Should Muammar Gaddafi pivot?

(This week’s guest post comes courtesy of a well-known celebrity VC blogger.)

When your startup’s magnificent plans inevitably crumble to Ozymandian dust in the face of some unforeseen market reality, VCs often say it’s simply your customers’ way of telling you to change direction fast, AKA “pivoting”. So, if Muammar Gaddafi were a startup in my portfolio, what do you think I should be saying to him right now? “Pivot, you moron!“, right?

Well… there are those who would point out that the sustained highlights of 42 years of the Libyan Arab Republic make pretty persuasive slideware:

• plenty of traction (usually at gunpoint)
• great channel control (also usually at gunpoint)
• extreme horizontal and vertical integration (forming a monolithic state apparatus)
• sustained dividends payouts to keep the execs motivated (typically in Swiss bank accounts)
• sustainable advantage from a chokehold on regional resources (of the liquid, black, underground variety)
• strategic alliances with well-funded allies (Idi Amin, Bokassa, Mengistu, Charles Taylor, Gordon Brown, Patassé, etc)

Having myself seen thousands of startup presentations, I think that if you presented a killer presentation deck full of slides like the above, most VCs would eat your hand off even for a slice of the Series Z round. So, when Gaddafi’s IP (‘Ideological Property‘) is so clearly a winning formula, why on earth would anyone want to fix something that isn’t broken?

Well… if you believe the news reports (which, as you know, VCs never do – the world outside Sand Hill Road remains eternally off our radar), events in Tripoli would superficially seem to indicate that Gaddafi now has active competitors in his segment. However as we modern VCs like to say, the presence of competition merely validates the whole marketplace. Hence for us, fighting on the streets is no more than a market signal that Libya is indeed a prize worth fighting for.

It’s entirely true that back in 1969, VC firms would surely have invested in risky, passionate, ambitious young guns like Gaddafi (though for, say, Sequoia Capital, this would not have been possible – it was founded three years later). But really, we’re now far more interested in backing old guns: those heady days are long, long gone. And even though as an industry, we continue to be obsessed with talking about startups and with blogging about pivoting, you have to understand that in reality we find it 20x easier to do deals with mature industry players (e.g. Gaddafi circa 2011), simply because the main reason they need money is greed, not growth. Which is an attitude LPs in Menlo Park can really relate to.

Don’t get me wrong, VCs still love backing startups: the only caveat being that we tend to define ‘startups’ as “40-year-old firms with multi-billion dollar revenue who don’t actually need VC money“. So what do you think now: should Gaddafi pivot? I’d say no way – if he was smart, he should email us a deck, I’m sure we’d be able to work something out…

* * * * * *

(PS: a note from the editor: it’s a little-known fact that the letters in the phrase ‘Venture Capital’ can be anagrammed to form

• An Evil Pact – True!
• Let Avarice Punt!
• Cue Viral Patent!
• Crapulent Vitae
• Vertical Peanut
• Teacup Interval

Enjoy!)

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Pivots vs epiphanies…

When a startup hits a market brick wall and has enough cash and investor confidence to change direction radically, it’s a Mike Maples (high level) ‘pivot’. Essentially: a market-driven strategic shift.

When a startup uses early customer feedback to drive its next product/service iteration, it’s an Eric Ries (low level) ‘pivot’. Essentially: a test-customer-driven tactical change.

However, when an entrepreneur suddenly grasps a significantly deeper aspect of the complex relationship between his/her startup, its people, its technology, its market and the underlying societal trends it’s betting on, that’s an epiphany. This may or may not lead to a pivot: but it certainly enriches all aspects of the startup by joining them together in a more connected, thought-provoking way. Essentially: an intuition-driven change of mind and heart.

Having just had such an epiphany yesterday, I can tell you it’s both exciting (because it helps you see your startup’s future roadmap more clearly) and unnerving (because it helps you see what you should have been doing differently in the past). While it’s happening to you, though, it feels as though the ground (specifically the “ground truth”) of your startup is shifting beneath your feet.

The background to my epiphany: having just read a long LinkedIn discussion exchange on latency in IP pan/tilt/zoom cameras (don’t glaze over, I’ll get to the point quickly enough), I suddenly realized why I disagreed with almost every single contribution to the exchange. Informed by 25 years experience developing computer games, I simply could not see how the latency introduced by state-of-the-art video compression techniques (such as MPEG and H.264) could ever be acceptable for interactive control of PTZ cameras. In what I see as an increasingly interactive world, this kind of video compression comes over as anti-trend.

But from there I suddenly grasped how my long background in the computer games industry made me ideally placed to be designing and building a new PTZ camera – for this too is an interactive video system (albeit one without Sonic the Hedgehog and Mario to help sell it). And from there it became clear to me that the tiny board I’m currently bringing to life is at heart an industrial games console. And from there I saw that a key part of Nanodome’s vision should be to make its PTZ cameras more interactive, rather than go anti-trend just to fit into the IP ‘new world order’.

So now I have a brand new set of thoughts to help me respond to the presentation deck provocation: “Why are you so uniquely qualified to meet this business challenge, to take it all the way to market and beyond?” Today’s answer: “because I have one foot each in the computer game and security camera worlds, I’m perfectly placed to design and build properly interactive PTZ cameras”. OK, as answers go this is still a work-in-progress: but you can at least see where I’m going with it.

Have you had a startup epiphany recently?

Is it time to pivot?

Pivoting is an enormous comfort blanket, that warms you with the reassurance you that it’s better to do something – anything – than persist in some perceived wrongheadedness. But… who says that you’re wrong?

Recently, I was lucky enough to have a conversation with an extremely experienced UK security camera principal, who generously let me see a little ‘behind the curtain’ to how things work in his security camera focused organization. He also advised me that though what I was doing was good, he thought I might have slipped a fraction behind the UK market and that I should now make a fairly significant pivot to attack quite a different segment to stay ‘in play’.

I agonized over this for a couple of days: should I follow the numbers I had on my desk and just keep on going, or should I drop what I had been doing and follow his (genuinely very informed) take on the UK market? Persist or pivot? Stick or twist? Should I stay or should I go?

And then it dawned on me that the kind of high-level ‘extreme pivoting’ Mike Maples talks about only makes sense if you haven’t really engaged with your customers from the start. Because if you haven’t built your startup around what your customers repeatedly tell you they need, then you basically deserve to fail: so extreme pivoting is just another way of saying “we failed miserably but still had enough VC money in the bank for another roll of the dice“.

Hence it seems to me that Eric Ries-style pivoting (learning from low-level exposure to customer feedback) is almost antithetical to Mike Maples-style extreme pivoting (learning just after it’s too late from a Game-Over failure case, but having enough credibility or cash to try again). Yes, they’re both “learning”: but Ries tries to learn before the failure (to avoid it), while Maples almost seems to be advocating a Nietschian learning after the failure (so as to emerge, phoenix-like, from the flames) – that which does not kill you makes you strong, etc.

In many ways, they’re both wrong – Ries arguably promotes learning too early (customers often don’t really know what they want, so how much can you sensibly interpret what they tell you when you show them an early version?), while Maples arguably promotes learning too late (failure can be a equally lousy teacher too, if you don’t honestly know why you failed).

In the end, the security camera principal guy was absolutely right, but he’s fixated on competing in his particular corner of the UK market and I decided that I’m looking at quite a different (and much larger) picture. But all the same, I researched and researched until I found a way of adapting our existing security cameras designs cheaply and quickly to allow them to compete in broadly the way he proposed (albeit in a completely different manner).

Demo’ing early product to customers is a kind of statistical sampling, in that you aim to take on board what they tell you to make a better product in the next iteration – but it’s pretty obvious this is replete with potential sampling errors. How did you select your customers? Have you selected enough of them to form a worthwhile dataset? Are they being honest with you? How did you decide what to ask them? How can you be sure that they’re responding in the spirit you think they’re responding in? How are you ensuring that you’re not suffering from confirmation biases (etc)?

In short, just because you can pivot doesn’t mean you should pivot. Something to think about, anyway.

“Funding pivots”…?

Following my post on the absence of a Lean Funding Movement, I thought I ought to at least try to come up with some lean funding concepts, put a bit of thought in. After all, high-concept business models are what MBAs are supposed to be good at devising, right?

The primary constraint on the solution is obvious: sufficient money needs to come into the startup basically before the startup needs it – but the issue is about whether it should all come in while the startup is iterating and learning. After all, it usually takes some time (in Mike Maples’ Jr’s terminology) to carry out “business model discovery”, and so the notion that the startup must have already identified the correct opportunity at the start (as well as its achievable share of that opportunity and its optimal path to achieve that share) in its business plan (Lord ‘elp us all!) goes against the grain of actual startup experience. It’s typically an 80-20 thing: even though knowing 80% is normally enough to take action, it doesn’t mean that you have the other jelly-like 20% nailed to the wall yet (if indeed you ever do manage this).

So, as a startup builds, tests and develops, it zigzags (and occasionally leaps) towards its product/market fit and its market position, both of which it knows only imperfectly at the start: conversely, the problem with business plans is that they almost always gloss over this zigzagging – after all, a typical startup narrative (i.e. repeated failure and delays tempered only by persistence and bloodymindedness) would not be hugely helpful in a business plan, which (after all) is an idealised process towards an idealized end line. So, the question is: how can the contract between angels and startups be made more honest to reflect this?

Firstly, because raising a single round is hard enough in the real world (whatever anyone tells you), let’s try to base a first attempt at a corporate structure for Lean Funding around a single round but with a modified shareholder agreement and modified shareholder behaviour. For the sake of argument, let’s consider a Lean Startup that thinks it needs to raise $500K. But (of course), it doesn’t really know that: for all its spreadsheets, plans and timelines, $500K is still no more than an educated guess – let’s say the figure is broken down into $250K for development, $100K for marketing and $150K of ‘sh*t-happens‘ contingency fund, all based on a post-money valuation at $2M (just because it puts the equity at an easy-to-work-with 25%).

As it develops, however, the startup’s knowledge of what it needs should iteratively converge on more realistic numbers as it moves towards product/market fit: however, what also changes is its “company/angels fit”, i.e. how well the company’s situation sits with its angel backers. It is surely rare to have a Borg-style level of accord amongst your backers – a pivot from (say) a niche strategy to a mass market strategy may leave one or more backers in an uncomfortable place, even if other backers think that it’s a good move.

Let’s say the round raises $500K, but the company puts $300K of it in some kind of escrow – as a ‘lean startup’, it wants to use the first $200K for product development and customer development, and to then give itself the option of making a pivot based on what it has learnt. My suggestion is that the company should then make a matching funding pivot. But what would a ‘funding pivot’ look like? Here are the five basic options I can see:-

1. “Abandon ship”. If it becomes clear that it’s never going to work, the whole lean startup idea of “Fail Fast” should be backed out to the angels. At least they’ve collectively only lost $200K and 8 months rather than $500K and 24 months: as losses go, this is a big win.
2. “Stay on course”. Of course, sometimes it so happens that customers really like what you’re doing. So, just carry on as planned. And why not? Release 50%-100% of the cash in the escrow account and take it to the end line.
3. “Slow down”. OK, this is for when there’s turbulence ahead. Development is going OK, but other confounding market factors are in play. Release (say) $100K to get to the next pivot (renegotiating where possible), and we’ll see how it develops.
4. “Speed up”. The startup’s big development risks are passed, and the market opportunity is significantly larger than we thought. The startup now clearly needs (say) $800K to go big, whereas there is only $300K in the escrow account. The startup needs a new funding round, but having $300K in the bank is surely a much better point to be looking for more money than if you have $0K in the bank.
5. “Change direction”. The hardest situation of all – but probably the most honest, because it’s based on much more information than the initial funding round could ever have been. Some backers might want out, others might want to double up, while some might want their share converted from equity to some kind of debt. You can think of all this as a ‘lean’ internal re-funding round, to try to find a better company/angel fit in light of what has been learned.

(…I’ll leave the issue of how such decisions should be made to another post entirely…)

Note that I don’t have all the answers, these proposed “funding pivots” are just my tentative reachings towards a better (and arguably more transparent and financially honest) way for angels and entrepreneurs to do business. If startups iterate, why doesn’t startup funding iterate too?

“Business Plans, R.I.P.”…

Mike Maples hates them (he thinks they’re static, when startups are dynamic), and that the way business plan competitions are promoted by business schools sends out completely the wrong signals to entrepreneurs. Dave McClure hates them too (and for all his sweariness, he’s not actually much of a hater), while Fred Destin says:

It’s been said 150 times, “Nobody reads business plans.” Let’s make it official. Nobody reads business plans.

Does any well-known angel or angel blogger actually endorse business plans any more? Even Guy Kawasaki seems to have gone quiet on the subject of BPs since 2007 (I’ve emailed him to ask what he thinks now, so we’ll just have to wait and see if he answers).

For my part, I suspect that business plans are just a hangover from the MBA-business-is-good-business mythology: relative to the IPO boom party, they’re the morning-after bottles-of-Cinzano-with-cigarette-butts-in. Which is to say that business plans are like ‘certainty dinosaurs’ trying to hang on an uncertain post-Cretaceous world. A bit like MBAs, really. (And I say all that as an MBA, not as an MBA-hater.)

Really, somewhere along the line, the whole ‘send me your business plan‘ notion seems to have died a quiet death: UK angels are now far more interested in a persuasive verbal pitch, an exec summary and a Y1/Y2 cashflow projection (even though that’s arguably no more than a ‘management accounting prØn’ take on business plans). The view seems to be: just prove you can survive 18 months, everything beyond that is a business fairytale.

All the same, I do still get asked for business plans, but I’ve edited mine down to seven pages, which comprises things like (a) a handy industry primer for investors (because angels don’t generally know about manufacturing), (b) the company’s business vision, (c) an ultra-short-term roadmap, and (d) description of the people. Yes, it’s basically a literate presentation deck, because that’s all that people want to see.

Probably the best thing you can say about a business plan is that it is a snapshot of where your conception of your startup is at. But of course, at the semi-glacial speed that angels typically move at, a lot can change in the three or more months that pass between drafting a killer business plan and any angelic money hitting the company’s bank account. Not only has your startup changed, but so has the world around it:-

• Your competitors have repositioned their products.
• Other new market entrants are making a lot of noise.
• Some of your key customers have closed down or merged.
• Money costs more or less.
• Liquidity is looser or tighter.
• Investor tax breaks have changed.
• The key exchange rates for your supply chain are better or worse.
• One of your suppliers has gone out of business
• Several of your designed-in components have gone EOL
• etc etc etc

All of which inevitably leaves your “business plan” constantly out of date. I can only repeat: the value of your startup lies not in its business plan, but in its ability to improvise and execute business tactics to help the company attain its overall business vision. And a properly-articulated business vision should fit on a single Powerpoint slide (and in a 30-point font). So… what were business plans for, again?

So it seems to me that you either believe in the whole package (i.e. that it’s a big enough round for the key people to move the startup towards the vision of its core marketplace despite inevitable market or development turbulence) or you don’t: hence I suspect that accepting or rejecting a particular business plan has only ever been a post-rationalization of other factors entirely.

But conversely, if you cut business plans out of the investment process, a whole set of related questions – each of which has been taken as a given for many years – becomes open again:-

• Ultimately, how rational are individual angels’ investment decisions?
• Can the members of an angel syndicate ever think alike enough to delegate due diligence to one person?
• Does due diligence achieve anything apart from sometimes finding out obvious mistakes?
• Is ‘spray-and-pray’ the only sensible investment methodology for 95% of angels?
• Can modern high-speed startup business ever be planned?

Tricky stuff. 😦