CEOs and Boards of Directors – Friends or Foes?

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 four. You can read episode one through three here.

In prior posts I have conveyed the importance of a proven CEO and his or her team in attracting venture capital funding. A “proven” CEO is one who has led one or more start-up companies to bountiful exits in prior incarnations, to the enrichment of VC investors.

A seasoned CEO and the team are way up the list of criteria that make funding easier. As a benchmark, I’ve heard multiple VCs observe they attribute up to 50% of a company’s initial valuation to the CEO and the team. Of course, unproven CEOs and their teams do attract venture capital funding – pervasively so. It’s just a matter of the degree of difficulty of the dive.

I remember attending a program in San Diego some years ago where the featured speaker was a young entrepreneur whose previous company scored a superb exit. He had launched his new company and mentioned he landed $6M of Series A funding on the back of just a 15-slide PowerPoint deck. Because of his prior success, investors believed in him and virtually threw Series A cash at him for his new company.

While nothing makes a VC happier than a big exit, we all know that the vast majority of start-ups fail. Close to them are neo-failures – start-ups that turn into lifestyle companies which are cash flow self-sustaining but cannot achieve the scale and scope that support an IPO or trade sale. [Hence, the VCs are left with no exit opportunities.] The question to ask is, “Why do so many start-ups fail even after securing huge amounts of funding over multiple rounds?”

I maintain the most pervasive reason for failure is a combination of the CEO’s inability to execute and the board’s inability to effectively oversee the CEO. A combination of a CEO who cannot execute and a board that in inept in oversight is especially toxic. I’ll put this mix of the CEO and the board in in the following schematic:

Of course, there are degrees of CEO execution ability and board oversight in the schematic.  It is just a matter of “flow” between the CEO and the board over time.

Also, beneath this schematic is the potentially worst case outcome: one of VCs becomes the CEO, and the VC-CEO brings other members of the firm into the management team. If the VC isn’t an experienced CEO (more about that below), then you can bet it is going to be a hard, painful, expensive and very low-probability road to success, saturated with Sturm und Drang along the way.

The issue of CEO execution ability is one reason why some VC firms maintain “entrepreneurs in residence” (there are variations on that designation) to work with their portfolio companies, particularly ones with younger and/or unproven management teams. Perhaps more VC firms should do that. Another risk-attenuating factor is where the board-member VC has been a successful entrepreneur. Mark Suster at Upfront Ventures comes to mind, who as a successful entrepreneur in multiple incarnations by definition has a leg up in board oversight. However, I come back to my mantra of qualifying VCs and, by extension, qualifying whoever they might designate to work with a CEO.  

What does “execution” (or “performance integrity,” as I also like to call it) mean? It means fulfilling the vision through leadership that dynamically aligns strategy, design, research, development, engineering, manufacturing, supply chain, logistics, financing, sales, customer service, marketing and business development and a raft of other things. These are the levers a CEO pushes and pulls in making a company successful. [Software and social media companies have an attenuated array of levers, e.g. no manufacturing, supply chain, logistics and the like, which along with comparatively low funding requirements is why they are so attractive to entrepreneurs and VCs alike.] At the end of the day, the CEO very much is like an orchestra director: under great direction the orchestra produces beautiful music. Without it, the orchestra degrades into producing cacophony.

Another way to look at execution is in the context of a great mission statement. A great mission statement embodies what the company does for a living, where it is going to be in a certain point in time, where it will stand vis-à-vis the competition, and what the quality of the business will be. For example, “Company Alpha will be the number 2 producer of 3D printers in the United States in 5 years with sales in excess of $700M and EBITDA margins above 40%.” This simple sentence captures everything that a CEO needs to accomplish. Mission statements that say things like, “Company Alpha is going to be a leading 3D printer that cares for and is loved by its employees, customers, shareholders and communities” are just tedious bullshit.

Together, CEOs who execute and boards who provide constructive oversight build value beyond expectations.  I will have more to say about honing execution skills in a future guest post. Recommended further reading is Brad Feld’s and Mahendra Ramsinghani’s new book, Startup Boards: Getting the Most out of Your Board of Directors.

Got any regrets? Burn 'em!

Not a bad bonfire
Dust storms rage across an apocalyptic landscape filled with brightly painted bodies writhing to the pulsing rhythm of electro beats highlighted by intricately orchestrated laser light patterns and roaring belches from a dozen military-grade flame throwers. 

Sound like a good place to seek enlightenment? Maybe not, but Burning Man is the frenetic center of the world's creative class and there are a lot of lessons we can all learn from what for many is an annual pilgrimage.

In 1986, Larry Harvey was dumped by his girlfriend. He took it hard and the doom and gloom of a failed relationship soon set in. But then he had an idea. He invited some of his friends to a bonfire on Baker Beach in San Francisco. Then he crafted a wooden figurine and added it to the flames. 

The "Burning Man" was himself. More specifically, it represented all the things he wanted to let go of so that he could turn a new page in life. It wound up being an interesting page to turn: since that first year Burning Man has moved to the desert in Black Rock City, Nevada and evolved into a 60,000+ person event.

There are 10 core values that form the cultural foundation for the event. The seriousness with which participants live by these values really transforms the event. Three of those values in particular shaped our experience every single day :
  • Radical inclusion. Anyone and everyone participates. Whether you're into tap dancing, software development, BDSM, environmental activism or corporate finance, you're invited. Participants set aside judgement and accept each other for who and what they are.
  • Radical self reliance. Everyone is camping in an extremely harsh desert environment. Given the sheer volume of people, large art installations, moving parts, sandstorms and flamethrowers my guess was that approximately thirty five people would die during the event. To our amazement, nobody died. The worst injury we witnessed during the entire week was a bike collision (the riders were naked which didn't help). Everybody has to pack in and out their own shelter, food, water, shade, etc.
  • Gifting. No cash is allowed at Burning Man (the only exceptions are for buying coffee and ice). Instead, participants bring things to give away if they want. We were gifted individually made Vietnamese iced coffees, a ride in bike taxi,  gourmet Montreal meat sandwiches, ceremonial green tea worth more than its weight in gold, a lecture on microeconomics, and much much more.   It reminded me of the potlatch ceremonies of the Native Americans in the Pacific Northwest.
The unifying theme of the event is letting go. Whether it's your cultural moors, societal norms, emotional baggage, or clothing, you're encouraged to leave it at the door. The result is an atmosphere of imagination. The air is permeated with possibility (and dust) and thoughts are unleashed beyond their normal boundaries.

You may not want to go camping in the desert, but every one of us could let go more often. We require permission only from ourselves to live the lives we want to live. Burn those regrets, tomorrow's a new day.

Co-posted on

Can we trust the experts?

Eric Ball is a good friend, former business school academic and Fortune 100 executive who also invests in technology startups. He co-authored the book Unlocking the Ivory Tower: How Management Research Can Transform Your Business, which summarizes cutting-edge research that helps entrepreneurs and business leaders be more effective.

One of the most dynamic areas of psychological research over the past two decades has been decision-making and cognitive bias. Economists like to assume that agents are rational, but researchers have discovered what many non-economists already know, which is that humans are bounded in several ways: in the time they take to make a decision, in their rationality, awareness, and ethics. It turns out that almost none of us accurately assess risk. This has implications for how we manage (and your next Vegas trip).

One example of cognitive bias is the “overconfidence bias” (described by Daniel Kahneman in his wonderful 2012 bestseller Thinking Fast and Slow). For example, what is the annual revenue of Exxon? Okay, maybe you don’t know the exact number but could you estimate a revenue range for Exxon with 90% certainty? You might say, “Well, it’s probably somewhere between $10 billion and $50 billion.” In this example you’d be right: Exxon happens to bring in $41 billion per year. But it turns out that if we ask a large number of people to estimate a range, the true number falls outside their range almost half the time. People think they can be more precise than they can.

What makes this result really interesting is that experts do worse than lay people. Confidence increases faster than skill. Experts give a narrower range (they might say $30 to $40 billion), but the true number falls outside the range they give more often than it does for non-expert responders. Be wary of the certainty of experts!

How do we square this with a body of research, by Gary Klein and others, which demonstrates the amazing intuition that some experts develop? Klein (1998) describes a firefighter who can assess in a second whether the building he has just entered is about to collapse, and he documents several cases where expert intuition saves the day.

In 2009, Kahneman and Klein set out to see if they could reconcile these very different conclusions about whether we can trust experts. Ultimately, they concluded that intuitions are skilled when an expert operates in a predictable environment with frequent feedback. This suggests that we can trust:  physicians, nurses, athletes, firefighters, police, and other professionals who make decisions and learn very quickly if it was a good decision or not. A quarterback discovers quickly whether his decision to throw the short pass during an unexpected blitz was a good idea or not. With frequent feedback, decision-making becomes skilled enough that instant intuition can work very well. Malcolm Gladwell talks about the 10,000-hour threshold to hone intuition.

Kahneman and Klein concluded that intuitions are unskilled for those making long-term forecasts, where it takes a long time to learn if a decision is correct or not. This means we should not trust the predictions of:  political pundits, stock market analysts, or (especially) venture capitalists. They have to wait too long to find out if they are good or not, and to distinguish between skilled and lucky outcomes. Unfortunately, they are particularly prone to an accelerating sense of confidence, so they have a tendency to think they have become experts when in fact they have not. The lesson: beware of anyone with a long feedback loop. These are the people you are most likely to see on TV and in newspapers.

I'm getting published!

It's high time for an update on my upcoming novel, Uncommon Stock. Many of you know I've been working on it since last Fall and I've been so involved in the trenches of grinding through the writing process that I've been lax about keeping everyone up-to-date on progress. So here's the deal.

I finished the first draft in July on Maafushi Island in the Maldives. Then I sent the manuscript out to a tiny group of beta readers for an initial round of feedback. They sent me back some extremely useful input and I went to work on a second draft incorporating some of their ideas to help make the story the best it can possibly be.

While I was hard at work on my second draft, I received an unsolicited publishing offer from a new independent publishing company (let's call them Company X) backed by a major venture capital fund. They're still in stealth mode so I won't be able to reveal their identity until their launch in January (stay tuned!). After some back-and-forth I signed a contract with them for Uncommon Stock late last month. In a future post I will discuss all the major terms of the contract in detail for all of you aspiring authors out there.

Those of you who know me well or who know the publishing industry might ask: why not self publish? This is a fantastic question. In fact, I was planning on self publishing all the way up to signing the contract a few weeks ago. The publishing industry is currently undergoing a fundamental transition not dissimilar to the revolution that transformed the movie and music industry a decade ago. Fortunately/unfortunately, the six established companies that dominate the book publishing industry seemed to have learned very little from watching their colleagues in music and film.

The upshot is that anyone with a modicum of project management skill and a network of good freelancers can produce a book of comparable quality to Random House for about $20k (substantially less if you're willing to sacrifice some production values; substantially more if you want a big name PR firm to help you with the launch).

The contracts the traditional publishers offer to first-time fiction authors like myself are, to put it mildly, complete horse shit. They give you a minuscule royalty percentage, draconian terms, no marketing support and a $5k advance (if you're lucky and have a great agent). It's a different ballgame if you're J.K. Rowling and can demand whatever terms you want because you have such a huge audience but for a first-timer like me, no go.

It was an obvious choice: self publish. So I lined up a bunch of freelancers, laid out a production schedule and was about to press the "GO" button when a publishing offer magically appeared in my inbox (look for a detailed post on this once Company X launches). Holy crap. What to do?

The more I talked to the people at Company X, the more excited I got about the prospect of working with them. They're extremely tech savvy and understand the fundamental trends that are reshaping the business of storytelling. Their founders have written books for the big traditional publishers and understand the frustrations that writers face everyday. Their offer included collaborative, author-friendly terms (again look for a detailed post on this soon). I'm able to retain creative control, get royalties that make sense and work with a new indie publisher that will help me share the best stories I can write with the best readers out there (i.e. you guys!). I'm thrilled to partner with them and hope to help subvert the Big Six along the way.

Plus, there's just a certain appeal to a thriller about startups being published by a secret new startup disrupting the dinosaur industry of traditional publishing. That's friggin' cool. Now, back to work on editorial...

P.S. Uncommon Stock will be released in Q1 2014. Get those Kindles ready.

Don’t waste your time with unqualified VCs or pitchfests

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 three. You can read episode one and two here.

“Qualification” is a powerful and purposeful word aligned with living a life of least resistance. Consciously or unconsciously, we tend to qualify just about every human being we seek to determine who best can heal our bodies, repair our appliances, represent us in court, style our hair, sell us a car, remodel our homes and myriad other undertakings. We qualify virtually all our activities to determine which provide us the greatest satisfaction, from where to live, to where to dine, to where to shop, to what movie to see, to where to go and what to do on vacation, and so forth.

Qualifying VCs you want to pitch your start-up to is no different. Do not waste your time pitching to unqualified VCs. You want to pitch to VCs who know your space and like it, who have invested successfully in it or are committed to doing so, and who bring deep Rolodexes in it particularly in partnerships and domain expertise. By not having a qualified VC, you will forfeit the synergies that a truly qualified VC brings to the table. Sometimes, money is not all green…

If you secure funding from a relatively unqualified VC – which certainly is better than no funding at all – you will be magnifying the risk of future conflict over key elements of strategy and execution. This is because in 6-12 months your start-up is highly likely to be a great deal different from the business plan you originally teed-up and got funded. Twenty to thirty years ago, startups approached VCs with 100-200 page business plans in hand. Today, an elevator pitch, executive summary and PowerPoint deck is all you need. The process evolved as people realized that those business plans had little utility as such an early stage.

At the same time, there is no more satisfying position to be in than having VCs compete to invest in your company. This will happen only if your investment thesis is pervasively compelling (check out my two prior posts for tips). If you have VCs competing to invest, you will be on the path to pre-determining a successful funding through leverage in the pricing, dilution, investor preferences, calendar to closing and just about everything else that goes into a term sheet.

If you do get multiple VCs competing to invest in your company, go with the biggest and the best. It is that simple. But, do your homework on the shortlist. There are VCs that have good reputations in working with their portfolio companies and there are VCs that have bad ones. As CEO, you will be busy beyond your wildest imagination running a company. You do not need to be busy managing your investors.  I will have more to say about this in a future guest post.

Nothing works like personal introductions from someone who knows the VCs you want to pitch to. Cold-calling and submitting business plans through VC websites are very low-probability methods of getting invited to pitch. Use your networks (develop them if you do not have them), including service providers such as law firms and accounting firms to get introductions. Mark Suster of Upfront Ventures and author of the splendid Both Sides of the Table blog, has written extensively about getting in contact with VCs. [Mark was on the Board of EMN8 (now Tillster) while I was CFO there, and EMN8 was the only 2010 Red Herring North America 100 and Red Herring Global 100 company in Southern California.] Instead of wasting your time with unqualified VCs, get out there and create contacts with qualified ones.

Regarding pitchfests and business plan competitions, I believe the pitchfest process is great for refining a pitch. Unfortunately, that’s where the value typically stops accruing. This principally is because the vast majority of pitchfest and business plan competition panelists are not qualified (including having been successful) in your space. I have seen this across the entrepreneurial spectrum in San Diego from pitchfests at the incubation/acceleration stage to pitchfests hosted by service providers, by professional organizations (e.g. San Diego Software Industry Council – SDSIC), by affinity groups (e.g. the MIT Enterprise Forum), and by VC organizations themselves (e.g. the San Diego Venture Group - SDVG). Pitching to an unqualified panel is just as big a waste of time as pitching to unqualified VCs, and it really pushes the needle into the “you won’t get a prize” zone. If you embrace my mantra of pre-determining outcomes, why bother pitching to an unqualified panel when you’d be better off pitching to a qualified investors to whom you have secured introductions and who are truly interested in listening to you?

This extends deeper because the pitchfest sponsors typically have a screening process whereby an array of applications gets shortlisted to a handful of finalists who will participate in the pitchfest. If those screening committees are not thoroughly populated with qualified individuals in your space, the problem is compounded.

I have attended many pitchfests in San Diego, including some very recent ones, where the panels were embarrassingly unqualified. I truly felt sorry for many of the CEOs who were competing, and I felt that the panelists should have recused themselves from opining on companies, products, technologies, market opportunities and the like that they really had no qualifications in.

MESSAGE TO PITCHFEST/BUSINESS PLAN COMPETITION SPONSORS: please make sure your screening committees and your pitchfest panels are populated with deeply qualified individuals in each of the presenting companies’ domains, and please convey this to your applicants. It is one way of really being a service to the entrepreneurial community.  

With unqualified panelists, typically it is the sizzle rather than the steak that wins the pitchfest prize. If you choose to go the pitchfest/business plan competition route, beef up your sizzle by presenting in a compelling/charismatic manner and by having a media-rich presentation. And, remember that pitchfest preparations tend to be very time consuming. Time spent preparing for a pitchfest is time not spent developing and selling your product and finding qualified investors.

As a final word of caution, if your pitch bombs, you likely have encumbered your profile in the local funding community. [“Encumbered” could be a euphemism for “poisoned the well.”] The word spreads fast around town among angel investors and VCs.  I have heard both say, “Hey, that company didn’t make it through the pitchfest. Why should I want to talk to them?”