Hypothesis - proove or refute

Most entrepreneurs (myself included) fall in love with their innovation. Yes, we are good at telling ourselves that we are objective, but be honest, we are "slightly" biased.

So, how can we know if we are on the right track, or the on the wrong one?

Well, the starting point is clear, we come with a hypothesis such as

• Our product does A, B, and C
• Our product is good for people that have pains X, Y, Z

Then we go to test our hypothesis


And then we fall

What do I mean by fall?
I mean that it takes us too long (months and sometimes even years) to understand that we are in the wrong direction, either we miss something in the product, or we are not answering a real pain. The lucky ones are able to do the necessary modification. The not-so-lucky-ones are doomed.

Have you ever thought "Why it takes us so long to see a mistake, which in retrospect seems so obvious?"

I found the answer in the book called "The black swan" (I think it is an excellent book). The author explains that as human beings, we are conditioned to seek for positive signs to prove our theories. Since, in most cases, it is easy to find some positive indications why our hypothesis still holds, we will not let it go so easily.

There is another way!
Instead (or in addition to) finding positive indications, we can look for an indication that if found, the hypothesis cannot be valid anymore. This is very difficult though, we are not used to think this way.

I know this is kind of blurry, so let me give you an example:
Suppose you assume you have a market X
Put a test where you invite your users and enhance artificially their incentive to use your product. Now if they still are not using it, then you know that this is not your market. The user does not want you

We have to learn the truth very early, we have to try and KILL our hypothesis and continue to modify it until it survives. Then we know we have something good

There is a scientific way of planning such predicted effects experiments. I might shed more light on this in another post, should you find this subject interesting

Check yourself and write me
Amir

Cash flow

Think of your natural response for the following question -
You need to have a new server to your start-up and you have two options:

1. Buy a server for $2400
2. Rent a server for $200 a month

Which option will you choose?

Most people I know will use the following calculation:
After one year the "rent" option will be more expensive than the "buy" option. Since a server typically can be of service for 3 years without any technical problems, it would be best to buy it. The alternative is clearly flushing money down the drain.

Makes sense, doesn't it?

My answer would be different though. I would also consider my budget and mainly my cash flow. The reason is simple: a start-up typically has a very modest budget. During it's very early stage, the budget might be only tens of thousands. For the sake of the discussion, let's assume it is $50,000.

Now, do you still think it is obvious to spend in one shot almost 5% of your budget for a server? Are you so confident you have more than one year to enjoy it's benefits and the money you think you will save? What about other needs you have which you need money for? What if during this year you will find out that you need a different server?

When a company has a negative cash flow and unless it has much money in the bank to compensate for it for a very long time, cash flow is the #1 consideration when you manage your budget. Savings for the long run is much less important.

I would like to give you more examples of typical mistakes

• Renting space - taking a long duration commitment (say 2 years) in order to save money per month.
• Choosing a wrong credit card processor to save 1% per transaction but having to deposit and secure money in bank as an insurance.
• Hiring a new employee when you can surely manage with an outsource solution (such as QA)

It is painful sometimes since you know you pay more than you should but this is exactly what you should do

Manage well,
Amir

The Venture Capital big Mistake - seek a huge exit

In one of my former posts I mentioned a mistake that in my opinion most of the venture capitals (VCs) are making and I promised to elaborate on it.

A big VC typically has much money to invest. The money is not correlated to the VC personnel. Suppose that a VC manages 100 million and has 5 partners. A much larger VC, that manages 500 million will not have 25 partners, but probably also 5 or slightly more.

A VC requires a seat or two in the board of the companies they invest in.

Now lets make some more assumptions and do some math

• VC has 5 partners
• A partner has an attention span for about 5 companies
• the VC requires only a single seat (A very conservative assumption)
• Therefore, the VC can support effectively 25 investments

For a small VC of 100 milllion it means an average investment of 4 million.
For a medium-large VC of 500 milllion it means an average investment of 20 million.

This is no wonder that a VC seeks for the next big thing. Even if they are fully aware that no one can identify upfront what the next big thing is. This is a high risk game.

Due to the high risk, the VC knows that most of their investments will fail.  In most cases, even the investments that succeed are not sufficient to cover for the ones that failed, unless the VC is very lucky. טes, luck is a huge factor here.

To cover for most loses and make money in this game, the VC must do at least 10 times on their money and they seek much much more since they want a high return. Lets assume that a typical investment provides the VC 25%-35% of the company and lets even assume that the VC share will not be diluted (yes, I know that this is rarely the case).

This means that if a VC makes a 4 million investment, gets 25% of the company and seeks a "modest" factor of 15 for their money, the exit should be about about 240 million. For a 20 million investment the exit should be almost 1 billion dollar.

There is another factor that serves as an expediter. Most VCs expect a return on their investment in 5-7 years. So, not only they seek the next big thing, they wish to have make it ultra quick.

During the crazy bubble years, when companies were sold for huge ridiculous sums and companies making a loss could have an IPO, this model worked just fine. However, when the economy does not allow it anymore, reality smashes back.

It is no wonder that we see that VCs are not surviving, and the ones that still exist raise very little new capital.

There are two extremes that will flourish though. The first one is the VC with a very specfific expertise in a specififc market and where their partners are very well connected. These VCs provide a real advantage to their portfolio. These VCs are rare, but they exist.

The other VCs are the new ones, called micro VCs. They avoid the problem by being small (say 5-20 million) and investing much smaller sums. They do not seek a huge return but a healthy one.

The wierd thing in my eyes is that a good model does exist and yet I have not heard on VCs that endorses it. To me an adequate model is:

1. Invest smaller amounts in healthier companies.
2. A healthy company chance of succeeding and providing a nice return on investment is not too bad
3. Since most companies now succeed, there is no need to ask for a huge return of investment to cover for loses
4. In addition, a healthier company requires much less VCs attention so the VC management can control many more investments and have an even broader portfolio
5. This create a very positive cycle of investments

It would be interesting to see what will happen in the next two years. I expect the VC world to be a different one.

Amir

Theory of Constraints (TOC) for start-ups

Today I wish to share an external post of my coach and mentor for the last 7 years: Dr. Eli Goldratt.

Recently, Eli has opened a TV channel called TOC.tv where he shares much of his knowledge with the world. Most of the webcasts are related to operations, distribution, strategy, sales & marketing of business that have "physical" products. However, one webcast is related to .... start-ups and moreover to technological ones.

I am not new to this and I still find great merit in hearing it again and again. I hope you will too.

The link to the webcast is:
https://www.toc-goldratt.com/TV/video.php?id=419&type=2

It might take some time to upload, so practice patience :)

Should you seek more knowledge about necessary but not sufficient, you can find the book in amazon and you can also write me questions and I will try to provide more information from what I have learned myself.

Happy New (Jewish) Year
Amir

A big company or a healthy one?

Many start-ups I know (including my first one), and mainly the ones who need to raise capital from VCs are saying something like:

• Our optimistic scenario - we are the next Google
• Our pessimistic scenario - the revenues are at least 100M USD
• Our realistic scenario - we make several hundreds of millions

The funny thing is that if they don't say it, they will never get the required capital. VCs are looking for the next big thing (one of their gravest mistake in my opinion but this is an issue for another post).

It is obvious that this message is a pure crap (pardon my language). No one know what the next big thing is. In most cases, it is more a matter of luck rather than anything else.

I attended a conference several months ago and I heard a lecture from Mr. Aaron Mankovski (chairman of the Israeli VCs) where he mentioned some interesting statistics. Aaron said that in the last couple of years, in order to have an IPO, a company needed to demonstrate revenues of about 150 million dollars. Aaron said that he checked how many Israeli companies succeeded reaching this goad during the last 30 years and the answer was merely 28 companies.

Once a company broadcasts such a message (internally and externally), it needs to try to deliver. This means that a company is likely to build a solution which is not geared for a specific vertical market (hey, the vertical is too narrow for us) or lie to itself and claim that it builds a generic platform that can serve many verticals, but it will start with only one. As logical as it sounds (I assume many know by heart the "crossing the chasm") it is very difficult to plan a platform rather than a specific solution.

I am not saying, that there are no big companies that had a huge goal to begin with and made it through. I simply claim that this is not the typical case. In most cases, start-up ideas are nice and cool. These ideas have a pretty nice market of few to tens of million of dollars. The team should not be so big, and the marketing budget can be modest. Therefore, the capital raised can be significantly smaller. The company will be focused on a single market and the company is much more likely to MAKE money and grows in an evolutionary natural manner.

This is a healthy company which is a good thing for the founders, the shareholders and the employees.

This also means that the odds to success are much higher. Sadly, many companies that had a potential aimed much higher and failed.

Don't optimize at first

There a tendency among technology oriented start-ups to do things the right way. How many of view hear the following:

• We must build infrastructure first.
• We cannot rely on existing products. They won't fit our needs.
• We cannot show clients half-baked products.

Such arguments are neither true nor false. They depend on the situation. If a company is a mature one.and knows its market and how the product serves its clients, then the claim is correct. For example: If the product needs to serve millions of users and there is no infrastructure ready on time, then the company will fail to provide an adequate service. However, if the company is young, it is very dangerous to build an infrastructure or tailor the product to an unknown need. It means losing precious time and gambling on technology.

When I founded my first company more than 10 years ago, my partner an I invented a way to handle an online event where a huge audience can attend. One example is a chat with million of people ( we had a discussion with CNN or having our platform during Larry King). Another example was a auditorium with a teacher and many students capable of asking questions during the lesson (not just a few question). The conceptual problem was how to allow any person to interact without generating so much noise that interferes with anyone. Think of a chat room with 25 people and you see how much noise reside there. Can you imaging what happens when numbers scale up? Well, we found a way.

We were thrilled, our team started build the large-group interaction platform and its GUI. We thought we can isolate the infrastructure and the GUI core components even if the market will change. We planned for the long horizon. Boy, we were so wrong.

• We spend so much time on the wrong things so we had no time to really invest it other features that were basic (i.e. all competitors have them).
• The market changed. Instead of education, we went to online presentations and then to market research. After seeing the real market, the product had to change and also the infrastructure had to adjust.
• The funny thing (or sad thing) was that we could not even reach our technology goals. We spent much precious time and energy realizing that. So instead millions we went in the end for less than a thousand. Turned out that this was OK. No one wanted millions of users.

The lesson is: In the beginning, you can cut corners, use third party solutions, use less than perfect GUI. Don't try to plan the perfect system. Rather, reach your potential users and clients and show them what you have. They love it when you talk to them. If you bring enough value they will also accept a half-baked product. After that, learn what they need and what your product really is. Only then plan carefully your long run.

I know it sounds obvious. Yet, look around and see how many fall into this trap.

Amir