasons to raise money for a startup that have nothing to do with asking for permission.

These include:

Doing more faster -- Yes, you can stay up all night coding by yourself, sleep under your desk and live on ramen. But you can probably do a hell of a lot more with a (slightly) bigger team, a stronger sales effort and a little shwag to sprinkle on your best customers. Money can't buy love, but it can buy speed.

Commitment / active support -- When investors write you a check, they'll (usually) feel compelled to actually do work to help you succeed, not only because they like you and believe in the business, but also because not doing so will trigger uncomfortable feelings of cognitive dissonance and inconsistency with their original decision to invest. The bigger the check, the more actual work they're likely to do.

External validation / social proof -- Getting complete strangers to back your business, especially if they do that sort of thing for a living, is a great way to demonstrate to customers, employees, and your parents that you're actually doing something worth paying attention to. Attention is valuable.

So by all means, raise money for your startup -- if all of the above hasn't convinced you I'm an irredeemable asshole, I hope you'll raise it from me -- but PLEASE don't hand over the keys to your business to anyone who's not a full-time, all-in, shoulder-to-shoulder co-founder. And especially not to your investors.

Flow

2012-03-09T22:42:00.000-08:00

"Only through freely chosen discipline can life be enjoyed and still kept within the bounds of reason" - Mihaly Csikszentmihalyi

I am not religious, but I am guilty of evangelism.

I spent the first seven years of my professional life careening from one unsatisfying corporate job to another, working my way down the ladder from a company of hundreds of thousands (AT&T), to thousands (Claircom/McCaw), to hundreds (Patagonia), until I found myself in the weird and wonderful land of pirate ships (Adjacency, Judy's Book, Founders Co-op, TechStars, etc).

The farther down the ladder I climbed, the harder I worked, and the more alive I felt.

I didn't discover Mihaly Csikszentmihalyi and his concept of flow until my kids were in Montessori school, but I experienced an immediate flash of recognition when I read his words.

Flow is...

"...being completely involved in an activity for its own sake. The ego falls away. Time flies. Every action, movement, and thought follows inevitably from the previous one, like playing jazz. Your whole being is involved, and you're using your skills to the utmost."

Entrepreneurship is grueling work. For every Mark Zuckerberg there are literally thousands of brilliant and anonymous founders toiling away on their dreams. For years. Most of these companies will fail. Most of these founders will never make vast fortunes or find their faces on the cover of a magazine.

But for all that, the fellowship of entrepreneurs is full of joy.

For those who haven't (yet) chosen an entrepreneurial path, it's easy to assume that startup founders are just bad at math, or greedy, or egotistical. Why else would they choose a life with such uncertain prospects and so little chance of success?

The answer is simple. So simple that it's impossible to explain to people who have chosen a different path.

Entrepreneurs have given themselves the gift of flow. Not all the time -- no one is that lucky -- but more often than they can find on any other professional path. And the older I get, the more I understand how precious and important this gift is.

Freely chosen discipline. Creativity. Autonomy. Exposure.

My business partner has cancer. I spent the weekend with two old friends; one recently had a pacemaker implanted in his chest; the other had a brain tumor the size of a golf ball removed last year. As the Buddhists, say, "death is certain -- only the time of death is uncertain."

It's none of my business, but I just can't help myself. It took me too long to realize it for myself, and now I preach the gospel with the zeal of the converted.

Choose flow. Choose joy. Choose life.

Who Loves You? | Who Fears You?

2012-03-06T15:29:00.000-08:00

Entrepreneurship and schizophrenia have a lot in common.

Every entrepreneur lives the Stockdale Paradox -- constantly toggling between the urgent daily realities of survival and their lofty dreams of massive success and cultural impact.

But entrepreneurs who take outside funding -- and especially those who raise "institutional" money -- have another dual life to live: one centered around customers and revenue, and another around competitors and incumbents in the industry they seek to disrupt.

If you raise venture capital you are signing up to a war on two fronts -- one based on love, one based on fear.

Let me explain.

Like other very high risk investment strategies, venture capital is an asset class that puts a huge premium on deals with "asymmetric" return profiles -- with limited potential losses but explosively large potential gains (i.e., where winners commonly return 1-2 orders of magnitude on invested capital).

In an exit environment dominated by M&A outcomes, the preferred liquidity path for venture capital investors is "strategic" M&A -- which is code for overpayment relative to traditional financial benchmarks. Strategic acquirers overpay for deals for one of two reasons:

Fear -- The target company threatens to disrupt the competitive landscape or destroy margins in a business segment core to the acquirer's business and strategy.

Greed -- The target company represents a new strategic opportunity for the acquirer to grow revenue / margin and improve competitiveness, thereby accelerating growth in enterprise value faster than normal / organic growth.

In this context, returns-maximizing investors who deploy capital with asymmetric returns expectations will tend to seek investments that meet (at least) two criteria:

Business Viability -- Can this combination of team and opportunity produce a business that generates positive cash flows with accelerating margins at scale?
Disruptive Potential -- If successful, can this team's approach to the opportunity represent a sufficiently dangerous threat (or sufficiently attractive growth accelerant) to two or more large and acquisitive incumbent players to generate a significant exit price multiple as compared to an exit based on purely financial benchmarks?

In other words...

If your startup idea -- implemented with quality + urgency -- doesn't scare the pants off one or more big and dangerous incumbents, most venture investors won't give a shit about it.

So, not only do you have to build an amazing product, get customers to love you and pay you money for it, find a way to acquire customers for less than they're worth to you, recruit great people, build a culture that keeps them happy, raise money, get press, pay taxes, etc. etc. (This is the "Love" part of the journey).

If you want to get professional investors involved, you also have to strike fear into the hearts of big, established companies that have (effectively) unlimited resources to throw at the same problem you care about. (This is the "Fear" part).

If you don't like the idea of fighting on two fronts and think that building a solid, cash-generating business is all that should be asked of you, don't be surprised when institutional investors don't get out their checkbooks to support you.

But if you think this kind of two-front battle sounds like a hoot -- and your team has the engineering, product and sales chops to back it up, please give me a call ;)

Retail's "Last Mile" problem (and how to make the most of it)

2012-02-29T18:53:00.001-08:00

A few weeks ago the New York Times ran a piece about near-record vacancy rates at shopping malls around the country:

"Malls, over the last 50 years, have gone from the community center in some cities to a relic of the way people once wanted to shop. While malls have faced problems in the past, the Internet is now pulling even more sales away from them."

A lifetime ago in internet time (~15 years ago in actual calendar time) I ran several product lines for outdoor retailer Patagonia and also led the creation of the company's first online retail presence. Even then -- in the earliest days of e-commerce -- I remember lively discussions about the need for location-based retail to reconsider its reason for being.

Once upon a time, retail stores served as valued curators, merchandisers and local points of distribution for national brands.

Slowly at first, and now in bigger and more decisive bites, each of those roles is being replaced by digital intermediaries:

Online megastores like Amazon.com deliver more assortment and convenience than any local store can possibly match;
Curation platforms like Pinterest, Polyvore and Fab.com make product discovery effortless and fun (especially for iPad owners); and
Peer-to-peer commerce platforms like Etsy, Storenvy and Shopify have enabled an explosion of "indie" shopping experiences that even the most artful local boutiques struggle to match.

So what's left for location-based retail to own?

Fifteen years ago the futurists in retail were all talking about "shopping as entertainment" -- thinking about the retail experience not in terms of merchandise (or even merchandising), but as a fundamentally social and sensory experience that occupied the same mental + economic space as eating in a restaurant, going to a bar or coffee shop, or attending a movie.

As the internet continues to undermine the traditional foundation of retail, this insight -- -- wrapping merchandise sales in social + high-touch experiences -- feels more valid than ever. The only part of the retail experience that the web can't take away is the social and sensory layer (which is a big part of the reason people -- especially women -- choose to shop in the first place).

There will always be a "last mile" problem -- and opportunity -- in retail, not to connect people with stuff, but to connect them with each other.

If I were creating a location-based retail concept today, it would include some combination of the following elements:

Subscription Commerce -- Like BeachMint, BirchBox or ShoeDazzle do for online sales, organize groups of local shoppers around tightly-defined lifestyle + merchandise segments, and offer them an ongoing stream of benefits that make them feel like members in a club.

Group Buying -- Give the group a reason to stick together, and invite others, by delivering more value to them as a unit than they would receive as individual shoppers.

Flash Sales -- It doesn't have to be the core of the value proposition, but artificial scarcity and time urgency are incredibly powerful intermittent reinforcement mechanisms to maintain engagement and keep response rates high.

Curated Experiences -- Remember, it's not just about stuff. As with flash sales, members will show up more often for one-off "exclusive" experiences -- all pivoting around your selected lifestyle theme(s) -- that take them out of their ordinary lives and make them feel special.

I don't know of any existing or insurgent retail brand that's running this exact playbook today, but bits and pieces of it are certainly visible among both online and the more forward-looking location-based retailers.

By pivoting around people and experiences, and not stuff, this approach turns traditional retailing on its head -- which is exactly what's needed to survive. It's only a matter of time before all these elements come together in a single offering -- and when it does it's going to kill.

Should Mobile App Designers Fear the Back Button?

2012-02-28T16:16:00.001-08:00

This morning I got together with Tony Wright -- one of my favorite Seattle-area entrepreneurs and a deep thinker on the topic of mobile app distribution and user experience design (among many other things).

We covered a lot of ground in the discussion, but one idea in particular stuck in my head. On the topic of designing for native mobile experiences, Tony said something to the effect that:

"I don't worry about the back button so much when designing for mobile"

It took a minute for this to sink in, but in retrospect it's a critically important idea for anyone who's trying to translate their web product experience into a native mobile context.

One of the longest-standing cliches in the web software business is that "your competitors are always just a click away" -- a first-time web visitor is a fragile and flighty creature, liable at any moment to click the back button and leave forever. A whole industry of landing page optimization, A/B testing and real-time analytics has grown up around this mythology of the all-powerful back button.

Tony's point is that much of this web-centric conditioning is just plain wrong-headed when applied to native mobile experiences.

This *doesn't* mean that you should treat your mobile customers like shit -- creating a great first use experience critically important for any product. But it *does* mean that you should reconsider where you are in the engagement funnel by the time a mobile user first launches your app.

In web terms, the "landing page" for any mobile app isn't actually in the app -- it's the page (either in the app store or on the web) where the user first decides to commit to downloading your app to their device. It's on that page (or set of pages) where you need to treat the user like the flighty, uncommitted web user you're used to dealing with. (This emerging discipline is called App Store Optimization, and it promises to be at least as big a deal for mobile as SEO is to the web.)

By the time a mobile user has evaluated your app, initiated download and agreed to the terms of use, they've escalated their commitment *way* beyond a traditional web visitor -- and you have more headroom than you think to surprise and delight them.

Not only is a new mobile user much deeper in the funnel than you might think, but switching apps is more costly (in terms of time + effort) than hitting the back button, so the power of inertia is also on your side.

What you do with this opportunity is up to you -- but don't make the mistake of porting your web design instincts to your mobile app without taking Tony's advice into account.

Amazon's Achilles Heel

2012-02-15T22:26:00.000-08:00

Disclosure - I'm an unabashed Amazon fan. Not only is it one of the most aggressive, forward-thinking and best-led companies in tech, it's also the beating heart of the Seattle tech scene. The comments that follow are offered out of deep respect and a sincere desire to see Amazon dominate the *next* decade of the digital economy.

I interact with Amazon.com all the time -- as a customer, as a supplier, and -- not as often as I'd like, but enough to keep me coming back for more -- as a partner.

These interactions are uniformly excellent -- crisp, smart, decisive, clear and direct. But they always leave me wanting more. And I'm worried that I'm not alone.

Poet and writer Maya Angelou captured the missing feeling better than I ever will:

People will forget what you said
People will forget what you did
But people will never forget how you made them feel.

Amazon is excellent at so many things, but as my partner Andy says about people with poor emotional intelligence, the company has "bad interface" -- they always deliver the goods, but there's no human warmth in the interaction.

Amazon doesn't make you feel anything at all.

Jeff Bezos has said that this robotic experience is a feature, not a bug -- here's his response to Wired's question about the cultural impact of the Zappos purchase:

Wired: In 2009, you bought [US clothing etailer] Zappos. Was that a bid to absorb their "culture of happiness" and customer service?

Bezos: No, no, no. We like their unique culture, but we don't want that culture at Amazon. We like our culture, too. Our version of a perfect customer experience is one in which our customer doesn't want to talk to us. Every time a customer contacts us, we see it as a defect.

The first rev of the consumer web was all about connecting people to information -- Amazon, Google, and Yahoo made it easy to search, learn about and purchase almost anything in the world. And we loved them for it.

But human beings don't just want data. They need more than stuff. What they crave most of all is human connection.

The current winners on the web are companies that make those human connections happen. Facebook and Twitter are the dominant platforms, but nearly every service that has captured customers' and investors' imaginations in the past five years -- firms like LinkedIn, Zynga, Foursquare, Etsy, Kickstarter, Pinterest -- is built around the power of connecting people with people.

Amazon has dabbled with adding "social" layers to their products -- Business Insider called their Facebook integration "the future of commerce" (and they were probably right), but if this feature still exists it's pretty hard to find...

Amazon is now making a huge bet on digital media -- a category where word of mouth has always driven sales and "social discovery" (via Twitter and Facebook shares) is becoming the default way to find new titles. But -- to take just one example -- the native "social reading" features in the Kindle platform are so buried / poorly implemented that it took an unauthorized 3rd-party startup -- a Steven Johnson / Betaworks collaboration called Findings -- to finally deliver a credible offering.

I know Amazon has the intellectual and engineering capacity to build a truly excellent social experience, so this isn't a failure of execution. It's a failure of will.

The only plausible explanation for the "empathy gap" in the Amazon experience is cultural -- actually having to interact with customers is seen as a defect, a failure of the machine -- and that cultural strain is embedded so deep and runs so high in the org that it can't be challenged.

Amazon is already a force to be reckoned with across an astoundingly broad spectrum of the digital economy. They have all the tools, talents and ambition needed to be a dominant force in the future of the web. My most urgent wish for Amazon -- as a customer, a fan and an advocate -- is that they take Maya Angelou's advice and pay just a little more attention to how they make people feel.

There is magic in the human connection that all the data scientists in the world will never decode. If Amazon can to tap into that magic with the same conviction they bring to everything else they do, they will be unstoppable.

Embracing Entropy -- the Consumerization of Work

2012-02-14T15:49:00.000-08:00

The global economy is in a long-term path toward disaggregation, a gradual shift in economic power from the enterprise to the individual.

This shift is most visible among the most "wired" segments of society -- workers on the leading edge of the mobile / social / "indie" revolution.

But as Venkat Rao illustrates in his excellent article, "A Brief History of the Corporation: 1600 to 2100", the erosion of corporate employment has been underway for over 30 years.

Bryce Roberts published a great piece over the weekend called "Rise of the Independents" -- in his words:

I think we’re entering a golden age for Indie businesses. Some will take the shape of long term durable companies, others will take the shape of projects that spin up and wind down to meet bursts of demand or to scratch a passing itch.

With democratized digital distribution and the rise of crowdfunding sources of capital, many companies will be in a position to stay independent and play by their own rules. And I think that’s a very important and powerful development worthy of it’s own word.

What Bryce *didn't* say (but acknowledged in the reader comments), is that this trend creates all kinds of interesting opportunities for entrepreneurs and investors with a passion for powering the rise of the indies.

This isn't a new idea -- some of the most exciting companies and technology trends of the past few years represent various flavors of "indie economy platforms"...

Etsy, Storenvy and Shopify in eCommerce;
Kickstarter, Y Combinator and TechStars in startup funding; and
the iOS and Android mobile app ecosystems -- jointly powering the biggest indie software economy in history.

But beyond these obvious, headline examples are dozens of lesser-known or more oblique examples of the same theme:

Maker Markets -- Elance is the grandaddy of technical labor markets, oDesk is a more recent (and more diversified) entrant, and recent TechStars SEA grad Group Talent is staking a claim to the high end of the "digital creative work" market (disclosure: I'm an investor).

Task Markets -- Amazon's Mechanical Turk pioneered the marketplace for lower-skill tasks, but sexed-up / localized Silicon Valley versions include TaskRabbit, Zaarly, and the most recent + high-touch entrant, Coffe + Power.

Content Markets -- There are dozens of pay-by-the-word content marketplaces out there, but Seattle entrepreneur Joe Heitzeberg brought the form up a level with MediaPiston, and TechStars NY grad Contently has now introduced the model at the elite levels of professional journalism.

Seller Markets -- Avon, Mary Kay and Amway are pioneers of Multi-Level Marketing (MLM), relying on armies of independent sales reps, peculiar wholesale value chains and complex, game-like seller incentive systems to drive sales. But lately this tired (and somewhat tainted) model has been reinvigorated by brands like Stella & Dot, Chloe & Isabel and Passion Parties, drawing a new generation of (mostly female) sellers into the game.

The bulk of the economy -- and the most obvious, near-term startup ideas -- still sit firmly within the traditional enterprise and consumer markets. But if you're interested in the future of work and not just the present tense, take a minute to think about a world in which the basic unit of economic value is the individual, not the enterprise -- not just the consumerization of IT, but the "consumerization of work"

Instead of fighting the natural entropy in the economy, I'm interested in makers who aspire to be the dark matter in this expanding labor universe -- the invisible but essential glue that holds it all together. If you share this passion, please give me a shout.

Toll Takers vs. Pied Pipers

2012-02-11T12:00:00.000-08:00

The "great acceleration" of software innovation over the past decade has fundamentally changed the playbook for entrepreneurial success.

The new methods are obvious to the current generation of software entrepreneurs -- the GenY applicants to Y Combinator and TechStars -- but seasoned participants in the old model still struggle to grok how completely the world has changed.

I was reminded of this generation gap by several recent conversations with senior execs in some of the biggest winners in the prior generation of tech entrepreneurship. The general topic of these conversations was "entreprise innovation" -- the ways that large-scale, incumbent players can foster disruptive innovation within their own firms.

Across a range of industries and firm types, the most common playbook I heard expressed by these enterprise players is what I call the "Toll Taker" approach -- define an opportunity on the horizon of innovation, quietly deploy big teams of engineers in secret labs to build prototypes and lock down intellectual property rights, and when you believe you've staked a sufficiently threatening claim to the opportunity, announce your position to the market and demand "tolls" (in the form of IP licensing fees, selling access to your enabling tech, etc.).

Perhaps the purest representation of the Toll Taker mindset is Intellectual Ventures, a massively-funded IP aggregation platform (led principally by ex-Microsoft folks) whose mission appears to be to erect tollbooths on every significant vector of tech innovation.

The intellectual and economic roots of the Toll Taker mindset can be found in the historical mechanics of technology innovation: a decade ago (and earlier), creating new tech was massively expensive and time consuming. Hardware and software were expensive capital requirements, engineer productivity was limited by crude tooling, and teams often had to build their own foundational tech before they could even begin work on the innovation layer.

The only way a business could justify the time and cost required to innovate was to seek total control over their intellectual property.

Contrast this Toll Taker mindset with the path to success represented by the two most valuable tech companies in the current generation: Twitter and Facebook.

Both companies began life as hacker projects, not strategic initiatives. Their beginnings were modest -- a way to help Harvard students hook up; a tool to help hipsters find the action at SXSW. And users were invited into the product development process from the beginning, sometimes directly, but always in the form of analytics-driven innovation, steering the future product direction based on the actual usage patterns of current customers.

This emergent pattern -- what I call the "Pied Piper" approach to innovation -- has been enabled by a dozen loosely related developments across software tooling (open source communities, more efficient language + framework development), infrastructure (cloud / IaaS, PaaS, NoOps), business process (lean / agile) finance (accelerators, super-angel funds), and culture (economic downturn, unemployment, loss of faith in institutions). Taken in aggregate, these changes have laid down a fundamentally different pathway to technology innovation than the one followed by the Toll Takers.

In the Pied Piper approach, long-term value creation and defensibility is based on customer engagement and velocity -- inviting customers to co-create the product with you, making frequent improvements based on customer feedback, and continually out-innovating the competition to retain customer loyalty -- as opposed to the massive investment, stealth and legal scaffolding typical of Toll Takers.

In the simplest terms, Toll Takers compete through fear, while Pied Pipers compete through love.

If Intellectual Ventures is the archetype of the Toll Taker method, Kickstarter represents the opposite extreme -- a site where entrepreneurs publicly declare their intentions before they've even begun to build, asking prospective customers to pledge their support as a precursor to product development. The site has been building fans in the maker community for several years, but just broke through to a more mainstream audience by helping game maker Double Fine raise more than $1MM in just 24 hours to develop a new title.

None of this means that Toll Taking won't continue to be a valid pathway to business success -- massive, secret allocations of talent and capital toward big visions will continue to produce returns, some of the time.

But if I had to place a bet on the best risk-adjusted path to value creation in software -- and on behalf of our Founders Co-op limited partners that's what I do every day -- I'd go all-in on the Pied Piper playbook. In software as in life, love conquers fear every time.