What
Customers Want
It’s not just startups that have
to worry about this. I think most businesses that fail do it because they don’t
give customers what they want. Look at restaurants. A large percentage fail,
about a quarter in the first year. But can you think of one restaurant that had
really good food and went out of business?
Restaurants with great food seem
to prosper no matter what. A restaurant with great food can be expensive,
crowded, noisy, dingy, out of the way, and even have bad service, and people
will keep coming. It’s true that a restaurant with mediocre food can sometimes
attract customers through gimmicks. But that approach is very risky. It’s more
straightforward just to make the food good.
It’s the same with technology.
You hear all kinds of reasons why startups fail. But can you think of one that
had a massively popular product and still failed?
In nearly every failed startup,
the real problem was that customers didn’t want the product. For most, the
cause of death is listed as “ran out of funding,” but that’s only the immediate
cause. Why couldn’t they get more funding? Probably because the product was a
dog, or never seemed likely to be done, or both.
When I was trying to think of the
things every startup needed to do, I almost included a fourth: get a version 1
out as soon as you can. But I decided not to, because that’s implicit in making
something customers want. The only way to make something customers want is to
get a prototype in front of them and refine it based on their reactions.
The other approach is what I call
the “Hail Mary” strategy. You make elaborate plans for a product, hire a team
of engineers to develop it (people who do this tend to use the term “engineer”
for hackers), and then find after a year that you’ve spent two million dollars
to develop something no one wants. This was not uncommon during the Bubble,
especially in companies run by business types, who thought of software
development as something terrifying that therefore had to be carefully planned.
We never even considered that
approach. As a Lisp hacker, I come from the tradition of rapid prototyping. I
would not claim (at least, not here) that this is the right way to write every
program, but it’s certainly the right way to write software for a startup. In a
startup, your initial plans are almost certain to be wrong in some way, and
your first priority should be to figure out where. The only way to do that is
to try implementing them.
Like most startups, we changed
our plan on the fly. At first we expected our customers to be Web consultants.
But it turned out they didn’t like us, because our software was easy to use and
we hosted the site. It would be too easy for clients to fire them. We also
thought we’d be able to sign up a lot of catalog companies, because selling
online was a natural extension of their existing business. But in 1996 that was
a hard sell. The middle managers we talked to at catalog companies saw the Web
not as an opportunity, but as something that meant more work for them.
We did get a few of the more
adventurous catalog companies. Among them was Frederick’s of Hollywood, which
gave us valuable experience dealing with heavy loads on our servers. But most
of our users were small, individual merchants who saw the Web as an opportunity
to build a business. Some had retail stores, but many only existed online. And
so we changed direction to focus on these users. Instead of concentrating on
the features Web consultants and catalog companies would want, we worked to
make the software easy to use.
I learned something valuable from
that. It’s worth trying very, very hard to make technology easy to use. Hackers
are so used to computers that they have no idea how horrifying software seems
to normal people. Stephen Hawking’s editor told him that every equation he
included in his book would cut sales in half. When you work on making
technology easier to use, you’re riding that curve up instead of down. A 10%
improvement in ease of use doesn’t just increase your sales 10%. It’s more
likely to double your sales.
How do you figure out what
customers want? Watch them. One of the best places to do this was at trade
shows. Trade shows didn’t pay as a way of getting new customers, but they were
worth it as market research. We didn’t just give canned presentations at trade
shows. We used to show people how to build real, working stores. Which meant we
got to watch as they used our software, and talk to them about what they
needed.
No matter what kind of startup
you start, it will probably be a stretch for you, the founders, to understand
what users want. The only kind of software you can build without studying users
is the sort for which you are the typical user. But this is just the kind that
tends to be open source: operating systems, programming languages, editors, and
so on. So if you’re developing technology for money, you’re probably not going
to be developing it for people like you. Indeed, you can use this as a way to
generate ideas for startups: what do people who are not like you want from
technology?
When most people think of
startups, they think of companies like Apple or Google. Everyone knows these,
because they’re big consumer brands. But for every startup like that, there are
twenty more that operate in niche markets or live quietly down in the
infrastructure. So if you start a successful startup, odds are you’ll start one
of those.
Another way to say that is, if
you try to start the kind of startup that has to be a big consumer brand, the
odds against succeeding are steeper. The best odds are in niche markets. Since
startups make money by offering people something better than they had before,
the best opportunities are where things suck most. And it would be hard to find
a place where things suck more than in corporate IT departments. You would not
believe the amount of money companies spend on software, and the crap they get
in return. This imbalance equals opportunity.
If you want ideas for startups,
one of the most valuable things you could do is find a middle-sized
non-technology company and spend a couple weeks just watching what they do with
computers. Most good hackers have no more idea of the horrors perpetrated in
these places than rich Americans do of what goes on in Brazilian slums.
Start by writing software for
smaller companies, because it’s easier to sell to them. It’s worth so much to
sell stuff to big companies that the people selling them the crap they
currently use spend a lot of time and money to do it. And while you can outhack
Oracle with one frontal lobe tied behind your back, you can’t outsell an Oracle
salesman. So if you want to win through better technology, aim at smaller
customers. [4]
They’re the more strategically
valuable part of the market anyway. In technology, the low end always eats the
high end. It’s easier to make an inexpensive product more powerful than to make
a powerful product cheaper. So the products that start as cheap, simple options
tend to gradually grow more powerful till, like water rising in a room, they
squash the “high-end” products against the ceiling. Sun did this to mainframes,
and Intel is doing it to Sun. Microsoft Word did it to desktop publishing
software like Interleaf and Framemaker. Mass-market digital cameras are doing
it to the expensive models made for professionals. Avid did it to the
manufacturers of specialized video editing systems, and now Apple is doing it
to Avid. Henry Ford did it to the car makers that preceded him. If you build
the simple, inexpensive option, you’ll not only find it easier to sell at
first, but you’ll also be in the best position to conquer the rest of the
market.
It’s very dangerous to let anyone
fly under you. If you have the cheapest, easiest product, you’ll own the low
end. And if you don’t, you’re in the crosshairs of whoever does.
Raising Money
To make all this happen, you’re
going to need money. Some startups have been self-funding-- Microsoft for
example-- but most aren’t. I think it’s wise to take money from investors. To
be self-funding, you have to start as a consulting company, and it’s hard to
switch from that to a product company.
Financially, a startup is like a
pass/fail course. The way to get rich from a startup is to maximize the company’s
chances of succeeding, not to maximize the amount of stock you retain. So if
you can trade stock for something that improves your odds, it’s probably a
smart move.
To most hackers, getting
investors seems like a terrifying and mysterious process. Actually it’s merely
tedious. I’ll try to give an outline of how it works.
The first thing you’ll need is a
few tens of thousands of dollars to pay your expenses while you develop a
prototype. This is called seed capital. Because so little money is involved,
raising seed capital is comparatively easy-- at least in the sense of getting a
quick yes or no.
Usually you get seed money from
individual rich people called “angels.” Often they’re people who themselves got
rich from technology. At the seed stage, investors don’t expect you to have an
elaborate business plan. Most know that they’re supposed to decide quickly. It’s
not unusual to get a check within a week based on a half-page agreement.
We started Viaweb with $10,000 of
seed money from our friend Julian. But he gave us a lot more than money. He’s a
former CEO and also a corporate lawyer, so he gave us a lot of valuable advice
about business, and also did all the legal work of getting us set up as a
company. Plus he introduced us to one of the two angel investors who supplied
our next round of funding.
Some angels, especially those
with technology backgrounds, may be satisfied with a demo and a verbal
description of what you plan to do. But many will want a copy of your business
plan, if only to remind themselves what they invested in.
Our angels asked for one, and
looking back, I’m amazed how much worry it caused me. “Business plan” has that
word “business” in it, so I figured it had to be something I’d have to read a
book about business plans to write. Well, it doesn’t. At this stage, all most
investors expect is a brief description of what you plan to do and how you’re
going to make money from it, and the resumes of the founders. If you just sit
down and write out what you’ve been saying to one another, that should be fine.
It shouldn’t take more than a couple hours, and you’ll probably find that writing
it all down gives you more ideas about what to do.
For the angel to have someone to
make the check out to, you’re going to have to have some kind of company.
Merely incorporating yourselves isn’t hard. The problem is, for the company to
exist, you have to decide who the founders are, and how much stock they each
have. If there are two founders with the same qualifications who are both
equally committed to the business, that’s easy. But if you have a number of
people who are expected to contribute in varying degrees, arranging the
proportions of stock can be hard. And once you’ve done it, it tends to be set
in stone.
I have no tricks for dealing with
this problem. All I can say is, try hard to do it right. I do have a rule of
thumb for recognizing when you have, though. When everyone feels they’re
getting a slightly bad deal, that they’re doing more than they should for the
amount of stock they have, the stock is optimally apportioned.
There is more to setting up a
company than incorporating it, of course: insurance, business license,
unemployment compensation, various things with the IRS. I’m not even sure what
the list is, because we, ah, skipped all that. When we got real funding near
the end of 1996, we hired a great CFO, who fixed everything retroactively. It
turns out that no one comes and arrests you if you don’t do everything you’re
supposed to when starting a company. And a good thing too, or a lot of startups
would never get started. [5]
It can be dangerous to delay
turning yourself into a company, because one or more of the founders might
decide to split off and start another company doing the same thing. This does
happen. So when you set up the company, as well as as apportioning the stock,
you should get all the founders to sign something agreeing that everyone’s
ideas belong to this company, and that this company is going to be everyone’s
only job.
[If this were a movie, ominous
music would begin here.]
While you’re at it, you should
ask what else they’ve signed. One of the worst things that can happen to a
startup is to run into intellectual property problems. We did, and it came
closer to killing us than any competitor ever did.
As we were in the middle of
getting bought, we discovered that one of our people had, early on, been bound
by an agreement that said all his ideas belonged to the giant company that was
paying for him to go to grad school. In theory, that could have meant someone
else owned big chunks of our software. So the acquisition came to a screeching
halt while we tried to sort this out. The problem was, since we’d been about to
be acquired, we’d allowed ourselves to run low on cash. Now we needed to raise
more to keep going. But it’s hard to raise money with an IP cloud over your
head, because investors can’t judge how serious it is.
Our existing investors, knowing
that we needed money and had nowhere else to get it, at this point attempted
certain gambits which I will not describe in detail, except to remind readers
that the word “angel” is a metaphor. The founders thereupon proposed to walk
away from the company, after giving the investors a brief tutorial on how to
administer the servers themselves. And while this was happening, the acquirers
used the delay as an excuse to welch on the deal.
Miraculously it all turned out
ok. The investors backed down; we did another round of funding at a reasonable
valuation; the giant company finally gave us a piece of paper saying they didn’t
own our software; and six months later we were bought by Yahoo for much more
than the earlier acquirer had agreed to pay. So we were happy in the end,
though the experience probably took several years off my life.
Don’t do what we did. Before you
consummate a startup, ask everyone about their previous IP history.
Once you’ve got a company set up,
it may seem presumptuous to go knocking on the doors of rich people and asking
them to invest tens of thousands of dollars in something that is really just a
bunch of guys with some ideas. But when you look at it from the rich people’s
point of view, the picture is more encouraging. Most rich people are looking
for good investments. If you really think you have a chance of succeeding, you’re
doing them a favor by letting them invest. Mixed with any annoyance they might
feel about being approached will be the thought: are these guys the next
Google?
Usually angels are financially
equivalent to founders. They get the same kind of stock and get diluted the
same amount in future rounds. How much stock should they get? That depends on
how ambitious you feel. When you offer x percent of your company for y dollars,
you’re implicitly claiming a certain value for the whole company. Venture
investments are usually described in terms of that number. If you give an
investor new shares equal to 5% of those already outstanding in return for
$100,000, then you’ve done the deal at a pre-money valuation of $2 million.
How do you decide what the value
of the company should be? There is no rational way. At this stage the company
is just a bet. I didn’t realize that when we were raising money. Julian thought
we ought to value the company at several million dollars. I thought it was
preposterous to claim that a couple thousand lines of code, which was all we
had at the time, were worth several million dollars. Eventually we settled on
one millon, because Julian said no one would invest in a company with a
valuation any lower. [6]
What I didn’t grasp at the time
was that the valuation wasn’t just the value of the code we’d written so far.
It was also the value of our ideas, which turned out to be right, and of all
the future work we’d do, which turned out to be a lot.
The next round of funding is the
one in which you might deal with actual venture capital firms. But don’t wait
till you’ve burned through your last round of funding to start approaching
them. VCs are slow to make up their minds. They can take months. You don’t want
to be running out of money while you’re trying to negotiate with them.
Getting money from an actual VC
firm is a bigger deal than getting money from angels. The amounts of money
involved are larger, millions usually. So the deals take longer, dilute you
more, and impose more onerous conditions.
Sometimes the VCs want to install
a new CEO of their own choosing. Usually the claim is that you need someone
mature and experienced, with a business background. Maybe in some cases this is
true. And yet Bill Gates was young and inexperienced and had no business
background, and he seems to have done ok. Steve Jobs got booted out of his own
company by someone mature and experienced, with a business background, who then
proceeded to ruin the company. So I think people who are mature and
experienced, with a business background, may be overrated. We used to call
these guys “newscasters,” because they had neat hair and spoke in deep,
confident voices, and generally didn’t know much more than they read on the
teleprompter.
We talked to a number of VCs, but
eventually we ended up financing our startup entirely with angel money. The
main reason was that we feared a brand-name VC firm would stick us with a
newscaster as part of the deal. That might have been ok if he was content to
limit himself to talking to the press, but what if he wanted to have a say in
running the company? That would have led to disaster, because our software was
so complex. We were a company whose whole m.o. was to win through better
technology. The strategic decisions were mostly decisions about technology, and
we didn’t need any help with those.
This was also one reason we didn’t
go public. Back in 1998 our CFO tried to talk me into it. In those days you
could go public as a dogfood portal, so as a company with a real product and
real revenues, we might have done well. But I feared it would have meant taking
on a newscaster-- someone who, as they say, “can talk Wall Street’s language.”
I’m happy to see Google is
bucking that trend. They didn’t talk Wall Street’s language when they did their
IPO, and Wall Street didn’t buy. And now Wall Street is collectively kicking
itself. They’ll pay attention next time. Wall Street learns new languages fast
when money is involved.
You have more leverage
negotiating with VCs than you realize. The reason is other VCs. I know a number
of VCs now, and when you talk to them you realize that it’s a seller’s market.
Even now there is too much money chasing too few good deals.
VCs form a pyramid. At the top
are famous ones like Sequoia and Kleiner Perkins, but beneath those are a huge
number you’ve never heard of. What they all have in common is that a dollar
from them is worth one dollar. Most VCs will tell you that they don’t just
provide money, but connections and advice. If you’re talking to Vinod Khosla or
John Doerr or Mike Moritz, this is true. But such advice and connections can
come very expensive. And as you go down the food chain the VCs get rapidly
dumber. A few steps down from the top you’re basically talking to bankers who’ve
picked up a few new vocabulary words from reading Wired. (Does your product use
XML?) So I’d advise you to be skeptical about claims of experience and
connections. Basically, a VC is a source of money. I’d be inclined to go with
whoever offered the most money the soonest with the least strings attached.
You may wonder how much to tell
VCs. And you should, because some of them may one day be funding your
competitors. I think the best plan is not to be overtly secretive, but not to
tell them everything either. After all, as most VCs say, they’re more
interested in the people than the ideas. The main reason they want to talk
about your idea is to judge you, not the idea. So as long as you seem like you
know what you’re doing, you can probably keep a few things back from them. [7]
Talk to as many VCs as you can,
even if you don’t want their money, because a) they may be on the board of
someone who will buy you, and b) if you seem impressive, they’ll be discouraged
from investing in your competitors. The most efficient way to reach VCs,
especially if you only want them to know about you and don’t want their money, is
at the conferences that are occasionally organized for startups to present to
them. |
/1 
