Markets, Customers and Angels' Risk Aversion

Famous entrepreneur and Stanford Technology Ventures Program lecturer,Steve Blank reports that business failure from technology failure (the business' technology encounters operational conditions under which it cannot perform as hoped) is about 10%. Business failure from misunderstood and miscalculated markets, market failure, is about 90%. Why?  I propose that the nature of the "entrepreneurial brain" has much to do with it.

Entrepreneurs by nature are innovators, problem solvers: they perceive a need (more convenience, more speed, less cost, whatever) and instinctively start seeking a solution, a fix. That initiative and independent thinking is the power of entrepreneurs, but is also a curse. Asking  "what do others think" does not come as automatically. So, the entrepreneur finds a solution to "the problem", a problem possibly perceived by only one person, himself, and presumes it is a widespread need.  Then, enamored with the conceptual "solution" (s)he commits time, effort and treasure to create a prototype.  Sometime for lack of sufficient resources a detour is needed into fund raising to finance the idea now morphed into a business venture.  

Eventually a product is ready for sale and the surprises start coming: customers are not as enthusiastic about it as hoped, they have difficulty using the product because of a million reasons, or they could benefit from using it, but other circumstances prevent its adoption (e.g. supply chain disruption, legacy systems, not invented here, etc.). In a few words our entrepreneur has invented a Bricklin or a Segway, an innovative design with definite benefits but overall unsuitable for the larger market originally targeted. The outcome is then outright failure or a walking zombie of a business.

In product and software development there are long standing disciplines (use case analysis) to ensure that acceptable performance will be possible in specific instances of use.  Use case is a discipline that forces  asking questions, and more questions, and more questions.  The same discipline is needed with respect to markets and customers. Here are the questions to ask:

What are your customers top problems?
How much will they pay to solve them?

      Could they do nothing and get by?
Does your product concept solve them?
      Do your prospective customers agree with you on this? [Your guess that they do is the issue we are trying to avoid!]
Draw a day-in-the-life of a customer (the customer's use case) 

      before & after your product adoption

      what will the product improve

      what will the product hinder/change/complicate

Draw the org chart of users & buyers

     are they the same?

     we must satisfy both, but buyers control

     who has a vested interest in favor or against adoption?

     who is the loser if adopted?

     can your customer afford to upset the loser?

Are there enough buyers NOW to make it worthwhile?

Can we scale our processes to match the market size?

The only way to know for sure is for the founders to go out (out of the office, in the real world) and ask the customers.  Go out and ask are obvious, but would marketing consultants be able or even better at doing this research? Definitely NOT.  Consultants can go out with clipboards to get data and analyze it, but at this stage the critical component is intimate understanding of BOTH the customer and the product concept/prototype.  Only the founders-inventors can "feel" both sides of the equation and catalyze a workable solution based on the customers' responses.  If the consultants could do it, they would have been the inventors-founders.

So, early on, even before prototypes, go out and ask your intended customers how your product will meet their needs and what issues it will cause and LISTEN. The product will almost inevitably be modified by this effort, but at much lower cost than building and rebuilding prototypes or final products. You may discover that your product is perfect at a perfect price with the expected benefits, etc.  Too bad that its adoption would kill another more important part of your customer business and therefore your customer would have to be mad to adopt your product.

Validating your value proposition in person and directly with the customers (taking into account all vested interests involved)  may just reduce the probability of your business' market failure from 90% to something less. Any improvement will likely appease your angel investors' risk aversion.

Marco Messina

Did you just say THAT to an angel?

One of my favourite Dale Carnegie quotes is: "If you want to gather honey, don't kick over the beehive."

Just like bees, angels have adverse responses to certain stimuli. Keeping those in mind will make getting to their honey far more likely.  Following are some examples of statements (S) often made by "honey seekers" and the mental responses (R) they are likely to stimulate in the angels.  Depending on the mood of the moment, the responses may or may not be verbalized. Often, in front of a large audience, the "honey seeker" is better off if the response is just a silent smile.

S   We have no competition
R  Either you have not researched it, haven't found it, or are so deluded to not recognize it...
R  If no one does it, perhaps it's because no one needs it

S   We have made very conservative projections
R  Sure.  So did the 1000's that came before you; and you are not even smart enough not to say it
R  If you are conservative you are no entrepreneur, buddy, you better go work for the Census surveys

S   We researched it so much, this is now a sure thing
R The only sure things are death and taxes.  We do not like sure things.

S   We are creating a market
R Excellent! This is an answer in search of a problem, that will be a real quixotic adventure
R Cool! If I wanted to create "futures" I'd be buying into a kindergarten or a primary school

S   Our solution will become the standard
R My goodness! We only have to stop the people who today are doing whatever by the current standard and force/train them to do it a new way. Along the way we only have to redesign all regulations, training programs, certifications, cajole all vested interests, etc. AND we make no money until it's done. Where is my checkbook.

S   If we get 1% of .... to buy our product we'll make millions
R Ah! Here comes the 1%er again.  If I could only have a dollar for only 1% of the 1%ers that presented plans I'd have the best performing fund at next years ACA Summit
R  Sure buddy, and we are going to do it all with viral marketing too

S   I am the only resource but I'll have key man insurance
R I like that!  So for an early exit all I have to do is to pray for trucks to hit you.  This is so new a strategy, we could write a white paper for HBR
R  We could optimize this plan by doubling the premium and make you open a branch office in Darfur

S   We are co-managers
R No way.  We want to know which throat to choke when things don't work.  Only one throat.
R So, we are supposed to pay two to make decisions that one should be able to do?

S   We only have to scale... 
R But of course! The difference between your local taco stand and McDonald's is only scale.  Same for mom's kitchen and Campbell Soup or my kids' tree-house and the Sears tower. It's only scale.

Lastly there are the responses that "seekers" give including an implied  "you dumb ass" commentary.  They are always a good bet for making angry bees out of angels:

you have to understand...

No buddy, I have the cash and do not have to do anything, you have to make me understand

everybody knows...  

Ah well, I must be the only idiot that doesn't.  I stand corrected.  Thank you so much for that clarification.

as I said before...  

Excuuuse us! We are either forgetful, slow or inattentive.  We'll do better next time... since you ain't getting any "honey" this time around.

Conclusion

Much has been written about human communications since Dale Carnegie wrote his masterpiece, little of substance has been added. It remains one of the best  manuals around: you might read it again with your angels in mind.

Marco Messina

The Five Dimensions of Impactful Presentations

In a world of people with ever diminishing patience it is not enough to be brief and to the point. You must find a way to engage your audience on more than one dimension at a time. Dr. Andrew Abela summarized it well a few years back.

The Five Dimensions of Extreme Presentation

A central hypothesis at the heart of this research is that the Extreme Presentation must address five dimensions. These are Logic, Rhetoric, Graphics, Politics and Metrics. The problem with most approaches to presentation design, as I see it, is that they tend to focus on only one or two of these dimensions. So the current focus on using storytelling to improve presentations, for example, while a welcome and powerful idea, is misleading unless it is thoroughly integrated into the other dimensions.

Logic is about making sure that the problem is correctly defined and rigorously solved. Absolutely necessary, but not sufficient;
Rhetoric is the storytelling dimension: your audience usually contains human beings, not machines, so they need to receive your information in ways that are appealing to humans;
Graphics is the visual dimension;
Politics is the recognition that "power and politics are part of life in organizations everywhere" (Charles Handy, Inside Organizations, p. 115) and therefore that the best recommendations in the world will go nowhere unless their implications for all relevant stakeholders are thought through and syndicated in advance as far as possible; and
Metrics is the objective of the presentation and how you will measure its success.

So, in the world of the Power Point presentations we use to pitch angel investors we better look at each slide  five times and strive to have our message strike a bull's eye and be consistent in at lest three out of five dimensions.  If not, rework the message.

Marco Messina

Fishing for Angel Fish

The scarcest resource of entrepreneurs is not money, is time.  Money, when you can get it, is just a means to increase available time by hiring outsiders to do for you whatever you are smart enough to delegate and manage.  Conversely, all the money in the world will achieve nothing more than the going rate of interest in a bank account (3%) unless one puts it to work with time and energy. SO, NEVER WASTE  TIME.


One way I see many entrepreneurs wasting time is chasing funding from angel investors with propositions that do not come close to having any chance of success.  It is like going fishing for the wrong fish in the wrong pond with the wrong bait - most unlikely to make dinner tonight.

So in the interest of better fishing let's study the angel fish.  It is easy because: 

• these days most angel fish school in groups 
• most states and regions have well advertised (web) ponds, 
• the fish have the kindness to spell out in advance what bait they will strike

Here is an example taken from "one billboard at a well known California pond":
      Tech Coast Angel members invest in southern California companies, only. We look for products and services that can achieve rapid adoption in very large markets. Some of our criteria: 

• Scale: annual revenue potential of at least $50 million
• Market: a compelling, well articulated strategy for capturing and defending a significant market share
• Barriers to entry: patents or proprietary technology
• Team: a strong, not necessarily complete, team
• Exit strategy: some idea of who will eventually acquire your company
• How we fit: a desire for advice and coaching
• Valuation: you must fit within our risk/reward expectations

At other ponds the billboards list:

• specific industries (because the fish have expertise in them)
• level of business development (no pre-revenue plans)

So, figure out what business (bait) you have and decide if you stand a chance to catch angel fish.  If not, go fish for other species that bite on different bait, presumably the one you have. Here are examples:

Friends and Family:  this species bites on you personally and your trust factor with them.  Returns are hoped for but often the motivation is to help you along with the world changing idea you shared with them.

Banks: They still have money and do lend it if your business is the right bait for them. You'll need collateral and cash flow to have an chance. Beware of lines of credit that appear to be a strike, but you cannot count on for very long. 

Factors and Receivable Discounters: They bite on (and take a good chunk of) invoices you carry as receivables from financially reliable customers (they bite on someone else credit). 

There are many more, each specialized in different aspects and needs of your business.

Back to that favorite species: the angel fish.  The words that carry value with them (shiners in the fishing parlance) include:

Scalable: 1. the business can grow into a big business, 2. you and your team are capable to grow it

Market size and dominance: "1% of the world" is probably meaningless, "80% of left handed investment bankers with an income over 500k" is a concept one can measure and relate to. Attractive markets have size and allow some level of dominance.

Early Exit: a plan with an Exit is a requirement (remember: angel fish get to eat only at exit time). Early Exit is golden. More on this in a forthcoming post.

Barrier to Entry: the stronger your position, the less spooky the fish will be

Risk: This is the monster from the dark depths that scares angel fish away. They know it is part of the game, but they hate it. To manage their fear, show that you have identified fall back positions and fail safe conditions at every step; be able to simulate the cash flow projections accordingly. 

BE BRIEF: this is the most impatient fish in the world 

Happy fishing.  There is fish in that pond for the right bait. Do not waste time otherwise.

Marco Messina

Brevity again... The One Page Term Sheet

In my continuing search for KISS answers - Keep It Simple & Short, I read Basil Peters' proposal for a One Page Term Sheet. I've been following Basil's blog for years now and I think it's one of the best sources of experienced and clear thinking about angel investing. It will be a wonderful day when this becomes a best practice because it will set owners and investors much closer together at the start of a negotiation by establishing shared expectations. In a few words we will start from a known point and negotiate the variances required by the specific circumstances.

As an investor do I believe all the terms in here ideal? I do not pretend to argue that point here. In time the industry (angel investors and funds) will refine it and the sooner the better.

As an entrepreneur pitching your deal to angels, you can only hope they pitch back to you something this clear and straightforward. Now, read and hope.  If you have guts, present it as the guideline you positioned your company by and for: at a minimum you might just impress your angels as the first instance they encountered in which the "seller" appears to have made an effort to understand the "buyer" - what a concept.

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The 'One Page' Term Sheet for Angel Investors

This is not a theory or academic exercise. This term sheet is in actual use today by angel funds in BC.

This term sheet is based on exchangeable shares. This simplified term sheet is based on the underlying assumption that an effective, independent board is in place and that the board will make the best decisions for all shareholders. It also assumes the company is built on a fair and equitable structure.

Term Sheet offered to the"Company"

This Term Sheet has been prepared for angel investments made at an early stage by "the Angel Fund". The terms have been simplified to match the stage of investment and are offered for consideration and acceptance.

Offer of Investment

The Fund will purchase, together with any syndicated investors, (collectively the "Investors"), common shares (the "Shares") at a price of $* per Share. The total round for all Investors will be $* of which the Fund will invest $* to acquire a total of * Shares. So long as the Investors hold their Shares and until a liquidity event, they shall have the right to exchange them for the same kind and class of securities issued by the Company (the "New Securities") in any follow on financings should such New Securities have rights superior to the Shares. The Investment will be made pursuant to an Investment Agreement made between the Investors, the Company and certain of its principals (the "Principals"). The capital structure on closing will be as described in the attached Share Register.

Board of Directors

The Fund believes that early stage investments need strong mentoring and governance provided by a high quality, engaged Board. On the completion of the investment, the Board will be comprised as follows:

• a total of five members, being the CEO, one nominee of the Fund and three nominees independent of management that the Company and the Fund agree on; and
• each director must have made a meaningful investment in the Company.

Share and Option Vesting

The Fund believes that it is important that the Principals' interests align with the Investors. In this regard the parties agree that all stock options and all nominally priced previously issued shares will vest on the following basis:

• 50% of the shares will vest daily and linearly over a three year period; and
• the other 50% will not vest unless and until there is a sale of the Company.

All share and option vesting will accelerate on a sale of the Company. An Escrow Agreement will be entered into to provide for the vesting.

Liquidity Event

To ensure that a return can be provided to all of the Company's shareholders when an opportunity presents itself to sell the Company, the Fund will require a "drag-along" right be added to the Company's constating documents to allow the holders of 51% of the issued shares of the Company to cause the sale of all of the shares of the Company.

Reporting to Shareholders

The company will send a CEO Update monthly to all shareholders. Financial statements are also available upon request.

Investor Rights

Investors have the right of first refusal to participate in future financings.

Any changes to the capital structure, new shares, options or debt requires the approval of the majority of the investors in this round.

General

The Company will pay the legal costs of the Fund not to exceed $6,500, plus taxes and disbursements thereon. The Company will keep confidential this Term Sheet and all discussions with the Fund for a period of two years.

Binding Nature

This Term Sheet will terminate on *[date], unless terminated earlier by the Fund. The Company will not seek alternate financing unless and until this Term Sheet has terminated or been terminated by the Fund. The confidentiality provisions will survive termination of this Term Sheet. Acknowledged and agreed to by the Company and by the Fund this * day of *, 200* by: [Signatures]

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Yes! That is all of it!

Comments will be greatly appreciated.

Marco Messina

How to P... off an angel

I considered holding this post off.  Then I realized that my raw response to the circumstance that originated it may be a useful component of the lesson.

Background
Last week I met a college student intent in starting a new business and looking for help financing and marketing his venture. Admittedly I am a deal junky and cannot resist helping a startup along; here is the result.

Anatomy of a (lost?) deal
The young man I first met (P1) seemed quick thinking (+), amiable (+), articulate (+) and entrepreneurially flexible and opportunistic (+)
At our first meeting he gave me no means to contact him (-) but he followed up and contacted me (+) [if you want to appear like you can play, at least get some $5-precut-forms-inkjet-home-printed business card]
The business idea may have legs (+)
I have a lead into a potential customer and stated so (+)
The prospect, on my recommendation, may be willing to pay for a pilot test (+)
I asked for a follow up meeting specifying what  I needed for my due diligence before pitching their deal to my prospect.  To T-up the meeting I emailed that: i) I'd be willing to sign an NDA, ii) I need to know material costs to figure the financial commitment required to do a pilot (particularly if I and friends are to be angels), iii) I need to satisfy myself that there is a really working system capable of doing what is proposed, before I go put my good name on the line.
The meeting was scheduled but no information requested was sent ahead of time (-)
At the meeting I met Partner #2 (P2)
P2 from the outset displayed a surly and arrogant attitude apparently intent to require my demonstration of why I should be granted an audience (-)
P2 barely introduced himself [another one with no business cards] and gave no additional details about himself or his experience (-)
P2 pointedly asked whether I had a resume to demonstrate I deserved any attention (-)
P2 shoved in front of me an NDA of 4 pages (filled by hand with the company name), folded open to the signature page requesting I sign (apparently without reading it) before we continued (-)
After a few years experience with hyper-self-important student entrepreneurs, this was not a total surprise. Rewind to 1973 and probably there go I. I declined signing an NDA I could not review for lack of time. I proposed to limit the conversation to information not requiring NDA.
As expected, I got none of the information I sought (-)
P1 tried to mend fences offering whatever information he could without agitating P2 (+)
P2 spoke in roundabout ways of their IP, yet unfiled, unsearched, unsubstantiated (-)
At first sight P2 has little sense that his "idea" is unlikely to be defensible from competition (-), particularly because all components of hardware and software are readily commercially available (-) and the idea was already published by many including Steve Wosniak five or six years ago (-)
Speed to market is their ace, P1 gets it (+) P2 doesn't (-)

Conclusion
The odds that I will find the time and motivation to try again have dropped by 90% (-)

Lesson to be  learned
Angels invest in people first.
Beware the partners you have and display in public.  In a single session they can trash whatever you had carefully T'd-up.  For student entrepreneurs there will be many more chances. Later in the career path you may be betting the house on a losing hand.

Marco Messina

Brevity, Impact and the "P&G 1 Page Memo"

Since I routinely recommend maximum brevity in communications with angel investors and with the world in general), I am often asked if this need for brevity is a result of the age of the Internet, of information overload, of shortened attentions spans, etc. It isn't. In what we now regard as the near-stone-age of the 1970's Proctor and Gamble became famous for its "1 Page Memo".  Whatever you wanted to propose at P&G had to written to fit in a single page, and followed a fixed format. Its objective and value rested in the need to think very carefully all the aspects of whatever is proposed and summarize it clearly and effectively.

Dr Andrew Abela summarized it best as consisting of  five parts.

1. The Idea. What are you proposing? This is typically one sentence.

2. Background. What conditions have arisen that led you to this recommendation? Only include facts and information that everyone agrees upon - this is the basis for discussion, so it needs to be non-debatable.

3. How it Works. The details. In addition to How, also What, Who, When, Where.

4. Key Benefits. This is the "Why?" There are usually three benefits: the recommended action is: i) on previously agreed strategy, ii) already proven (e.g. in test market or in another business unit), iii) will be profitable. You can think of these three in terms of the old Total Quality mantra of "doing right things right." The first (on strategy) means you're doing the right thing. The second and third mean you're doing things the right way, because you're being effective (proven to work) and efficient (profitable).

5. Next Steps. Who has to do what and by when for this to happen?

Clearly a 1 Page Memo is no easy task and neither was working at P&G.  The outcome of that guideline was that off-the-cuff proposals were few, those made were thought through carefully, were clear and actionable. The old maxim of thinking before talking applies to writing too.  Striving for brevity increases thinking and reduces fluff.