I am often asked about business plans (whether to write them, what format, how to know if a business idea is legitimate, etc).

There are lots of right answers (and wrong answers) to this question.  For purposes of this short note, I’d like to recommend a tool that is in use at top consulting firms and which can help you quickly organize yourself or a team around the key issues you need to understand in a business.   Please step through the PowerPoint below and let me know if you have any questions!

Using the Pyramid Principal to Get Organized

In product development, conventional wisdom tells us that we need to constantly ask our customers, “What do you want?”  We listen carefully to the answers, prioritize those that get the most requests, and we turn around and build them.  Within a few months, we have a killer product.  Product development could not be simpler.

However, if you’ve ever participated in a “What do you want?” product development effort for a startup, you’ve seen the actual results.  Instead of killer new applications, you will likely have a me-too product, a poor-man’s version of the market leaders in your space.  Your customers are not visionaries or industry thought-leaders.  Instead of projecting into the future to imagine radical new solutions, they will recall what they liked about other products they have seen.  Or they will think of minor tweaks to the existing product that will make the experience slightly better for themselves, but possibly worse for your other customers.

Even Google has been criticized for pursuing a data-driven approach to the “What do you want?” question.  The New York Times wrote on the subject earlier this year, when top designer and ex-Googler Douglas Bowman openly criticized Google’s approach:

Mr. Bowman’s main complaint is that in Google’s engineering-driven culture, data trumps everything else. When he would come up with a design decision, no matter how minute, he was asked to back it up with data. Before he could decide whether a line on a Web page should be three, four or five pixels wide, for example, he had to put up test versions of all three pages on the Web. Different groups of users would see different versions, and their clicking behavior, or the amount of time they spent on a page, would help pick a winner.

“Data eventually becomes a crutch for every decision, paralyzing the company and preventing it from making any daring design decisions,” Mr. Bowman wrote.

That is not to say that that this type of customer feedback is not valuable, Google has leveraged it well.  But, used alone, it can create a process that leads to middling innovation instead of big leaps forward, especially for a startup when big leaps forward are critical.

The real problem is that you may be asking the wrong question.   You are relying on the customer to take on your job as innovator and to tell you what your product should be.

Two better questions are, “What do you do now?” and “What problems do you face when you are doing it?”  These questions move customer feedback further up the innovation process to problem identification rather than product definition, which then puts the responsibility on you to be the innovator and design the product.

“What do you do now?” is a question that gets to the heart of how your customers are trying to solve the underlying problem today.  By engaging a customer in this discussion, you should learn more about the fundamental problem they are trying to solve, and how they currently think about solving it.  You should begin to understand how they spend their time, their willingness to spend money on the problem, the roles that friends and family play, and their level of need, all of which will help you design a product that fits into their current lifestyle.

The answers to “What problems do you face when you are doing it?” should give you insight into their pain points with current solutions, their frustrations, and areas of satisfaction.  By the end of several of these conversations, you should be able to see clear opportunities where a new, differentiated solution would make their lives much easier.

One of our portfolio companies, iChange, is developing an online service to help people lose weight.  We worked hard to get customers to be part of the product development process, but early on found that if we simply followed the “what we want” comments, we would have quickly ended up with a second rate version of Weight Watchers.   When we finally stated asking “What do you do now?” and “What problems do you face when doing it?” we started to get a different picture of our customers and began to generate ideas on how we could truly help.  We learned that if a spouse or best friend was dieting with them, losing weight became much easier.  Without a supporter it was nearly impossible.  We learned that a scorekeeping system of points or calorie counting was intimidating to many people and didn’t address some of the underlying personal issues that ultimately led to weight issues.  We learned that fitting into an old pair of jeans was an immensely satisfying experience, even more so than seeing a five-pound drop on the scale.  The responses gave the team a much clearer view on the customer, shortcomings of existing solutions, and opportunities to create an innovative and unique solution.   It resulted in a very non-Weight Watchers product where customers consult with nutrition experts and online support groups for guidance and accountability.  So far, the customer response has been overwhelmingly strong.

In truth, the most common error for early-stage companies is not listening to customers at all, so any feedback into the development process is helpful.  “What do you want?” certainly has a place, especially further down the innovation process when you are testing and refining, rather than creating.  But as an early-stage company, where great leaps forward are going to be what make you a success, make sure you are asking the right questions.

Entrepreneurial Optimism

After 20 years of building entrepreneurial ventures I have had no choice but to be a devout optimist.  The challenges are overwhelming, the naysayers abound but we as entrepreneurs persist.  Over this period I have personally been involved in over a dozen start-up ventures with two-thirds of those under the umbrella of Momentum Venture Management (www.mvmpartners.com), the early stage venture fund/accelerator I started 6 years ago with Matt Ridenour.

The Undeniable Reality

However, we as entrepreneurs most acknowledge the nature of the challenges we face.  Not so that we can become discouraged but so that we can be prepared and thoughtful about how to overcome them.  I think right now it is undeniable that we are facing an extraordinary pull back across the venture spectrum.  I strongly disagree with Wil Schroter’s recent post on SoCalTech (SoCalTech.com) that people are“eager to write checks.”  The rule today is that raising venture financing is extraordinarily difficult. The exception is that a few sharp, experienced entrepreneurs like Wil can still quickly pull in modest amounts of capital from the personal wallets of a few name investors who under “normal” conditions would typically be writing much larger checks from their funds.  Furthermore I anticipate only a gradual thawing which I don’t expect will begin in any material manner until the first half of 2010.  The evidence of this broader reality is overwhelming and is directly contrary to Wil’s personal experience:

•    Venture capitalists invested 48% less capital in Southern California during the third quarter with $458 million put into 66 deals (Dow Jones Q309)
•    Dramatic move away from first time/early investments – 60% decline year over year in first time financing dollars (PWC MoneyTree)
•    13 year low in technology investing (Dow Jones09)
•    Massive drop off on new deals from groups like TCA and Pasadena Angels – now primarily focused on supporting existing deals (just ask a TCA or PA member)
•    Recent showing of investors (or lack there of) at VentureNet (which I believe is one of the best early stage gatherings in SoCal)
•    Personal experience at Momentum where we historically could work with a portfolio company and secure the next round of financing in 3 months; now we are looking at 9 – 12 months if at all
•    Massive drop off in valuations and dominance of down rounds (as they say, flat is the new up . . . if you are lucky!)

OK – I think you get the point.  It is ugly . . .  .really ugly!

Getting the Cash Flowing Again

So what is the basis of this massive slow down and what has to change to get investors to start writing checks again?  First, I believe that it is unlikely we’ll see a return to pre-crash levels (it will be similar to unemployment – a much more gradual up-tick).  Many of the issues are structural and may never go away.

For institutional funds:
•    Reallocation of institutional investors to more liquid asset classes (embarrassing that Harvard had to issue $1.5Bn to pay its bills)
•    Reallocation of institutional assets due to the denominator effect (essentially rebalancing of their portfolios to reflect the depreciation of other more liquid asset classes)
•    It is widely known that many institutions have instructed their funds to limit additional capital calls even though the capital is “committed” – the implication is that there are now funds that can no longer count on having “dry powder”.
•    Lack of liquidity in current funds and unrealized returns make it difficult to raise new funds
•    The recession has depressed growth rates and extended timelines to reach cash flow break-even, thus increasing the need to invest additional capital in current portfolio companies rather than new companies.
The common wisdom is that we are at the beginning of a massive contraction in the asset class both in terms of dollars under management and number of firms.  The National Venture Capital Association has publicly commented on this: Washington Post

I think the angel story is marginally more positive:
•    Clearly the massive depreciation of individual balance sheets has forced many angels to take a more conservative approach to riskier investments
•    The lack of investment by down stream capital has required they put most of their dollars toward protecting current portfolio

However:
•    Recent stock market rebound and bottoming out of real estate has provided some level of stability in their balance sheets – though the scars are still fresh at this point
•    Investing is usually a “hobby” that they enjoy so there is generally a passion to return as soon as it seems somewhat sensible
•    Decision making is concentrated in the individual and not tied to investment committees or LP’s; if they start to feel good they will start to write checks (witness Wil’s previously referenced experience with affordit.com)

We are already seeing some early indications that angels want to take advantage of current market conditions and do deals that historically they could not access at valuations that are often 50% less than what they were at 12 months ago.  Part of the success Wil experienced was probably associated with these factors.

So What Does it All Mean?

Entrepreneurs need to accept that capital will be much scarcer for quite some time.  There are particular implications depending on where one is in the company building process.

•    Just starting out:  Find businesses that are highly capital efficient where you can build a company with your own capital or friends and family without relying on traditional VC; possibly consider consortium models or strategic partners instead.  With the abundance of free or inexpensive technologies available to entrepreneurs, the cost to start many businesses is a small fraction of what it was a few years ago.
•    Ship has left the dock: If you have started a company that is heavily reliant on VC be prepared to work closely with your current investors as they most likely are the ones who will have to support you for the duration; look at revising your business plan to reduce capital needs.  If you need to access VC then allow plenty of time and do everything possible to show traction.
•    Later Stage:  Reset your expectation around potential partial take-outs through mezzanine rounds and time to IPO or exits.  Consider yourself lucky if you have achieved sustainability but be prepared to be “pulling an oar” longer than you had expected.

In this changing environment, even perpetually optimistic entrepreneurs need to adapt their strategies and expectations for fundraising.  There will always be money out there for great businesses led by passionate entrepreneurs.  But the amount, the time to raise, the types of investors, and their expectations on traction will likely make the fundraising experience a much greater challenge than in years past.  My hope is that rather than denying today’s reality, entrepreneurs will do what entrepreneurs do so well – look at the situation and use their creativity and enthusiasm to turn a challenge into an opportunity.  Go build that business, solve that problem, change the world.  But be careful about counting on VC backing to be the primary fuel to power your dream.   The cash simply may not be there for you. Like Wil, seek out angel investors and other pockets of capital who believe in what you are doing.  Good luck!

Will it and it will be so.  Sounds crazy – but then again what isn’t in the world of entrepreneurship?   I have been accused of being a naïve optimist, seeing the world through rose colored glasses, drinking the Kool-Aid and various other clichés for someone who always is looking for upside.  Does this mean I am disconnected from reality or losing my mind?  Perhaps.  Then again, perhaps not.

I have been giving some serious thought about what keeps entrepreneurs going.  There are so many things working against a start-up: no resources, no brand, no cash, naysayers, etc.  It is all about the dream.  It is the pursuit of the dream that motivates entrepreneurs to do what it takes to succeed; things like staying up all night several nights in a row to get a release completed, tapping into home equity to buy servers (probably less so now) and begging first customers to give your product a test drive.  Does this mean that entrepreneurs are disconnected from reality?  In some ways, yes  They see a better future based on their vision of the possible – potentially something beyond today’s current reality.  I think this type of thinking is foundational to successful entrepreneurs.  It is a crazy/maniacal commitment to making this dream a reality that provides entrepreneurs with more energy than a tractor trailer full of Red Bull.

However, entrepreneurs MUST acknowledge the risks and pitfalls and be open to counsel about how to mitigate unnecessary peril while pursuing the dream.  The goal is to climb Everest, which by its very definition is insane, but with proper planning and good mountain guides the odds of reaching the summit go up and the risk of death go down.  Clearly the entrepreneurial journey is full of pitfalls and littered with corpses.  So what is my point?  I think it is valuable for friends/advisers/VC’s to assist entrepreneurs in their pursuit of the dream by offering short cuts, pointing out unforeseen perils or sprinkling magic fairy dust.  I do not think it is helpful for advisors to challenge the fundamental premise of the entrepreneur’s dream (they are climbing Everest with or without your support) – you may not agree with their dream so don’t get involved or don’t invest.   In my years of dealing with true entrepreneurs, I have never seen a debate between a third party and a founder that has had a positive outcome when the topic is about the fundamental nature of the dream.  To be clear, debate is good around the execution and realization of the dream but not around the core assumption.  I’d argue for true entrepreneurs their dreams must be irrefutable otherwise they won’t have any chance of making it to the summit.

Recently, the website, “PerfectBusiness.com” did a series of interviews with the team at Momentum.  Check them out at:

Andy Wilson Interview

Stu MacFarlane Interview

Matt Ridenour Interview

Yesterday’s VentureBeat had an article suggesting that the old “2 and 20″ method of compensation should be changed.   Unfortunately, they suggest that perhaps fees should be reset across the board.  It seems that while the larger investment community is finally focused on the problem of mega-funds that they are missing what is perhaps the bigger problem — the lack of early stage funding.   If fees for all funds were reduced it is even less practical to run a small fund!

Following is my comment on that blog:

First, I completely agree that the venture model is broken. I also agree that large funds cause most of the problem and huge fees are the big incentive to raise large funds. HOWEVER, wholesale implementation of lower fees as “standard” would actually make part of the VC problem even worse.

One of the biggest challenges facing start-ups today is a lack of seed and early stage funding. Part of the reason for this is that institutional investors no longer back early stage funds (which is strange since they’ve always had the best returns – but that is different story). Part of the reason is that it is not economically practical to operate a small fund on 2% fees. Let’s assume that the perfect size fund for first round investments is $20mm. The annual fees for this fund would be $400,000. Many would argue that it actually takes more staff in a small fund than a large one (because early stage companies generally have more challenges).  So, running this size fund with 2-3 partners, a few associates and an office is simply not possible.

My view (which is extremely unpopular in VC world) is that compensation should actually be tied to PERFORMANCE.  Institutional investors should negotiate a maximum base salary with GPs (like investors do with CEOs!) and the carried interest should represent the upside (like a CEO’s stock options). I think this change would go a long way to resetting the industry as the best GPs might start migrating back to early stage deals where the upside has always been much greater, rather than getting fat and happy with management fees.

I attended the Los Angeles Dealmaker event that featured several angel and seed-stage investors on the panel:  Jarl Mohn, Scott Sangster (Organic Startup), Rob Hayes (First Round Capital), and Thomas McInerney (TGM).  The audience of entrepreneurs were witness to some candid discussion on how to make contact, structure deals, and manage relationships with angel investors as well as some of the differences between angel investors and venture capital investors.

If you attend many of these events, you often hear the question, “How am I supposed to contact an angel investor or venture capital investor?” with a hint of frustration lingering barely below the surface.  It’s a legitimate question.  Every entrepreneur has had emails or telephone calls go unanswered, or has felt like giving up after navigating around a VC website in search of an email address only to find the dreaded black hole of info@[name of vc].com.

The same question was posed last night.  Rob Hayes was the first to answer it and addressed it in a way that will frustrate some would-be entrepreneurs but satisfy others.  To paraphrase, he said that “True entrepreneurs just figure it out.”  He went on to give examples of how the most interesting entrepreneurs didn’t just find one way to reach him, but were able to find several different channels.  “Once someone finds three ways to reach me, I have to get on the phone to find out why I don’t know this person already.”

His point is that anyone who has the persistence and creativity to reach him is probably using the same skills in other parts of his or her business, from recruiting to sales to negotiating a lease.  In other words, that person is a true entrepreneur and was just able to figure it out.  For the true entrepreneur, figuring out how to reach Rob is probably second nature.

For the rest of us that aren’t born entrepreneurs, what can we learn?  The first is that if you are going to be a successful entrepreneur, you have to train yourself to be aggressive, persistent, and creative about problem solving.  In the case of reaching out to a potential investor, if you are the type of person who gives up after sending one email to the general information email address, you may not be the right person to start a company.

Understand that investors are just like you and most people you know.  They are social creatures who rely on trusted relationships to send them good leads.  It means that the best way to reach an investor is to find and build trust with someone in the investor’s network who will pick up the phone to tell the investor that they absolutely have to talk to this brilliant entrepreneur.  Better yet, you find two or three people that make the same call.  It won’t take long for Rob Hayes to be dialing your cell phone number and inviting you to coffee.

The best tool to find common relationships is LinkedIn.  If you are a first degree relationship with someone, you will likely be able to view all of their contacts, and most VCs and many angel investors will have hundreds of contacts on line. If you’re not connected, LinkedIn will show you common connections.  After you check one investor, do the same for all of his or her partners.  Then check to see which company boards the investor sits on to see if you know anyone who might work there.  You should check their blog, tweets, interviews, anything you can to see if there is a common connection or path in.

Once you find a connection, you need to treat that person as well as you would the investor himself.  That person is your gateway and needs to be convinced that you are worthy of mentioning to the investor.  Don’t just ask for the introduction and expect it to materialize.  You should be prepared to give them your best pitch, show a product demo, and get them so interested that they feel an obligation to pass your information to the investor.  You should also have a short blurb on your company that your gateway person can paste into an email as well as a short executive summary that they can send.

Finally, while you need to be aggressive, always remember to remain professional.  While you are pushing hard, make sure you come across as someone with whom an investor would want to work.  Make sure your pitch is convincing, your materials are well prepared, and that you listen to questions and critiques.  Keep a sense of humor along the way.

In other words, “Just figure it out.”

After almost 3 years at Momentum, I’m rounding the corner on my final week.  I’m headed back to school full-time this fall, so for the last several days, I’ve focused on winding down and transitioning myriad projects.

It’s always such pain to recount everything worked on and dig up all sorts of important details.  But compared to my exit from consulting 3 years ago, this is MUCH easier due to the tools below (and more).  I’ve been almost completely paperless while at Momentum, but in previous jobs I dealt with tons of boxes and file cabinets.  Yuck.  But all this got me thinking about how much the world has changed since 2006 due to a handful of technologies.

File storage

In every other job, I worked in an office, and everyone stored their files on a file server.  This made sense since if a desktop/laptop went out, all files were fine.  But at the same time, copying and pasting files between folders in Windows was routine and error-prone.

This time, I’ve set up “drops” using one of my favorite tools, dropio (www.drop.io).  I just drag and drop a few files using the firefox extension, give it a password, choose a URL, add some comments, and I’m done.  No VPN’ing in to the office remotely and dropping connections in the middle of file transfers. No having to send long directory paths to someone else so they can find the file.  I just e-mail a URL and password and that’s it.  Collaborators can leave comments on files and add their own versions.  And it’s so much more “green” to e-mail a URL than a 10+ MB file attachment!

SaaS > desktop software

It recently occurred to me that I use SaaS almost exclusively.  In 2006, I barely used any applications through the browser, but now I barely use any applications on the desktop.

Unless I need to build a model or run pivot tables on large datasets in Excel, I make all my spreadsheets in google docs.  It’s only a matter of time before Excel is obsolete.  And anytime I’m collaborating on a document that doesn’t require heavy formatting, it’s google docs as well (it now has styles and an killer table of contents feature).  Management dashboards, small project plans and sales pipelines?  Yup, google docs.

What about structured information?  Well, lots of great tools exist for that:  Zoho for CRM, wiki, screen sharing and much more.  Liquidplanner for project management (or sharepoint if some insist).   A few years ago, I’d have to get IT approval to purchase a client/server project management system, someone would have to install/manage/support that system and install desktop software for each user.  Now, almost everything SaaS is turnkey and can be used by anyone with a browser.

Training

In the old days, I’d write a long memo in MS Word or Powerpoint along with printscreen to document some sort of process.  Sure it took a long time and it was hard to communicate certain ideas.  But now, I’ve embraced the magic of screencasts.  I use jing (www.jingproject.com) very frequently to create a demonstration along narration.  Jing runs on both Mac and PC and will upload a .swf file in flash format to screencast.com.  Just share the URL and others can learn from your video.

But the best part is that everything above is free (or freemium)!  And I think we’ll see even more improvement over the next few years with the remaining few desktop apps lose their footing.

What emerging, office productivity tools / methods have you started using?

Post ideas or questions to comments below.

I frequently have people come up to me and tell me that I am a great networker.  Especially in this economy people want pointers on how to build a high value network.  As I have gotten older I have come to realize two profound truths: 1. who you know is as important as what you know and 2. it is better to be lucky than good.  Like many things, networking is part art and part science.  Some people (like myself) derive great pleasure from meeting new people and building new relationships.  I estimate that I spend 10 – 20% of my time every week developing my network.  Because I enjoy meeting interesting people I have no problem developing my network after hours and on weekend.  Frankly it is one part of venture capital that I like the most.  While personality traits do make a big difference in one’s ability to create a network, anyone who has basic social skills can build a network.  Here are some general pointers: 

• Decide why you want a network.  I find people who just want to network with no purpose in mind to be annoying. Think about what common interest can link you together.  Obviously networks can be for business, a hobby, social, non-profit, etc.  The best networkers learn to develop overlapping networks – this way you can leverage your relationships for multiple purposes.
• Target your energy to people who fit your profile.  If you are a serial entrepreneur who frequently needs angel investors then you may want to set your filters for people who do angel investing in the areas that you are likely to pursue.  This is not suggest that you be rude to folks that don’t fit your filters but graciously move on as you may find a future need to connect to that person.
• Develop networks proactively.  Networks take time and need to be nurtured.  When you find someone who fits your target profile be sure to pursue them.  Be persistent but not pushy.  Follow up but don’t be presumptuous (i.e. don’t invite someone to a long fancy dinner as a follow up to a short conversation – try a phone call or a coffee instead).  You will want to look for mutual benefit in the relationship in order to engage the other party in maintaining a two way relationship.
• Make networking fun.  Though networking is a serious business tool, don’t make it drudgery.  If you are not having fun then no one will want to hang with you. Think of it as a game – set goals for yourself (i.e. meet 1 new high value contact a week).
• Categorize your contacts.  You can flag contacts in Outlook.  I use such flags as CEO candidate, entrepreneur, angel investor, industry leader, etc. so I can search my contacts when I am trying to accomplish something.
• Cull your network.  As you get more experienced in networking you will be able to upgrade your network so don’t be afraid to prune your network over time.  Unfortunately we have limited time and mental capacity so even working smart there will be limits to how many relationships one can cultivate at a single time.
• Other tools.  Beyond your own personal networks, I find leveraging shared backgrounds works well in connecting with people. In particular school affiliations (HBS alum) or previous employers (Bain & Co) are good basis for connections.  I find LinkedIn to be a great way to find relevant contacts.  I think Facebook, or possibly Twitter, can be valuable as well but I have yet to masдиваниter them.

I guarantee it will deliver highly valuable dividends if you define your purpose and commit to building your network. So go out there and have some fun meeting some interesting and relevant people.