Sunday, October 12, 2014

Six Steps to The Maximum Desirable Customer

By Christian Dahlen & Oana Olteanu


The-Usual-Suspects.jpg


Technology startups and mature companies alike know that building successful products requires a close collaboration with the customer. Steve Blank in particular has championed the idea of the Customer Development where startups can systematically improve the chances of product success by developing a better understanding of their customers.


So why is it that so many startups still end up in the product graveyard, need to pivot after significant development investments have already been made, or, even worse, gain only a handful of customers and join the living dead?


Much has been written about the Minimum Viable Product. Based on our experience with startups and large companies in the enterprise software space, there seems to be a common theme: Not picking the ‘right’ customers and not spending enough time with those customers from the beginning is likely to cause damage which proves irreparable.


Here then are six steps to finding the Maximum Desirable Customer
  • Profile and qualify your initial customers. A startup need to have a crystal clear hypothesis about its product target audience, unless it wants to be at the mercy of random customers with ulterior motives. Early customers in particular may simply want to use the start-up as an extended development bench, and that hidden agenda is easy to overlook when a startup is hungry for first customers.
    Two caveats are particularly noteworthy: A mature company with existing customers needs to watch out for Christensen’s innovator’s dilemma and actively seek new users, buyers and partners. And everyone likes to brag about Fortune 50 companies as customers: However, these sought-after brands usually have the most complex requirements that far exceed a Minimum Viable Product.
  • Validate problems/solution with all your channels. It may be comfortable to validate your product with the initial and existing customers only. But the reality of today’s channel landscape is complex and imposes product requirements on your product from day one. Involving partners early will also prepare the ecosystem when the product is finally launched.
  • Talk to all of your customer stakeholders. The buying decision is never influenced by one person only. One must ensure that each layer of customers wants to hire the product for the job that they have to do: The end user needs a great user interface and a necessary and sufficient set of functions. The buyer has to weigh competing priorities, and may have a different job for which he might want to hire the product for. Other stakeholders in IT and in finance may have the final budget authority. There is a whole ecosystem around these stakeholders who influence the buying decision.
  • Solicit active feedback from your customers. It may be very comfortable for both parties to have the product team broadcasting what they plan to do. But shouting out and not getting an engaged response is a clear warning sign that things are not going well. If in doubt, make sure to engage with the business users.
  • Find a stable use case and persona. Working with only two or three initial customers only is a risky undertaking. A customer advisory council helps build a stable persona that survives even if some initial customers decide to drop out. Moreover, the more customers are involved in defining the persona, the higher the chance of catching the common traits and building a true Minimum Viable Product (MVP).
  • Build a low fidelity Minimum Viable Product for customers requiring the least amount of features. Now that the ‘right’ customers have been picked, comic book type storytelling and simple proof of concepts can save the startup from wasting months of development work and having to start all over again.

In a nutshell, the time spent with future customers before beginning a massive development effort is time well spent. Following the six simple rules to finding the Maximum Desirable Customers ensures that the right customer pipeline is built from the start.

Photo credit here

The Future of Venture Capital - Of Startups, Seed Funds, and Limited Partners

The annual PreMoney conference in June 2014 was themed ‘the future of venture capital’. One topic of discussion was the proliferation of angel investments and seed funds.
1. How to find the right match between startups and angel investors?
2. How do angel investors decide where to invest?
3. How should Limited Partners decide which seed funds to invest in?
Investors and startups should fall in love.  Elad Gil looked at the two sides of the angel investor - startup relationship. For a startup to fall in love with an angel investor, an angel can do several things to help the entrepreneur: making introductions to the network and providing access to privileged information, offering support like CEO dinners, and being available and discrete.
Investing requires to be principled. Elad suggest the most important criterion for angels to invest in a startup should be the market - as Andy Rachleff said, the market always wins, and the only way to make money is to be contrarian and right. Companies such as eBay and AirBnB were initially considered overvalued and are in fact perfect examples of those criteria. Jeff Clavier from Softtech VC added his key criteria for investing
  • Do I like the founders? Are they a good fit for the category? Do the founders know what they don’t know?
  • Am I passionate about the product? Do I love this deal? Every new piece of information in the course of due diligence should make you more excited.
  • Is it fundable in 12-18 months?

He strongly suggested to invest if the founders are legit and the referrer is respectable. He also advocated building a strong investor syndicate to help fix the founders shortcomings, and to avoid the party rounds where no one is responsible.
Elad also offered suggestions how to avoid the trap of becoming a bad angel: re-inventing yourself, building networks and knowledge for your company, and focusing on things you can uniquely help with.
Network centrality and follow-ons distinguish seed funds. Limited Partners get inundated with pitches from 50+ new seed funds which have been created in the past years. The Limited Partner community cares about these MicroVCs, but needs help to understand which funds have deal flow and syndication. Jeff Clavier pointed out the importance of having a ‘shtick’ - a differentiated strategy by geography, sector, infrastructure, ecosystem, value add - to  distinguish from the hundreds of other MicroVCs. Anand Sanwal from CB Insights provided quantitative insight on the relative attractiveness of the funds and general partners
  • Network centrality: Google PageRank for investors, and to high quality investors. Three of the top six leaders here are also members of Y Combinator: Alexis Ohanian, Max Levchin, Gary Tan, Marc Benioff, David Tisch, Paul Buchheit.
  • Syndication and follow-on investments: Who invests afterwards provides more confidence. Follow on rates are highest for seasoned investors and entrepreneurs such Bobby Yardani, Larry Augustin, Matt Coffin, Gil Penchina. As an aside, CB insight found that VC involvement in seed rounds creates more follow-on funding.

None of the funds have a track record yet, and similarly, neither do many of the fund’s general partners. But the analysis promises to be an indicator of future success.

How To Become A Super Angel, Part Two: How To Spend It

In the first installment on how to become a super angel, we reviewed the seven steps to achieve liftoff and raise the first outside funds. This second installment takes a look at the subsequent evolution of the super angel cohort.




  1. Put the outside money to work quickly. A $10 million fund will spend $4 million over the first two to three years, and keep $6 million in reserve for follow-on investments. The $1 - $2 million annual spending can still be used to pray and spray approach, but, more likely, the angel will write bigger checks to double down on initial investments. Given that the angel has made a significant number of investments over many years, deal flow should not be an issue. And if it is, there is always the option of creating one’s own accelerator, or leverage AngelList.
  2. Increase the investment size.  At this stage, super angels typically still invest on their own time. Previous investments are taking up some of that time, and therefore super angels will very likely have to increase the size of their investments going forward. However, angels typically still do not lead investments and don’t take board seats at this stage. Their ability to provide timely advice may also be impacted.
  3. Raise the next round. To take advantage of the momentum and the afterglow of the early successes, angels again need to raise as quickly as 18 months after the first round.


  1. Hire some junior partners. Now that there is more money to spend, there are many more investments to be made. At this stage, the super angels run out of time and need to start leveraging their time.
  2. Create a following among VCs. An analysis of micro venture capital firms by CB Insight shows that many investments of Chris Sacca’s LowerCase and Aydin Senkut’s Felicis Ventures are followed by blue chip venture capital firms. On their web site, Felicis notes that they have had 51 notable exits, evidence of an angel investor who he is highly networked with venture capital firms and with serial corporate acquirers such as Google and Facebook.
  3. Adapt the business model. Quo vadis, super angel?  
  • Become a micro/boutique VC. The bigger micro VCs like SoftTech VC and Felicis have raised in excess of $100 million and seem well on their way to becoming a traditional venture capital firm. Because they now lead rounds and are board members, they have hired and promoted additional partners.
  • Build an accelerator. 500 Startups in particular has combined an accelerator with seed, early stage and later stage investments. Dave McClure has put in place a whole ecosystem of investments, events and global sourcing of entrepreneurs.
  • Stay small. K9 Ventures seems to pursue this path where Manu Kumar remain a sole operator of a $40 million fund. According to Crunchbase, K9 has made 32 investments in 23 companies as of October 2014, two years after raising the second fund.
  • Be opportunistic. Chris Sacca of LowerCase has been a master of doubling down on prior investments and leveraging his network. He first raised an $8.5 million fund from high net worth individuals he had built real relations with, and then raised additional funds just to buy Twitter shares as people were leaving.
  • Start a syndicate on AngelList. Jason Calacanis and other angels have used their network and name recognition to launch nano funds. The committed amounts are still significantly below $10 million, but can eventually lead to larger investments from Limited Partners.
There is no public information available about the performance of any of these super angels and their funds, many of which are still relatively young. There is some anecdotal evidence that the returns of some the funds are below the water mark, but similar to venture capital firms, success stories tend to be told and re-told, and losses swept under the rug called survivorship bias. For the time being, proxies like the CB Insights network centrality and investment follow-on analysis have to suffice to provide Limited Partners with insight about the potential returns of these newly minted super angels.

Saturday, August 16, 2014

Angel On Vacation?



It is a common perception is that venture capital firms close down for business during much of the summer. Start-ups should align their fundraising activities with the annual calendar, and not waste their efforts when it is unlikely that a full partnership group is able convene. As an active angel investor, this also rings true for new deals, even if there are no partnership decisions required. Starting in early July, first time meetings with entrepreneurs are postponed until after the summer. Knowing that many other investors also take the time off, the chances of not being able to take part in key deals seems small.


Existing investments are living, breathing organisms where the activities are not controlled by the boards and the advisers. In most of the cases this does not constitute an issue. During the most recent summer vacation period, six of my portfolio companies did nothing which would have required my attention or intervention. For another two companies, planned and ongoing  activities simply spilled over into the summer: In one case, a new CEO was brought on board. In another, the critical introduction to a future business partner was initiated and resulted in a first productive meeting.


However, two portfolio companies provided unexpected, and in one case material, surprises.  In one case, the startup was publicly hit with presumed claim about the company’s intellectual property (IP) and its development practices. Making sure that the IP is rock solid should be one of the foundations for investing, and attacks on these grounds are always cause for concern. While such claims are often not resolved immediately, they need to be put down as quickly as possible and before the next funding round to allow the company to focus on the business. In this case, the founders responded promptly to what appears to be a fraudulent claim.

The CEO of the other start-up company sent out an urgent and surprising email to the company investors. He announced the need for an immediate cash infusion within two days, or else the company would have to shut down and the assets would have to be sold. He also informed that two of the board members had stepped down in the prior two days. All of this after things seemed to have been going well. In hindsight, some warning signs had been obvious, but it was hard to believe that such a perfect storm could arise within a few days. 11 days later and thanks to the hard work of many of the stakeholders, the impending demise has been avoided, the company has been restructured, and new capital has been infused. 

In the past weeks, I took time off from pursuing new investments. For the existing portfolio companies however, the involvement never stops - it may just pause.

Tuesday, June 3, 2014

Incubators, Accelerators, and Combinators Have Entrepreneurs Cheering - Here's Why



Since the founding of Y Combinator in 2005, the number of incubator and accelerator programs has rapidly proliferated. Akin to popular rankings for colleges and universities, Forbes magazine and Techcrunch have even published rankings of top accelerator programs.


Many of these programs have modeled themselves after Y Combinator. Just to mention a few, Techstars launched in 2006, 500 Startups, AngelPad and the Citrix Startup Accelerator launched in 2010, and Alchemist in 2012. Each of these programs operate based on a similar business system. They source small start-up teams  of one to three founders, screen them in a concise interview process, provide some seed funding, nurture the team in a three to six months long process, and graduate them at the so-called demo day. Most programs offer admission twice a year.  

The impact on company founders and on early stage investors has been profound. This post sets out to shed some light by asking three key questions: How do these programs operate? What value are they providing for entrepreneurs? What impact do they have on the early stage investing landscape?



Sourcing of Founders


Many first time entrepreneurs are looking to become of part of a startup ecosystem. These programs provide an equal opportunity to gain instant access to such network.


Y Combinator initially built a follower community through Hacker News and Paul Graham's blogs. The Google pedigree of Angelpad’s founders helped attract other ex-Googlers. 500 Startups has gone out of its way to recruit entrepreneurs in Korea, Mexico, and many other locations from outside of the U.S.. Other programs are building reputations in specific focus areas. For instance, Alchemist is an enterprise focused program, and Rock Health is health focused. Eventually, successful programs attract founders because of the strength of their program brand alone.



Candidate Screening

Research on angel investment returns shows a strong correlation between investment success and time spent in due diligence. Accelerator programs often attract founding teams with little startup track records, and therefore place an emphasis on the founder versus their business ideas to reduce team risk. Applicants are asked to submit videos and describe critical moments in their lives. The tendency is to bet on teams who have worked or at least studied together. The actual interview process is conducted in batches, is limited to a few minutes, and decisions are made within 24 hours or less. Dave McClure of 500 Startups has further minimized the due diligence process and stated that the portfolio itself replaces due diligence.


The class sizes continue to change and vary from 10 (Angelpad ) to 50-70 (Y Combinator) to hundreds each year (500 Startups). Admission rates are in the single digit percentages, similar of top university programs.

Startup Funding

Y Combinator pioneered a model where the start-ups are giving up a single digit share of equity in return for funding that lasts the team for the duration of the program. The exact funding amount has varied over time, and is a function of team size, duration, and program reputation. Most often the terms are in the form of a convertible note with a conversion cap, although the structures vary and evolve over time.


The funding amount and structure appear to play less of a role in the entrepreneurs’ decision where to apply compared to the program reputation, although corporate programs tend to offer the most entrepreneur friendly terms. For early investors, the prevalent convertible note structure offers an easy way to invest, but often at the price of high valuation expectations.

Incubating and Accelerating

Successful angel investment outcomes are also strongly correlated with mentoring, coaching, providing leads, and monitoring performance. Incubator and accelerator programs have taken this participation to a new level where they emphasize different elements of advice and networking. The class type collaboration, competition, rhythm and co-location facilitate regular discussions, dinners, office hours, and social events. Program participants can show weekly progress on their product development and in meeting their target metrics. For content, many programs leverage Eric Ries’ Lean Startup approach and Steve Blank’s Customer Development process. The 24 week Alchemist program is extending this approach from three to six months by splitting the program in to a first half focused on customer development, the second on product development.

The efficiency of the partner advice is maximized by the condensed time frame, the co-location, and by the partners not taking board seats. And some programs like AngelPad and Alchemist have chosen to keep the class sizes small to deliver consistent advice.

Those programs wanting to further scale are adding more partners, and are growing the network of external advisers. As the accelerators mature, executives from former incubated start-ups are being recycled and brought back as advisers.

As Y Combinator’s Paul Graham has stated ‘... startups at all stages benefit from YC. That’s probably the best word to describe the atmosphere. For 3 months, it’s all start-up, all the time.’’ This is in marked contrast with a more traditional angel approach. There, advice is delivered on a one-on-one basis for the duration of the relationship, and is based on the strength of the individual angel and her network.



Follow-on Funding

The concept of a demo day is an attempt to ‘formally’ graduate start-ups, although the businesses are at widely varying maturity stages. Demo day also creates a 'American Idol' like marketplace where a large number of seed investors and early stage startups compete for attention and money. Some incubators have been able to generate demo day momentum and attract venture capital for a significant number of their incubated companies. For startups, the exposure to a large number of investors and the time saved in fundraising is extremely efficient.

VCs and angels can get early access by participating in the mentoring of the programs' participants. That way there are no signalling risks, and the demo day simply creates the urgency for them to make an investment decision before everyone else.


The usefulness of the demo day itself has been questioned by many investors. The limited time to get to know the company, to do research on the market and the competitive landscape, or to get meaningful customer references often force investment decisions under duress.

The program's brand can also be strong enough to crowd source follow-on funding for the whole portfolio of class participants. AngelPad is using the Angellist syndicate model where the momentum from the demo day is leveraged to attract additional investors who are not demo day participants.

Summary and Outlook


The impact of Y Combinator and other programs on the entrepreneurial landscape and on early stage investing has been enormous. They have built repeatable processes bringing together large numbers of startups and investors. As Angellist’s Naval Ravikant has stated, ‘Accelerators have branded advice and have institutionalized it.


Participants in the programs, and in particular first time entrepreneurs, very highly value the advice, the network and the funding acceleration. Post demo day, the power of the program's alumni network also helps recruiting and providing the seeding ground for new products and even new companies.

The corollary is also clear: Why should an experienced founder give up expensive equity if the product has some traction and the founder knows how to build a company? However, there have already been some cases where the team opted to join a program if even only one of the pieces was missing.

Programs make the first investment into founding teams with little track record. As valuation expectations rise significantly in the three months from inception to graduation, the demo day effectively creates a new investment 'gate'. This may leave traditional angel investors for these types of investments in a lurch. At the front end, they may not be able to compete with incubators in delivering services in a consistent and timely fashion. At the back end, valuations at demo day often reach levels which make it unattractive for angels to participate.


Thanks to Ken Arnold, Ryan Nichols, Mike Palmer, Riley Scott and David Wu for commenting on the draft version of this post.

Thursday, May 29, 2014

Most Accidents Happen Close To Home - An Example of Startup Failure

In 2011, I invested in a promising gaming start-up. The promise was to license TV and movie content for related games, and get a jump start by using the brand name and co-marketing agreements to quickly build an audience. The leadership team was strong, the company attracted many experienced angel investors, and internet gaming sector was buoyed by Zynga’s impending IPO.


Yet, not even a year later, the investment ended up a complete failure.
When a company comes out a winner, everyone takes credit. When a company fails, it is like the scene of the traffic accident: Car drivers, passengers, bystanders, perpetrators, victims, police, ambulance - they all have slightly different perspectives about what happened. In this situation, one needs to peel back the onion to understand what really happened.


Research indicates that angel investors’ outcomes can be positively influenced by spending more time on due diligence, leveraging industry expertise, and frequently interacting with portfolio companies. To get a better understanding of the events, I talked to a number of board members, investors, and company executives. What were the early warning signs that something was going wrong? Was it a lack of due diligence? What actions should have been taken?  Did the board not take corrective action early enough? And would the outcome have been different?


The obvious answer is to point to a market failure. After its IPO in December 2011, Zynga’s stock price briefly rose and peaked in March 2012.  In March, Zynga acquired OMGPOP, the maker of the Words With Friends game, so there was an brief opening for gaming companies to be acquired. Even as this acquisition was consummated, Zynga’s stock fell off a cliff in April, taking with it the hopes of many start-ups to be acquired. The disappointing Facebook IPO in May further put a chill on the market. Raising funding for a gaming startup in early 2012 certainly was a challenging endeavour to say the least.


Both founders had worked together on the project part-time for two years before raising the initial funding. The energetic and talented CEO had a strong product vision and experience as a founder. The COO had a background in finance and operations, start-up experience and connections in the media business. The board consisted of several highly experienced angel investors. And yet, majority of stakeholders thought the founding team had failed. The money was wired in July of 2011 and the team started to ramp up. At the first board meeting in September, the directors had trouble getting financial and market information. It became clear that the CEO lacked business acumen. Soon after, the CEO, who also was the CFO and the chairman of the board, started behaving increasingly autocratic. By late fall, the relationship between the two founders had deteriorated to a point where the board started counselling the CEO. Checks and balances between the two founders disappeared, and the relationship became emotionally charged. To make things worse, the COO developed health issues  in November and the CEO was hit by a car, partly incapacitating both founders during a critical time. And none of the outside directors had experience in the online gaming industry.


At the end of 2011, revenue had come in short, and cash reserves were rapidly dwindling. January saw a rapid succession of board meetings where the CFO responsibilities were finally removed from the CEO and moved to the COO. At the same time, the COO faced a declining health situation and ended up having to step down at the end of January. The CEO ventured to raise more money, but the money never arrived in the bank accounts. Almost weekly board meetings continued throughout February. In late February, the CEO obtained a short term loan in exchange for company common stock and receivables to stave off immediate bankruptcy. In doing so without informing the board and without its consent, he breached the investor rights and was subsequently removed as chairman. The money that had been promised never arrived, and in early March all employees had to be laid off. Only a minimum amount of cash was left. In April, the company missed a royalty payment for the marquee game, and the game was cancelled by the content owner. The outside board members resigned.


But all the executive changes and board actions were merely too late. Coming out of the 2011 summer break, the marquee game had good metrics per user but did not get the expected traction. The company had been struggling grow the number of users, and made no progress until December. The introduction of new features during the Halloween and Thanksgiving holidays did not move the needle. And a critical co-marketing agreement and a new TV season would only kick in in April 2012. In retrospect, the product issues were apparent in the fall already. Instead of focusing on fixing the game, the team embarked on a multitude of projects such as replatforming the game for mobile, developing a second game, and taking on project work on behalf of others. Moreover, resources were diverted to build a proprietary metrics platform to save money paid to 3rd party providers.

The truth lies in the eye of the beholder. In this case, it appears that some of the best practices for a successful angel investor outcome were ignored, and that events spiraled out of control faster than anyone anticipated.

Sunday, April 20, 2014

Top Accelerator Generates 50X Return - How Can Investors Participate?

Accelerators and incubators have claimed prominent roles in the earliest stages of startup formation. These programs have seeded thousands of new companies and created significant value.


Y Combinator is the program with the longest track record and the largest amount of publicly available information. As of February 2014, Y Combinator has seeded an astounding number of more than 630 startups. At a per company funding of $15,000 to $20,000, Y Combinator has invested $10 million since its launch in 2005.  Y Combinator receives 6% of equity, effectively valuing the startup at approximately $250 thousand. Kawasaki's law of pre-money valuation assigns a value of $500,000 for every full-time engineer and subtracts $250,00 for an M.B.A. For a team composed of two technical co-founders, Y Combinator's investments constitutes a 75% discount compared to this rule of thumb.


Recently, Y combinator announced that its portfolio companies are worth more than $20 billion. AirBnb and Dropbox account for around 75% of that valuation. Assuming, pro forma,  five successive rounds of funding and a 15% dilution per round, the original 6% stake now is down to 2.7%, equal to a value of more than $500 million. In other words, Y Combinator has achieved a 50X total return on the $10 million invested so far. While almost all of these investments are still illiquid, the likelihood of realizing these returns is high. And since Dropbox and AirBnB were members of the classes of 2007 and 2009, respectively, there may be more hits to emerge still.


Until 2009, Y Combinator only invested its founder’s money. In 2009, Y Combinator raised a $2 million fund from Sequoia Capital and a number of angel investors, followed by a $8.25 million fund in 2010. Y Combinator raised and manages these funds to increase the number of startups it invests in.


Since 2011, startups in the program are offered additional funding after the initial Y Combinator equity investment. Yuri Milner and SV Angel launched the YC managed Start Fund to provide $150,000 in convertible debt to every startup in the program. In 2012, YC VC replaced Start Fund with a reduced amount of $80,000 instead of $150,000. Y Combinator was looking for each of the fund investors to provide the startups with advice, and consequently Khosla Ventures replaced Yuri Milner in 2013. In times when capital is cheap, advice is at a premium.

As the Y Combinator case shows, accelerators may prefer having prominent angel investors and venture capital firms as partners in their own earliest stage funds. Other early stage investors can create their own next stage index fund by spreading their investments over a wide range of accelerator startups. The returns can still be above average, but will require significant capital and effort.