Month: September 2016

It may not seem it, but coming up with an idea for your startup is probably the easiest part of launching your own company. As one industry insider told me, there are a million ways to screw up that idea through poor execution, and many, many lose their way in spite of having a good initial idea. Yet a precious few fight through the problems and the challenges, and somehow with a bit of luck and a lot of moxie, make it to IPO.

The four original founders of Box, one of those companies that made it through that long journey, talked about their experience in a panel discussion this week at BoxWorks.

While CEO Aaron Levie and CFO Dylan Smith have long been the public faces of Box, there were two others — Jeff Queisser, chief systems architect and Sam Ghods, services architect — all childhood friends in Seattle, who quit college to follow the startup dream.

The idea

The group seemed destined to launch some sort of startup, and often bounced ideas off one another, even after they went their separate ways to college. After Levie came up with the idea of what would be Box as part of a marketing class, the group saw potential, at least Smith did. Ghods didn’t see the value right away, but eventually all four were on board and Box was born.

These guys were living a Silicon Valley cliche in the early days, giving birth to their idea in a dorm room, then quitting school and renting out a converted garage that acted as their office and living space. You have to remember, these were four young men in their early twenties with no business experience whatsoever, yet they fell into their roles, as Levie with some marketing classes would be CEO, Smith with his financial sensibilities became CFO, Ghods with some coding background headed up engineering and Queisser, who had spent summers installing cable modems, became the de facto head of IT.

The core group soon began selling Box subscriptions and were making a little bit of money. They even found an early backer at DFJ, who gave them some initial funding and helped form their fledgling board of directors.

Moving beyond the core group

One of the first inflection points for any startup is when you move beyond the core group of founders and begin to look for additional employees. The core group has passion, and in the case of Box, were four guys who had grown up together, further complicating the hiring dynamic, but as with everything, they had some luck in the deal (and they have some advice for those starting on that journey now).

The core team knew they were looking for a good cultural fit, but they warned don’t get people who have the same exact skills and think just the way you do because you just get an echo chamber. Early on, any startup needs people who can cover a lot of jobs. When you get a little bigger, specialization begins to take over.

Even if they weren’t quite sure what they were looking for, they had a sense. They definitely had a “no asshole” rule and they needed someone they would be comfortable brainstorming with in a small room for hours. They lucked out when they brought in Karen Appleton as their 8th or 9th employee. She brought a level of professionalism and business experience the founders lacked and she encouraged them to form partnerships.

“We were 19 or 20 years old. We didn’t know how it would work to hire more experienced people. Karen was the first of those hires and changed our hiring trajectory from cultural fit to cultural add,” Smith explained.

Changing direction

One thing that most startups do is pivot from the original idea, and Box was no exception. In about 2007, they began to recognize that consumer online storage was becoming increasingly specialized with Flickr handling photos and YouTube video. They didn’t think they could compete with that, and at the same they began to recognize a need for a file sharing product for business.

There were a lot of heavy discussions about how to proceed. Eventually Box switched to the enterprise, but they didn’t make the transition willy-nilly. They actually went out and hired a consultant, who made some calls and gathered some data for them to confirm they were making a sound decision. You have to remember in 2007, the iPhone was just coming out and it wasn’t obvious that content and collaboration would move to the cloud. The consultant confirmed that some companies were thinking about this and there would be a business in that space.

There was still a lot of discussion among the founders, but they eventually all agreed it was the way to go — and it turned out to be a good decision.

A couple of years later, the iPad came out and this was a major turning point.. “I had a simple rule of thumb. Bet on whatever Steve Jobs is betting on,” Levie joked. The company turned its attention to the iPad right away and was one of the first enterprise companies with an iPad app. It was then that they realized content management was changing in a big way and it was going to be about protecting content in motion.

It’s a learning process

The founders learned you need to compromise and that was all part of the process. They also were voracious readers and reading books like The Innovator’s Dilemma and Crossing the Chasm helped shape the company philosophy over time.

They all recommend getting mentors and learning as much as you can because it’s tough going it on your own. You don’t know what you don’t know and mentors who have been through the startup experience can help point you in the right direction — and they found when they asked, people generally wanted to help.

They also say that there will be scary moments in the life of any company. They point to 2008 when they went looking for a Series B round in the middle of a huge economic crisis as one of those times.

There will also be tough times. You will definitely fight with your co-founders and you may question what you’re doing, but if you believe in the core mission, you can reach the goal of becoming a public company. It worked for Box — and it’s worth noting that the four founders remained close friends through it all.

Like most VCs, we often review dozens of deals each week. We have developed a funnel that enables us to quickly eliminate those that do not fit our general investment criteria (e.g. industry, stage, model).

The deals that survive this initial culling process are subjected to much greater scrutiny and due diligence. This process includes a thorough review of the deck, financial statements and projections; discussions with the founders, customers and other investors; and a review of third-party information relevant to the company, its product and industry. Companies are eliminated from further consideration during various stages of this process and, in the end, we ultimately invest in a small percentage of the deals we review.

When we decide not to invest in a company, we always take the time to explain to the founders the reasons for our decision. The purpose of this article is to provide a review of the 11 most common reasons why we choose not to invest in companies in hopes that some founders will find it helpful in improving their chances of raising capital.

Lack of transparency/candor. If we detect that a founder is not being forthright, we immediately lose interest. Venture investing is based on relationships; being opaque makes for an inauspicious beginning of a relationship.

Nothing proprietary/defensible. If a company doesn’t have something that is proprietary that makes it defensible against potential competitors, then its success will lead to its downfall.

What do I mean by that? Without a moat, the company’s success is easily replicable. The more success it has, the more competitors it will attract. But if it has a secret sauce — which could include technology, processes, knowledge, relationships, etc. — its odds of sustained growth are far greater. And while first-mover advantage is helpful in the early stages, it usually doesn’t mean much in the long run (e.g. Myspace).

No proven, scalable paid marketing channels. We like to invest in companies where our capital can be used to fuel revenue growth. If a company has not yet identified cost-efficient marketing channels that are scalable, they are more likely to burn through our capital experimenting and testing to find them.

We prefer to invest in companies that have already done at least enough of this initial testing so they can use our investment to scale the channels that are working. And we have a strong preference for founders who intimately understand paid customer acquisition and don’t reply to our questions about growth by saying “We’re hiring a growth hacker.”

Don’t know your Key Performance Indicators (KPIs). We find there is a direct correlation between the depth of a founder’s knowledge of the company’s KPIs and the company’s success.

First, founders must demonstrate they understand which metrics are important to their business. Second, they must demonstrate they are properly measuring and calculating those metrics. Finally, they must know which levers to pull to affect each KPI and which KPIs need to be tweaked for the business to succeed.

Short runway. When we invest in a company, we like to see that it will have at least 12 months of post-close runway. Raising money requires a lot of time and effort and distracts founders from growing the business. We want the company to have adequate resources to enable the team to focus on growth without having to worry about quickly raising another round. Also, the next round becomes much easier to raise if a company has demonstrated 12 months of improving KPIs and growth.

To calculate post-close runway, founders must know the current cash burn and must have formulated detailed projections of how they will spend the funds they are raising and how much cash they will be burning each month post-close. This calculation can be done assuming: (1) zero revenue, (2) current revenue with zero growth or (3) reasonable revenue growth based on historical trends.

TAM is too small. We often see companies that have innovative, sometimes ingenious, solutions to a problem faced by a relatively small group. For a company to achieve exit velocity, it needs to be addressing a large enough market to make its upside revenue potential meaningful to an acquirer. If a company can’t demonstrate to us that the size of the market that its solutions address is reasonable (for us, that is usually north of a $1 billion-per-year market), we usually pass.

Pre-revenue or pre-ship. We find there is a disproportionate decrease in investment risk relative to the increase in valuation when a company makes its first sale. In other words, the risk decreases more than the valuation increases once a company graduates from pre-revenue to building and shipping a product for which someone is willing to pay. Thus, we think it prudent to invest after a company has made this first sale and has shown some early evidence of product-market fit.

No vision. We like to invest in companies whose founders have a clear vision for how to grow the company to 100x its current size. While getting there will certainly require the company to deviate from this vision, not having a vision makes it infinitely more difficult. A North Star keeps founders on track, even in the craziest storms.

Don’t intimately understand your competition. Companies often tell me “we have no competitors.” I generally find this difficult to believe and push back with “How is your target market currently solving the problem you intend to address? That’s your competition.”

Beyond this rudimentary knowledge, founders should thoroughly understand the solutions being offered by their competitors, which market segments they are addressing and how they are selling. A company’s potential customers will be comparing the company’s product against other available solutions, and sharp founders will have properly positioned the product for success.

Not being extremely knowledgeable about these other options and differentiating your product accordingly is a recipe for failure.

Lopsided founding team. Products need to be built and products need to be sold. These tasks require vastly different skill sets that are rarely possessed by the same people. We prefer to see a founding team with experience in a variety of disciplines, from engineering and development to sales and marketing.

Having all disciplines baked in from the founding of a company helps ensure that it creates both great products and products that can be sold. Yes, companies can hire talent in areas in which they are deficient, but then that deficient area is not really part of the company’s DNA. Plus, it’s always preferred if the folks managing the hired hands have experience in the relevant area.

No skin in the game. We want to see that founders are 100 percent dedicated to the company before we jump in. At a bare minimum, they need to be working full time on the business. Ideally, they have invested a relatively significant amount of their own money in the company, as well. Paul Graham wrote that once founders take steps such that it becomes “unthinkably humiliating to fail,” they quickly become “committed to fight to the death.” We agree.

This list is not exhaustive, but hopefully it gives founders a helpful checklist to make sure they are addressing some of the most common reasons why we (and probably other early-stage investors) pass on deals. And, by the way, if you’re doing all of these things right, we’d love to hear from you.

Featured Image: Martin Konopka / EyeEm/Getty Images