The Fallacy of the Exit

Recent news on the write-down of unicorns, IPO scarcity, and what’s to come next show it’s hard to win in venture capital, and that’s why eyebrows always raise when an investor exits a startup. However, if you didn’t figure it out yet, there’s a fallacy behind exits.

Behind the mirror

Venture capital is essentially a business of failing – but failing the less possible. This fundamental principle is connected to lean practices and the reduction of waste, though incredibly dissociated from the modus operandi and public assertions of the average VC.

Regardless of their M.O., VCs like to boast about their exits. And exits, sometimes brilliant and profitable, are often an overestimated solution for a bad execution. So when you hear “we exited for an undisclosed amount” you may be hearing “we were bleeding money and sold for pennies”. There are exits and emergency exits.

Take a write-off, which is giving back invested equity for nothing. Whenever a VC goes public about a write-off, the implicit argument is often “we tried all we could, but you know… founders screw up.” Only write-offs are waste: they’re the consequence of overpricing and underperfomance combined – not one or the other. Here’s why: write-downs (investing more money for a lesser valuation) are usually the late consequence of bad funding decisions, and a lot of write-offs are write-downs that became unaffordable. Hence, The VC is as guilty as the founders (but magically excused).

This is why VCs sometimes welcome bad (undisclosed) exits as tools to achieve three things:

  • Good publicity, signaling solidity and success for the press.
  • Impress investors, making it easier to raise the next fund.
  • Partial payback, so bad investments can return part of the debt.

It’s also why you should respect any investor who says “We made a mistake” after an exit or write-off. But it can get worse: sometimes bad exits don’t even pay a fair return to founders.

Reason, not looks.

Most founders believe all investors match the same greedy archetype, but that’s far from the truth. There’s a (varying) bit in all of us that believes in empowering entrepreneurs to change the world, and be part of that story.

Despite of our personal motivation, angel investors (and sometimes early-stage funds) differ radically from big fund managers in one thing: the first manage their own money, while the latter mostly manage other people’s money. Typically overlooked, that aspect is key to determine their investment decisions and how they plan towards an exit: when you manage your own money, emergency exits are waste and unaffordable. They’re (again) bad investment decisions that shouldn’t have happened in the first place.

That’s why sometimes exits are just for looks.

Panem et Circenses: An Investment Thesis Inspired on Pagan Rome

Decimus Iūnius Iuvenālis must have had a full life. He was the poet who wrote the Satires, criticizing Rome combining comedy and wit around 100 A.D. As a teenager, I read some of Juvenal’s work out of pure curiosity, enriching my premature codes of conduct with two expressions full of meaning:

  • mens sana in corpore sano: “You should pray for a healthy mind in a healthy body; Ask for a stout heart that has no fear of death (…) What I commend to you, you can give to yourself; For assuredly, the only road to a life of peace is virtue.”
  • panem et circenses: “Already long ago, from when we sold our vote to no man, the People have abdicated our duties; for the People (…) anxiously hopes for just two things: bread and circuses”

The first has helped me follow a peaceful and righteous track for life. The second helped me understand the relationship of power, money, and the behaviour of the masses. But it was not until lately that I realized: panem et circenses can directly impact my investment decisions.

Here’s why.

First, some context.

A much deeper discussion is justifiable, but I’ll simplify to save time: when Juvenal was alive, the gladiator battles reached their peak, and any politician who sponsored a great spectacle would be reminded on coming elections. When those came, families received substantial grain portions from those who ran for Senate. Rome even tried to pass anti-corruption laws that refrained those tactics, but failed miserably. The common people no longer cared for history, politics, or heroism: they wanted food on the table, and some fun to forget the daily struggle.

What changed?

The average consumer, the one startups fight hard to conquer, is not very different today. Humans have not evolved too much, and most of our everyday decisions are unconsciously-biased and highly influenced by how quick arguments have been molded to win us. Believe me, there are hundreds of books about it 😉

Whenever I discuss a business model twist or analyze a new early-stage product, I think about panem et circenses and try to broaden its reach. This way, I can see how that startup will bring two sets of things to the user’s table:

  • Panem = food. Money. Complementary income. Goal achievement. Self-education. Food for thought.
  • Circenses = fun. The ability to bring fun to others. Sense of belonging. Self-deception. Happiness.

Those two lists go on and on, and I could write pages about those concepts. I’ll keep this post short and leave the interpretation to you, because it all boils down to this: if a startup is directly marketing and delivering at least one of those concepts properly, even if not explicitly, a further look is granted. It may be able to solve two pains we know are common to everyone.

Practice this on the next potential investments you face. Let me know how it works for you.

Preparing Startup Assets for a Future Exit

My last post allowed for some interesting discussions AFK – some properly hydrated. A particular one involved a roundtable of investors and entrepreneurs regarding three main topics:

1) who am I to propose a new definition for anything
2) what are the typical derisking practices any startup can use
3) how business assets and real options relate to startup strategy

I believe the latter deserves a deeper discussion, so writing this post helps me get rid of that burden.

Business Assets Can Be Planned from Scratch

Remember that time you were drafting your Business Model Canvas and felt kinda clueless when filling the “Key Activities” and “Key Resources” blocks? That’s you right there and then, still immature and unsure of what can be the most important assets of your early-stage startup.

The harder you think ahead those resources and activities, the better your view on what is really valuable for your business. The processes and resources that only your startup can develop and improve – really, only your startup – are not only the pillars of your business, but also the things that support your true value proposition. They are your most precious assets, and have to be polished until they are the very engine that differentiates your business from all others – then, scalability and repeatability may be only natural consequences.

Consider anything that may be of great value in a startup: a killer algorithm, a secured patent, an incredibly loyal group of early adopters, or a founding team who will create the next big thing. The end consumer sees only the consequence of that: the service provided by the startup. The key assets of a startup are useless if they haven’t been proven critical to materialize the business, whatever importance founders brag they have.

Invest time planning ahead for your startup’s most important business assets.

The Best Business Assets Become Real Options

Real options can be defined as the alternatives that bring management flexibility. The concept is not commonly found on the vocabulary of entrepreneurs, but is widely used in venture capital and private equity. When a startup consolidates a product, achieves tactical or strategical advances for its assets, or simply marks the territory with a positive market move, it may be buying flexibility to pursue new future directions for the business.

For early-stage startups, real options are like breadcrumbs you leave behind when you pivot: they are backtracking paths you can follow back if everything blows up on your next move. It is so because when you’re grasping towards validation, it’s very hard to see farther than your closest objectives – and they’re often more tactical than strategic. When you leave plan-Bs around, it’s much easier to secure previously abandoned directions that are now promising – compared to the disastrous pivot you just spent months on trying.

If handled carefully, an unsuccessful pivot may be pocketed and saved for a better time. And as startups mature, the planning for real options can help prioritize on where to pivot next.

Startups: A Remixed Definition

Startup acquisitions usually involve one strategic business asset or real option. The most common are:

  • Client portfolio, mostly in B2B startups and important to big enterprises that wish to expand to the longer tail of revenue profile.
  • User base, mostly in B2C startups that present an above-average user growth – an example is Whatsapp, that grew in 4 years what Facebook took almost 10 years to grow.
  • Growing revenues and/or profit, simply because it’s cheaper to buy now a startup that’s growing fast than after it has grown even more.
  • Geographical dominance, mostly when a global startup is expanding to a new country and it’s cheaper to acquire the local leader than to invest in a regional operation from scratch.
  • Patents or products that are technologically advanced and provide the buyer an open path to diversify, or to make a strong stand before competitors.
  • A killing team that may operate a new business unit and oxygenate a big company wishing to innovate.

If you’re a startup founder, analyze the assets that will become one of those exit motivations. If you’re an investor, forward this post to your invested founders. Remember: in the startup game, it’s all about strategy.

To close the post and reinforce the sentence you just read, I’d like to come out with a remixed definition of a startup, coined after a late conversation under light effect of single malt:

Real startups are investment targets that develop and secure unique real options faster than my next raise

Can’t say I disagree.

Redefining a Startup: an Investor’s Perspective

A lot has been said about startups, and words of wisdom from countless experts, entrepreneurs, and investors have collectively built dogmas accepted worldwide. Steve Blank and Eric Ries are two consistent contributors of that knowledge body over the past decade, and their joint definition of a startup could be stated as this:

 

A startup is a temporary organization in search of a scalable and repeatable business model, designed to deliver new products or services under conditions of extreme uncertainty

 

Blank’s words before the comma, Ries’ right after. Beautifully complementary definitions, self-explanatory, and polished to perfection. Yet…

I’ve been approached by thousands of entrepreneurs looking for funding, and I’ve preached that same complete definition in response. Strangely, their typical reply to my gospell always denoted a lack of understanding on what exactly the terms on that definition really meant. This is why I always felt the need of a definition that tells them how to assess themselves as a true startup or not, and also to help them visualize startups their right path through investor lenses.

I’m not aspiring to pivot the original concept, just flip that definition coin to reveal what could be engraved on the other side. And this is what I came up with:

A startup is an organisation intended to derisk and maximize the value of business assets in record time

Let’s break down the key concepts.

Organisation

Startups aren’t necessarily a formal company. On the other hand, we often find independent teams inside big companies working with a startup mindset. Therefore, organisations comprise groups of friends / researchers / professionals, recently incorporated businesses, teams inside big companies, using part-time or full-time schedules towards a common goal: create a startup together around the same product or service, either inside a company, as a spin-off, or as a formal company.

Derisk

No matter how uncertain the product/market fit or how innovative the business model, investors have a bias towards lower risk and against extreme uncertainty. Hence, the best startups combine gradual decrease in risk probabilities with a consistent increase in potential returns. Great startups derisk their success over time, and the best way to do that is grow, grow, and grow… In addition, many risk factors can be detected, acted upon, and minimized with careful planning. Legal protection, patent applications, commercial partnership agreements, NDAs + non-compete signed with big competitors, letters of intention from potencial buyers, anything that can make sure a startup gets future revenue or has a safe harbor when / after launching.

Maximize the value

There is no purpose in a startup that doesn’t aim to increase its value, and that purpose is less rich and noble in proportion of how much waste a startup generates. When one stands for maximizing the value of something, it means to reach the utmost value one can achieve – and not accepting less. Founders who maximize the value of their startup assets stretch their bones in a daily fight to extract everything they can from their team, technology, management, and results.

Business assets

Any asset can be valuable in a startup, such as an innovative technology, a massive user base, a great founding team or a single approved patent. Even so, those assets are only attractive to investors and executives (as representatives of funds and enterprises) if they have a business application and provide competitive advantage to someone working the market – present or future. After all, if the startup’s business model proves not to be scalable and repeatable (or the management screws up), you can still liquidate those assets and get huge value in return…

That is a key aspect that armies of entrepreneurs forget or underestimate. Investors will only have their equity valued in 10x if founders are working hard to turn assets into business assets. Executives will only vouch for a startup that presents strategic features, technologies, customer base or teams that are usable in a turn-key fashion, or very close to turn-key. If startup S1 has less valuable assets than startup S2, but assets are more business-ready on the first, it may win the race.

Consider any kind of exit as a plan B, but as important as plan A: not ever needing an exit. Maximizing the value of business assets is mandatory on both scenarios.

Record time

Not much to explain here: a startup has to execute and grow as fast as it can, and much faster than its competitors. Be it swimming, racing, or whatever endeavor humans undertake to achieve greatness, record times are hardly broken (though some people struggle their whole lives to break those). It works the same for a startup: growing in record time means one is faster than all others.

Use it as a compass

How many entrepreneurs are able to fully abandon their biases, personal beliefs, and prejudices in favor of creating the best startup they can? Even though most startups are presented as potentially scalable and repeatable business models, that is frequently a premise and not a validation. In other words, entrepreneurs very often hammer their startup vision onto anything they see, because they believe they’re pursuing a scalable model – and not because it indeed is or will be. Unfortunately, Blank’s and Ries’ definitions allow that plausible mistake to happen and don’t hint on how to close that gap (not unless you look at all the methodologies / practices they’ve thoroughly described on their books and blogs).

My proposed definition serves as magnetic north to founders or corporate teams who wish to understand their potential return on investment. But most importantly – despite being funded or not, formal or informal – they can look at that compass, self-check if they’re off-course, and understand how much of a startup mindset they really have.

So if you’re running a startup, occasionally go through the checklist literally derived from the definition:

[    ] Are you actively working to derisk your startup?
[    ] Are you maximizing the value of your assets?
[    ] Are those assets business-oriented?
[    ] Are you doing all that as fast as you can?
[    ] Are you doing all that faster than similar startups?
[    ] Are all your actions, everyday, planned to answer “Yes” to all questions above?

Each negative answer to those questions screams “you’re not running a startup”. Are you? Then follow this recipe:

1. For every negative, ask the team “Why not?”
2. Write down the real reasons
3. Devise simple solutions to address each reason
4. Make it work.

I’ll tell you what: whenever your reason is “we don’t have enough money”, think of another reason. Every startup needs capital, but the best ones find alternatives that transpose those obstacles even without funding. And always remember… startups may not be your thing.

Getting it right, it’s like building a strategy SCRUM board. Believe me, it pays off and will make you a better founder everyday.

 

The Secret Behind Stripe’s Atlas: Onboarding as a Service

With no previous hustle, Stripe suddenly unveiled Atlas to the world – showing how it can support foreign companies in speeding up their process of becoming an American operation, and quickly start charging with Stripe. The selected companies won’t need to address complicated issues such as incorporating a Delaware company, reducing legal and financial risk, and getting US$ 15,000 in infrastructure credits from Amazon. Stripe will provide all that for only US$ 500.

The question in everyone’s minds was “Brilliant! Why hasn’t any e-payment platform thought about this before?”. However, this is an end-user perspective. What Stripe is really doing, from a company perspective, is trying out a simple idea that can drammatically shake a startup’s world: Onboarding as a Service, or OaaS.

Onboarding: soothing users in

Every business needs a constant stream of new customers. The fastest they understand the value of a particular product among its competitors, the highest their potential as future loyal customers. You can’t love a product you don’t use, and won’t advocate for a service you don’t love.

The process of soothing in prospects and leads and trying to transform them into customers is called onboarding. On most startups, onboarding is delegated to the marketing team – either integrated with an inbound channel or sales representative. There are several tactics to increase efficiency on this process – such as lead scoring, top-of-funnel content marketing, and others. What Stripe did different was finding a key pain point of its prospects and create a multidisciplinary team to give them what they need. By packaging processes that are usually done offline, Stripe offered something considerably valuable for practically no cost.

What startups can learn from Atlas

Stripe knew about this pain point for a long time, but most startups aren’t aware of all the small things that prevent prospects from adopting their product or service. That understanding only comes as a consequence of a thorough and strategic analysis that is (maybe) easier for unicorns than for earlier-stage startups.

For Atlas, Stripe gets a US$ 500 deduction to its CAC (Customer Acquisition Cost) whenever a customer is selected. The secret then lies in three key issues:

  • The costs and expenses (from the onboarding team salaries to the incorporation expenses) have to be paid for in the future, and the partner credits (such as AWS’s) help increase the value of Atlas without additional costs
  • Controlling the growth scale, so the OaaS won’t need constant boosts of HR to comply with the lead demand
  • Making sure the drop rate isn’t high, and that the LTV (LifeTime Value) of the Atlas customers by far surpasses their CAC

Stripe solved those with an invite-only format. The result is (probably, since I don’t have access to numbers) tens of thousands new international leads in only a couple of days, for the cost of a conference participation… Another result is that the company doesn’t have to release Atlas adoption metrics unless they’re very good (after all, it’s a beta service and invite-only). And the most beautiful thing of all: Stripe disguised an intricated onboarding internal process as a value-adding service that solves a deeper layer of its very own problem/solution fit.

OaaS strongly justifies itself when a startup wants to diversify customer segments, expand geographically, or just increase market reach. What I believe: any startup should use Stripe’s example to devise their own OaaS strategy and kick competition in the ass. Now think, no matter the stage of your startup: what is your OaaS MVP?

The Doom of Twitter And The Innovation Chasm

As we watch celebrities defend their honor and make millions just by typing stuff on Twitter, others discuss whether Twitter is doomed or not, and there’s constant hammering on that. But besides Kanye’s and Oprah’s, other tweets have been particular interesting for founders and VCs over the past week. Paul Graham triggered the discussion, apparently unintentionally:

“Startups: instead of appearing on Shark Tank, spend that energy fixing whatever makes your product so unappealling you think ou need to.”

Then a long thread followed, curated below to make your life easier:

tw_pgmccsdm

PG’s remark on product and Dave’s polite reply are the tweets that motivated the blog post you now indulge me by reading, because they show that even people who live and breath early-stage venture capital disagree on what are the most fundamental strategies towards growth or doom.

Twitter might be doomed, but that real-time debate might have never happened if it wasn’t out there. So could we assume Paul Graham is right, and getting the product right may be what’s dooming Twitter? Or is Dave right, and it’s a great product that’s not marketed properly? Maybe they’re both right? Or wrong?

Way Beyond the Chasm

“Crossing the Chasm” by Geoffrey Moore became the innovators bible in the 1990s, later followed by “Inside the Tornado”. Both books digress on the same theme: the life cycle of innovation and technology adoption. I’ll speak Startupish for a quick review:

chasm

  1. Funded or not, every startup gathers a small crowd to try an MVP. Usually those innovators are looking for new trends and use the product at their own will, but some may have been handpicked by the founders to give feedback.
  2. When the early adopters hear about it and start showing up, the MVP is probably shaping up as a product – but the founders didn’t quite get it right yet.
  3. The innovation chasm is the gap every startup has to cross if it wants to get to the common people, pivoting back and forth across different customer segments to refine its problem/solution fit – Moore calls that process the bowling alley strategy. The startup then ups the pace to accumulate its first million users, and that fast-growing bunch of signups is called the early majority).
  4. The tornado is the relentless chaotic period where the startup strives to find product/market fit and grow way past its initial traction. Getting to main street means everyone out there is using the product, and some time later, their moms and dads as well. This is when the addressable market starts shrinking.
  5. The end of life approaches when the haters have silently been beat and start using the product as well. There’s not much market left to conquer. It must diversify or expand geographically, if it wants to keep growing.

Let’s give Moore a try and throw Facebook and Twitter against that graph. We’ll see they stick in different places: Facebook is definitely approaching the end of Main Street, but it didn’t stop the bowling alley strategy: it has no shame and keeps molding the product here and there to better fit advertisers, small companies, grandpas, and different mobile transfer speeds.

Twitter, on the other hand, chose to be an intelligent and minimal product that covers a major need for real-time information, but still respect you enough to let YOU decide what your timeline shows. It went all in with promoted tweets and other revenue experiments, but is still reluctant to get to full Main Street because of core changes that might have to be done. Maybe it’s just… not made for everyone.

We’re all doomed

So in the case of Twitter and at the light of the Innovation Chasm framework, Paul Graham may initally seem the one who’s right: but the key issue of it all is a product premise, not a product misfit. That means it’s a strategic problem, not only a product problem. Twitter chose to remain Twitter, and that’s costing them the market. It is a better product in terms of design and user experience, while Facebook sacrifices the product essence in order to maximize the stickness x monetization x audience equation – and the Twitter audience is not as broad.

Twitter is not doomed, because it can still decide to try out various business models without changing the product. We ourselves are all doomed, because Facebook – a massive black-hole of attention – is winning the current race. Facebook completely tilted towards money: video auto-play, timeline curation, cluttered interface, and destinated the whole user experience to maximize revenue. Twitter, on the other hand, kept its soul. We love it for that, but our grandpas will never get it. And grandpas are (respectfully) cattle for Facebook’s revenue model, since if you’re not paying for it, you ARE the product. Not me – I’m not on Facebook.

Instead of the typical click bait on your Facebook timeline, I daily restore my faith in mankind because of Twitter. Hey, I can feel the real world’s pulse on twitter – and I believe that’s worth keeping. Maybe the other millions of users such as myself – the loyal Twitter early majority – would be able to avoid another orphanhood like we had with Google Reader by paying a few bucks every month to keep using Twitter as it is.

Would you? Or should we just shrug?

On Startup Metrics and Picking The Right Investment

Controlling the right metrics is one of the indispensable features of a great founder. Management by numbers is key for growth, and critical in adapting a startup operation along its quantum leaps of scale. However, we can’t predict when your path as an investor will cross the path of a founder who have already reached that maturity… so the question becomes: since scale is the trigger for better metrics, how can we detect a precocious number orientation in a pre-growth startup?

Numbers don’t lie

You may want to read Semil’s recent take on how investors should spray and pray versus be picky. It’s a very good article, and this particular quote had me wondering:

So, is it just “spray and pray?” No, that is too easy. It’s about branding for deal flow, about securing the perimeter for coverage, about staying close to your companies and helping out, and having the financial access, right, and flexibility to follow along into subsequent rounds as the best companies emerge

The best companies emerge, he said. As an investor, how can you be there before it happens? This situation reminds me of Mark Zuckerberg right after the IPO, when asked about Facebook being overpriced. He said the company stock was undervalued and that it was a great opportunity for people to double down before it went up. Only he and the Board had the real glimpse of how Facebook was going, and that was because only they knew the key growth metrics. You can only price well what you measure well.

The deeper and faster you get into the metrics of a potential investment before closing a deal, the better are the odds to make a good decision. This looks like an obvious conclusion, but you’d be amazed that many investors don’t know which metrics to analyze. Doubling down is significantly de-risked with real numbers (even if they’re still small), and this is why I’m picky on metrics and dedicate long hours to make them right. Good metrics are a collateral benefit of a good strategy.

Startups are a tool to build scalable businesses, so you’re not looking at a “role model startup” if you don’t get the numbers – and role models are the only ones worth investing in. Even when there’s not enough operation history, the proper metrics are mandatory and key for a VC to evaluate the business evolution.

Using a simple analogy, startup founders who don’t know their metrics are like slow drivers on the fast lane: they should either go faster or pull to the right. The ones who drive faster and measure their way are still on the race; the slow drivers who don’t measure performance are thinking about something else than the race – and startups are all about winning that freaking race.

How to pick them?

Instead of focusing on the metrics themselves – because they vary according to the business model and there’s extensive online content on that matter – this is how I assess founders and startups with a simple framework and four levels of metrics maturity:

  1. they have no idea (or are uncertain) of what are the right metrics for startups
  2. they know the fundamental principles for startup metrics, but don’t know which ones to pick
  3. they know which metrics are the best for them and do perform measurements, but didn’t create a routine evaluation process
  4. they implemented an automated dashboard and the business is constantly refined according to the right measurements

This way VCs can easily prioritize the deal flow with one single objective criterion, instead of looking in the mirror every morning and pinching themselves thinking how unbelievably good they are when picking investments. Startups scoring 3-4 should be looked into before others. The higher the investment round, the closest they need to be to 4.

One might argue there may be excellent investment deals out there who operate under the radar, run kick-ass products but still didn’t figure out the right metrics. Well, considering the amount of information on the subject, that would be as condescending and contradictory as listing good VCs who don’t guide their strategies relentlessly and insanely by their own performance metrics.

We’re constantly being reminded that seed-stage valuations are reaching all-time highs. Check out the Q3 2015 Halo Report to understand why. I believe the proper intepretation of metrics reduces venture capital waste – but you need to be sharp on which ones to look into.

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Herd Behavior in Venture Capital: The Rise and Fall of Everything

Venture Capital is based in the expectation of returns, and that involves mainly two things: trying to predict future scenarios for a particular company, and comparing that future with other company futures to determine which to pick (if any). The fact is that some will become global, others will die miserably, some will gradually rise or graciously fall – and all that is like the birds and the bees for founders and investors.

Nevertheless, even after unveiling the mists of venture capital intercourse, most entrepreneurs take some time to notice a simple truth… that not all investors are bright, but most think they are.

Herd Behavior

To understand how good and bad decisions are made in Venture Capital, let’s segment investors under two simple criteria… how much they really know about the VC market, and how pretentious they are about that:

  1. those who don’t know much, and are aware about that
  2. those who don’t know much, but think they are wise
  3. those who are wise, and recognize their own wisdom
  4. those who are wise, but know there’s so much to learn

Group 1 is the Conscious Herd, mostly formed by angels and wealth managers who invest in startups to diversify and experiment, not necessarily expecting a massive return. A lot of novice LPs and executive-angels also fall into this first category. Recognizing their limitations and low expectations is key for their survival since they have no wish to risk more than they should – and that’s why they intend to follow the market and bet on information symmetry.

People in group 2 form the Unconscious Herd. They are following whatever venture capital trends published by media or celebrity investors, so they can mimic their bets. “Clean tech is the new bubble” and “50M is the new series A” are remarks they use that end up driving the market sideways and creating a zero-sum game. Those VCs sometimes are the ones who provide easy money for bad founders (since great founders tend to avoid them).

The Elders are in group 3. They look from afar and wait because they can’t run too fast. Most billion-dollar funds and experienced investors are in that category and feel no need to move fast because they’ve been there and done that (and that is millions/billions in return).

Founders should always be good friends with the VCs in group 4. They know their kung-fu, but know they can never be too fast. Their gut feeling and experience play an important part in deciding who will get a term sheet, but they also know data, experimentation, and sometimes pure luck and serendipity, carry a lot of meaning. They are The Leaders, and that involves leaving elders and the remaining herd behind if they can.

So what?

When people are looking for problems where no problem exists, I use an old Brazilian saying: “You’re looking for a horn in a horse’s head.” In the VC world, it might just as well mean that you shouldn’t search startups for future unicorns… but a lot of investors think they’ll bump into one.

Venture Capital is a strange industry because some of these groups act and interact for emotional reasons. There will rarely be a bubble in a market when there are only Leaders and the Conscious Herd; bubbles are caused by Elders (in the higher atmosphere) and the Unconscious Herd (who agree to inflated valuations in early and seed stages).

The rise and fall of everything in venture capital start with a herd behavior of those two groups. Either a small trend that suddenly escalates, a specific snowball effect that changes habits in 1-2 years or a strange move that seems good at first but rationally makes no sense. Here’s what happens next:

  1. The Conscious Herd experiments more or follow the Leaders
  2. The Unconscious Herd will stay behind and moan their dead
  3. Elders co-invest with larger bets
  4. Leaders lead because there’s no other way

Groups 1 and 2 generate waste. The ones in group 3 don’t care about waste (but may change their minds when the market turns). Lean VCs are mostly in group 4 because there’s no worse vision than waste in capital. Being conscious about your limitations as a VC – regardless of past wins and losses – is a fundamental feature of a lean investor.

The secret is to make a move, no matter where the market is going. There’s no bubble for startups that grow fast and strong, and for VCs that ignore the herd.

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Vanity Metrics in Venture Capital

Venture Capital is a craft. Despite of the scientific, academic, and economic models that form the fundamental grounds of the venture capital industry, there are everchanging variables that make it hard to define the exact business model of a successful VC. After all, you can model the past performance of a portfolio and understand it, but you can’t even predict the future of a single investment with precision. In other words, investors can’t prove in advance how they’ll leverage high-growth companies to multiply other people’s money… hence, past numbers are all VCs have on their defense.

Speaking about numbers, a lot has been said about the vanity metrics used by entrepreneurs to impress investors: facebook followers, registered user base, number of Fortune500 clients, you name it. VCs repeatedly remind those founders that it’s not about how much you have, but how much you deliver. So they discuss user engagement, churn, lifetime value, and montlhy recurring revenue growth to make things clearer, paving the way for a potential investment negotiation.

Fine. But have you ever thought about VCs and their own vanity metrics? What numbers do VCs use to impress founders and their own limited partners, in a way they feel confident and seem attractive to people, companies, and organizations that hold a considerable amount of money to be multiplied? Let’s look into three of those.

Capital under management

First thing most big funds use is capital under management. Fair enough: billions of dollars are a pedigree certificate, and it usually takes a long time to build an asset that big. But that’s just deployable money, right? And not performance guarantee. Yes, the fund has a track-record and has been able to harvest that amount of bling – but the taller you are, the harder your potential fall by bleeding money on a bad investment. They compensate that risk by following other funds on big rounds in already established companies, or aiming for thinner air and creating a private equity operation.

Return on managed capital is a much better metric than capital under management. When considering a fund, potential limited partners usually know the gain of each managed fund…So wouldn’t it be great for founders to have access to the same metric, and what’s the story behind it? So when analyzing funds, aim for leveraging and returns, not how much money they hold.

Number of big portfolio companies

Imagine the thrill a founder feels when clicking “Portfolio” in a fund’s website and seeing companies like Dropbox, AirBnB and Uber on that list… This is how big funds hook entrepreneurs. Even so, there is a considerable chance that fund followed another fund on that investment. In other words, it didn’t find that startup by itself. But isn’t this how a fund differentiates in the VC market? By finding all the great companies long before they’re discovered by others?

Instead, find the big companies where the fund has been an early investor. Since big funds will often concentrate their bets on billion-dollar companies, the foreseeing powers of a fund will often translate on the companies it found way before everyone else. It’s even better when they’re a big fund, but bent their rules to invest small bucks on a promising startup.

Return multiples

You’ve probably heard this somewhere: “Our most recent exit was a 10x return” – meaning the return was 10 times the capital initially invested. Consider an investor holds 30% of the startup’s equity:

  • If the fund invested $2M, the startup exited in a valuation of ~$60M
  • If it invested $10M, the startup exited in a valuation of ~$300M

Thus, the multiple helps if you know the amount of capital originally invested and when did the fund invest. If you don’t know round details, the return multiple is just a vanity metric. A tenfold increase in valuation takes considerable time for most startups: was 10x a great investment? Maybe, if it didn’t take 10 years or longer.

A 50x on the best investment made by a fund compensates for all the losses on all other portfolio startups. So if you’re really evaluating how the fund performs, the wins and losses could be on the table for a better analysis; the list of returns on single investments is a better metric than single return multiples, because it’s like a drill-down in the first metric: it brings all the 10x and 20x down to 0x sometimes, because a fund is not all about hits.

You’re so vain

You probably think this post is about you – well, not necessarily. But if a VC is looking into better investments and less waste, metrics should be a heavy duty.

The average founder is not always in a picky position to choose a fund – they mostly need the money, wherever it comes from. Smart founders, on the other hand, envision their subsequent rounds and think: what are US$ 5 billion worth if all we need is a US$ 5 million round? Then the questions become:

  • will they bring other funds to the table, diversifying networking and reaching other markets?
  • how did the other invested founders leverage the fund in their own benefit?
  • how does the fund relate to its invested founders over time?
  • how hands-on are these guys?

And many others related to quality, not quantity.

The vast majority of returns, even for big funds, lies in the basis of the pyramid: early-stage startups. When investing early in (still) small but promising startups, funds can dramatically improve their performance in a course of 5-7 years. If they look deep into themselves and consider the numbers that really matter (instead of self-deceiving themselves with vanity metrics), there is an incredible opportunity for improvement.

The MENTOR Framework: Six Things To Improve your Feedback Sessions

I’ve founded two startups and co-founded another, exited my last one, invested on a handful, and founded an accelerator. That added considerable experience to shape myself into a better mentor, and I’ve been paying it forward for some time now:

  • I have directly mentored 300+ different founder teams, some repeatedly, usually on closed sessions or skype calls. Each took from 30 minutes to extensive 4-hour discussions.
  • I’ve written 10,000+ emails with feedback on pitches, ideas, business models, or simply recommending useful literature on specific topics the founders needed to improve
  • I’ve worked closely (weekly meetings mostly) with dozens of startups and helped them grow, some reaching 7 to 8-figures revenue on less than five years

Those would be just numbers if I weren’t a conscious perfectionist. As a consequence, I’m insanely cautious about two things: a) achieving the best outcome I can, as every perfectionist desires, and b) doing more with less to quickly reach the intended results, thus reducing my exposure as a shameful perfectionist. To be more effective and efficient, I spend considerable time trying to find my work patterns and molding those into frameworks – always increasing reuse and reducing waste.

So I recently blueprinted a mentoring framework I’ve been using for years, and it occurred to me: the best way to improve it is to share it.

Overview

The framework uses six key concepts to be kept in mind before, during, and after feedback sessions, and together they form the acronym MENTOR:

  • the Mechanics of the business
  • the Empowerment of the founders
  • the Network a mentor can bring
  • the Trust that good teamwork can create
  • the Objectiveness of key arguments
  • the Results and mutual benefits

Let’s dive deeper into each one of them, and hope you memorize their meanings by the end of this post.


Mechanics

The M stands for Mechanics, so we can understand the engine that moves the company. The goal is to discuss refinements, validations, and improvements in the business model that may lead to a more scalable business.

I usually start with a business model canvas in my head, but the plot thickens depending on the startup’s stage. Here are the M questions to answer over time:

  • Are we satisfied with the present problem/solution fit? Is there room to improve?
  • What is the nearest business model we can validate to get initial revenue?
  • How can we improve the scalability of the business model?
  • What are the key drivers or metrics that must be tracked?
  • What are the riskiest assumptions we can validate first, for every model hypothesis we have?
  • How does all that propagate to the team, plan and operations?

Mentors who think out of the box often are the ones who suggest innovative and profitable business models. So mind the M.


Empowerment

The eagle teaches the eaglets to fly by staying close and letting them dive by themselves. Keep this metaphor in mind, because the E stands for Empowerment.

This is critical for early-stage startups: we must help the team find the answers, and not impose the answers we already have. The founders must feel confident they’re improving and learning together with the mentor – so they’ll solve the hard things by themselves.

Here’s what you must consider to empower the founders:

  • Am I imposing directions? I should not.
  • Did they get to the answer by themselves? If not, how can I run around the issue and help them figure it out?
  • Are they right and I’m wrong? Maybe I’m wrong!
  • How can I reach a middle ground that I’m confident will work?
  • What task or references can I list to help the founders decide on this?
  • Remember motivation works well to reinforce good behavior: “Nice!” or “You got it!” should come out naturally when the founders solve stuff out.

Is the mentor pushing too hard? The founders can drive the discussion towards those points and help the mentor realize opinions are too biased.


Network

This may seem obvious to most mentors, but not many exercise the N (Network) the way they should. The expression “Expand your network” needs no further explanation, so here are the key reminders:

  • What founders do I know who have been through the same problem?
  • What investors do I know who can help them out without being judgemental?
  • What contacts do I have in their Customer Segments who can try the product, or help validate it?
  • Can I help them sell this as it is, right now? Who should I pitch?
  • If I’m not able to help them on this, do I know anyone who can?

Founders should always remember the networking factor on a mentoring session. Ask for contact info right away, not later.


Trust

There’s no I in MENTOR. The T stands for Trust to constantly remind us that mentor and founders must form a cohesive and dependable team, each one resembling the rock climber fixing the rope right above you.

There’s also an intrinsic ethics present in every feedback session: confidential operations details will be verbalized by the founders, and personal stories will be disclosed by the mentor. Hence, some conducts must be observed:

  • Ethics is massively important on mentoring
  • The mentor should not impose his experience nor act as an omniscient deity (mentors learn as well!)
  • The mentor should not impose respect, and should avoid comparisons between how mentor and founders performed
  • Mentors and founders must compromise to deadlines and pending tasks
  • Mentors and founders must be able to simply have fun, even while discussing the heaviest topics

In my experience, when founders and mentors build a bond that allows for straight-up teamwork and trust, feedback sessions and the overall relationship play a key role in the evolution of the business.


Objectiveness

Remind everyone in the room to be Objective: when someone says “I think” or “I like it better” in a feedback session, a fire alarm should go off. That speech balloon should be instantly replaced with “Warning – I’m stating an opinion that may in NO way relate to the inexorable truth. That said, [ insert the original remark ]”.

That doesn’t mean people can’t issue opinions, but instead prevents subjective decisions to influence the startup in a harmful way. Here are the tips:

  • Look up numbers and facts that corroborate your opinions
  • Define the metrics that will validate which path to follow
  • Propose assumptions that invalidate the present conclusions (they are mostly intuitive ones, and those should be minimized whenever possible)
  • UX is only validated by users, not anyone’s (much less a mentor’s) design skills
  • Shut up and listen. Rethink what you’re about to say, and rephrase it in a non-subjective way

So be objective, and trigger the fire alarm whenever an opinion may clutter your perception of reality and what must be done.


Results

It all comes down to the R: Results. They provide greener pastures and better crops; they must be found, measured, and compared. As a consequence of great results, a mentor may become an advisor, investor, board member or earn sweat equity. I dare to suggest a recipe for R:

  1. Finish all mentoring sessions with “What have we learned today?”
  2. Then ask “What are the key issues that need further addressing?”
  3. Then ask “Who will take care of what?”
  4. Take notes of “Who – What – When” to make sure things get done
  5. Follow-up on those notes at the start of the next session
  6. Mark down the strongest results so you can review them later

Make sure results are tracked; see that the work and effort spent on mentoring sessions will not be lost into oblivion. Keep them either on a shared Evernote, spreadsheet, or even Slack channel, and you’ll be amazed of how much can be done with mentoring if you follow this framework.

Exercise all six concepts equally

First of all, remember that the best mentoring is long-term. Quick feedback sessions can make great use of this framework, but its real benefits are only tangible over frequent sessions.

I don’t believe I’m the best mentor many people have had. I’m more demanding than I should, way too blunt sometimes, but that bug is my best feature to help get things done. The specific issues I need work (and constantly try to exercise that) are E and T, and my highlights are M, O, and R. So I do recommend you try to know what your strengths are, and improve your weak spots.

It’s hard to go through all six concepts in MENTOR on a single mentoring session, but always keep them in mind. As your experience progresses (or as a founder, as your mentoring sessions flow) you start getting the whole picture and the modus operandi unconsciously falls into place. If you’re a bad mentor, you will get better by exercising this framework. If you’re already a good mentor, you will gradually notice your effectiveness increases as the time passes; and if you’re a founder, you may use it to make sure your mentoring sessions – good or bad – tilt towards what you need by getting the mentor into the right path.

Click the image below to download a quick reference card on the MENTOR framework. It is yours to use – let me know how it goes.


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