Book Review: Kill Decision

Once in a while I read a book that makes me very, very worried. Daniel Suarez's Kill Decision is high on that list. It's a thriller that explores the potential impacts of drone technology on defense, governance and privacy. Daniel's a technologist himself and the scenario he's dreamt up is so scary precisely because it's so believable.

Almost everything in Kill Decision is possible with off-the-shelf technology today. This is particularly close to home because San Diego is quickly becoming the hub for drone technology development. I've met with two brand new startups in the past year working specifically on civilian and military applications. 3D Robotics, a San Diego company, just secured a new investment from Foundry Group, one of the major VC placements in the region this year. The FAA is planning to use San Diego as a test case for rolling out new regulations on civilian drone use and momentum is building fast.

This is a prime example of machines taking over the world and it usually pays to get out in front of trends like this. It's much more fun to help shape a future empowered by new technology that be dragged kicking and screaming into a Kill Decision. Read it. And next time you see a hobbyist flying around a toy drone, think twice.

Pitfalls to raising venture capital

Jeff Donahue is a good friend and battle-scarred veteran of venture-backed and private equity-backed companies. He has raised over $275M of funding for early and later stage startups and has been CFO of 10 emerging growth businesses. He's worked across the table from leading investors like GRP (now Upfront Ventures), Invesco, ComVentures (now Fuse Capital), Allegis CapitalAlta-BerkeleyInvisionSteamboat Ventures and many more. I'm thrilled that he's offered to write a Venture Financing Series. Without further ado, here's episode two. You can read episode one here.

Entrepreneurs can get ahead in the fundraising game by paying attention to these twenty three factors that make VC funding easier, but pre-determining a successful raise requires more than that. In this second episode of the Venture Financing Series, I highlight some of the key pitfalls to watch out for.

  • Part-time entrepreneurship. You never will attract funding from a VC if you say, “As soon as we get funding we’ll quit our day jobs and dedicate ourselves to our start-up.”
  • High customer acquisition costs. At the other end of customer acquisition cost spectrum is viral customer adoption, which is close to heaven.
  • Barriers to customer adoption. These can include usability/user experience, complexity, extended time horizons, and disruptive changes to operational models. Why start out behind the 8-ball in the first place? 
  • Long technology development cycle. Investors back products, not technologies. A shorter development cycle is always better, and the VC model has morphed away from intensive development spending.
  • Sequential funding requirements. Optimize for cash flow breakeven as early as you can. Again, this is less problematic as long as VCs signed up to sequential funding rounds in the first place. VCs hate unpleasant surprises and will make you pay for them.
  • Modest market opportunity. Ideally, you do not want to be a small/niche play manifest in little or no scale and scope and underwhelming revenues/non-geometric revenue growth. Fundamentally, you want to ride big horses in big markets. 
  • Elephant hunting business model. This makes you dependent on a small number of very large customers. Be especially careful in the realm of hardware manufacturing and complex software applications. This is ameliorated if you have a long-term lock on at least one elephant.
  • Unproven/inexperienced management team. Funding will be easier if you and key members of your team have made VCs a lot of money in prior incarnations through execution.   
  • Crowded/competitive space. This translates into forfeiture of first or even second mover advantage. Lots of undifferentiated players in an anathema to VCs.
  • Pure execution play with little or no intellectual property. Social media is a great exception because many social media undertakings typically are land grabs where first-mover status is paramount.
  • Complex and/or cost-heavy sales channels. VCs can be turned off by:
    • Heavy reliance on indirect channels and channel partners (channels take a great deal of time and money to structure, educate, motivate, and manage).
    • Heavy reliance on a direct sales force that doesn’t scale.
  • Rigid technology. Be careful if your technology doesn’t have more products/applications beyond what is immediately at hand. VCs like to see extensible technology.  
  • A service provider business model, a consulting-oriented business model, a custom solutions business model, or a government contracting business model. There are a host of reasons these are very difficult to fund, and I will comment further on them in a future guest post. 
  • Complex ecosystems for the product. Watch out if the economic pie is divided many ways among established players and relationships. Mobile is an example – the ecosystem includes technology providers, application developers, carriers/network operators, MVNOs, MVNEs, content providers, content aggregators, integrators, handset manufacturers, chipset manufacturers, SIM card manufacturers, network equipment manufacturers, and last but not least the subscribers/customers who pay.
  • Disproportionate reliance on assumptions that cannot be tested. This also applies when tests provide debatable/questionable results. The opposite would be a business plan that can survive rigorous revenue haircuts and still be viable.
  • Revenues that follow investment. You don’t want revenues to lag behind investment in terms of risk profile and timing regardless of the development cycle.  An example is an investment where a lot of money has to be spent over a long period of time to acquire customers.
  • Hardware, as opposed to software. Hardware is just more complex and capital intensive (see “elephant hunting” above). If hardware is your solution or is part of your solution, you’ve moved the risk needle toward the red zone.
  • Having to build “infrastructure.” Do you need to proselytize your product’s application or your industry? This is akin to having to invest in creating demand in a situation where you believe people want your product for whatever compelling reasons but just don’t know they want it. There are no returns on building infrastructure. Your future competitors will piggy-back on it, and you will have made them successful at your expense.
  • Using more than one of the top ten lies of entrepreneurs (modified with respect and thanks to Guy Kawasaki):
    • “Our projections are conservative.”
    • “McKinsey says our market will be $50 billion by 2010.”
    • “Google and Amazon are likely to partner with us soon.”
    • “Apple and Samsung are likely to buy us in 2 years.”
    • “Key employees are set to join us as soon as we get funded.”
    • “No one is doing what we’re doing.”
    • “No one can do what we’re doing.”
    • “Microsoft is too big/dumb to be a threat.”
    • “Our patents make our product totally defensible.”
    • “All we have to do is get 1% of the market.”
At the end of the day everything boils down to the customer. Your  product is something people want and are willing to pay for because it alleviates their pain, solves their problem, enhances their experience, gives them instant gratification, etc. Beyond that, you simply must make your product easy to adopt and maintain. User experience is so important…

You need to give meticulous attention to the array of customer cost metrics embedded in your product beyond the cost of customer acquisition. These include customer provisioning costs (i.e. getting your product up and running with the customer), customer service costs, customer retention costs, and customer development costs (i.e. costs of upselling your customer). Of course, the flip side of customer service costs is having a product that customers want so intensely they are willing to pay for support.

The pitfall list above is ideal in the context of things that encumber securing venture funding, much as my previous guest post dealt with ideal factors that make raising venture funding easier. In terms of what to avoid, I never have been in or seen a startup that does not have some hairballs. Pitfall-wise, it is just a matter of how high up the hairball index you are. That completes the circle with my favorite subject, risk management.

Read episode one, Taking the pain out of raising venture capital.

Less and longer: a few words of wisdom on traveling right

So you’ve saved and budgeted for your trip and now it’s finally time to plan your itinerary. Six months of travel time stretches out before you like a magic carpet. So many opportunities to explore exotic locales! So much time to explore all those places on your bucket list!

Ahh, your bucket list… How many boxes will you be able to check? You have six months. Why not do the Inca Trail, explore Patagonia, go shark diving in South Africa, eat dumplings in China, climb Mount Kilimanjaro, go to a full moon party in Thailand and find yourself at an Indian ashram? Hell, you should probably throw in an Italian cooking class and a camel riding in Morocco for good measure. It all sounds great. Until, of course, you hit the brick wall of reality.

Inside a hellish bus for a heinous ride through Nepal
Travel can be hard, frustrating and draining. You start to think about that into your second day into a thirty-hour bus ride in Nepal where the space between the seats was apparently designed to be perfect for two-year-olds and there’s a box of meat rotting in the back. Or when you arrive in your fourth Tanzanian town and every single local is trying to cheat you for forty times the proper cost of accommodation. Or maybe when you get violently sick in the middle of the wilderness with no hospital (or road) for days. These are the times when you start to appreciate two magic words: less and longer.

Less really is more. Don’t stack your itinerary. It’s far better to spend two months than two weeks in any given country on your list. And in that country it’s far better to spend two weeks rather than two days in any given city or destination.

By doubling down on particular places you kill two birds with one stone. First, because you’re in one place for a long time you’ll find that perfect beach bungalow owned by the local mayor’s family and get invited to a massive wedding party where you make friends for life. If you were only there for two days you’d probably be at that guesthouse with decent but outdated reviews from Lonely Planet that now has a cockroach infestation.

Second, you minimize your exposure to the bane of all travelers: logistics. You don’t spend half of your time in country on a local bus. You don’t discover that your fourteenth taxi driver rifled through your bags. You don’t loose you luggage on an avoidable regional airline flight. You've taken six months off, use that time wisely: with less and longer you'll interact more with locals, enhance the quality of your experience and maintain very healthy levels of personal relaxation.

Basically, you’ve taken the work out of the travel. By staying longer in each place you actually get a feel for the local life there instead of blazing through in a series of photoflashes. As you get ready to plan your trip, doing a country a month would be a good rule of thumb. You may not check as many boxes but you’ll learn a lot more about yourself, a lot more about the country you’re visiting and a lot more about the true meaning of fun!

Co-posted on

Taking the pain out of raising venture capital

Jeff Donahue is a good friend and battle-scarred veteran of venture-backed and PE-backed companies. He has raised over $275M of funding for early and later stage startups and has been CFO of 10 emerging growth businesses. He's worked across the table from leading investors like GRP (now Upfront Ventures), Invesco, ComVentures (now Fuse Capital), Allegis Capital, Alta-Berkeley, Invision, Steamboat Ventures and many more. I'm thrilled that he's offered to write a Venture Financing Series. Without further ado, here's episode one. 

Successful entrepreneurship has a rigorous risk management component to it – maximizing the risk of success and minimizing the risk of failure – as the factors below regarding raising venture capital attempt to convey. In managing risk I always recall my three and a half years in Russian telecommunications and what I call “the Russian Rhythm.” By that, I mean doing things so proficiently, including managing risks so thoroughly, that the outcome is predetermined. “Predetermining the outcome” is a mantra for me.

I have never, ever, encountered a startup proposition that satisfies all 23 criteria below.  At the bottom of the list are some separate brief observations about that. In my next guest post, I will enumerate pitfalls to avoid when seeking venture capital.

Things That Make VC Funding Easier…
  • Pre-emptive technology. Your product changes the structure of a market and the way the world works (“disruptive”).
  • Massive market opportunity. You cannot beat a global market opportunity with a well-defined niche of early adopters.
  • Straightforward value proposition. A product that people want and are willing to pay for because it alleviates their pain, solves their problem, enhances their experience, gives them instant gratification, etc.
  • An easily articulated path to revenue and positive cash flow. Your focus as CEO should be revenue and not profitability. Revenue will drive profitability unless you screw up the cost side of the equation. Positive cash flow means you do not need more VC money unless, for example, it is for accelerated commercial expansion such as taking the product international.
  • Something that ramps. Preferably in an uncomplicated manner and a short period of time.
  • Ease of customer adoption, and low customer acquisition, provisioning, support and upsell costs. Barriers to customer adoption and high customer costs are a ball and chain on your business model.    
  • First mover / first to market. Any entity after the first mover requires greater specificity of differentiation, which complicates the dive.
  • Viral product uptake. This typically characterizes network effect plays.
  • Not dependent on sequential capital raises. Sequential capital raises are fine as long as they are expected up front. If not, the founders are going to be in trouble. I’ve been in multiple companies that went beyond Series D or E rounds. In virtually all cases, by that time most of the founders and senior management teams – and sometimes their successors – were long gone and crushed. Extension rounds, or keeping current rounds open for long periods of time, have the same consequences.
  • Tier-1 management team. Ideally including people that have made VCs rich in a prior companies.
    • Deep grasp of the operational and financial metrics, benchmarks and milestones inherent in the business plan, particularly regarding technology, markets, customers and revenues. This often is called “DNA” or “domain expertise.”
    • Strong execution history. A management team that consistently and persistently has hit the numbers in the plan. 
    • Demonstrable knowledge of the competition, their business models, their strengths and weaknesses, their likely responses to what you are doing, and how you are going to spank them.
  • Scalable business model. Unit variable costs go down while revenues increase.
  • Ability to demonstrate pricing power and pricing to value. The hardest thing to do is get prices up. However, you often will encounter intense pressure from VCs to price down in order to land the business. That has consequences.
  • Solid, referenceable customers and partners. Few things are as compelling as great customer testimonials. So much of venture capital these days has turned to growth capital on the back of a product, demo or prototype as opposed to development capital, which is now often the realm of friends and family and of angels.
  • Defendable positioning. You are not going to be pushed aside by competition that can readily replicate/duplicate what you are doing.
  • Virtual or close-to-virtual business model. Tell me that isn’t heaven...
  • A product that addresses the revenue side of your customer’s equation. Cost-side solutions are easy to document in terms of ROI, etc., but they almost always take a back seat to a CEO’s interest in the top line. If you find yourself pitching your product to the CTO of a company, you’ve guaranteed yourself a path of greater resistance.
  • Outsourceable development. It is demonstrably cheaper to develop in India, Croatia, China, Ukraine, Mexico and a lot of other places than in California.
  • Simple distribution models. Heavy reliance on complex distribution channels is a red flag.
  • Simple, facilitative and high-yield partnership opportunities. Think sales, marketing, distribution, technology.  [The value of partnerships tends to be highly firm-specific.]
  • Independent verification. This should validate what you are saying in your business plan, especially around revenue assumptions. That verification can come from potential customers, partners, vendors and other players in your ecosystem, as well as from reputable advisors.  Better yet, it can come from a VC’s other portfolio companies.
  • A bottoms-up customer validation-oriented business plan. This should withstand an arbitrary 50% haircut and still survive the cash burn. Even better, have a business plan that can withstand another arbitrary 50% haircut.
  • Protected intellectual property and/or a strategy for IP protection. The problem is that IP is time consuming and expensive for your team, and also your IP is only as valuable as your ability to litigate its defense. IP in general does not have wide applicability to the early-stage social media space.
  • Expandable technology. You don’t want to be locked into a given application in a defined environment; rather, you want technology that has visible extensions beyond the product or application at hand.
If I encountered a nascent start-up that met all these criteria I would put a second and third mortgage on my home and bet on it. Reality is different from this list of ideal factors. Perhaps the best way to tee up the factors is to delineate those that are most relevant to your technology and product and try to get them “right.” I would note that highest on the list of most VCs I’ve met is the management team.

Your startup doesn’t have to solve all the world’s problems and face a market opportunity in the tens-of-billions of dollars. The landscape is littered with highly successful start-ups with stupendous exits on a small scale.

Notice that I did not say anything about “exit” in the list. I don’t talk to CEOs and VCs about exits. If the CEO executes and the VC adds value, the exit will take care of itself. There is no reason to distract yourself and your team with thinking about how rich an exit will make everyone. I learned that painfully when pitching a company to what is probably the most successful VC firm in history. My CEO blurted out, “Yes, and if we get this right I know Microsoft will buy us in 2-3 years.” The VC partner on the other side of the table proceeded to call several of his senior Microsoft contacts all of who confirmed they knew nothing about the company and were utterly disinterested in the technology. My butt still has the imprint from the door handle hitting it on the way out.