Guest post by Jim Manzi, founder and Chairman of Applied Predictive Technologies, and the author of Uncontrolled: The Surprising Payoff of Trial-and-Error for Business, Politics and Society.
A few months ago, I was asked to give a talk to the MIT Enterprise Forum in London on the rules for executing a successful new start-up company. Having listened to more than one such bloviation session myself, I began with some caveats.
First, even though every guy who has done a successful start-up somehow feels he's therefore become the philosopher-king of business, all experience is bounded. Any observations I make apply to venture-backed enterprise software targeting scale-up. Many of the things you would do for a biotech start-up or a consumer-oriented social media business, as examples, are probably very different. Further, there are companies that exist to sell products at a profit, and companies that exist to sell equity to investors. I only know about the former. The latter tend to flourish in the later stages of a bubble, and rely on a totally different set of skills related to promotions, networking and PR.
Second, even within the universe of relevant companies, all "rules for success" are either obvious or incomplete. Each suggestion in this post will be incomplete, in that it will ignore inevitable exceptions and complications. In other words, there are no rules for success. If there were, lots more people would do successful start-ups.
I'll divide these observations into those relevant for each phase of getting from a new business idea through about the second or third year of operations. After that (if you are the unusual start-up that makes it that far), things become quite different again. Caveat emptor.
IN THE BEGINNING..
You are selling a dream to prospective investors, employees and customers. Be ruthlessly honest with yourself at all times.
Have a co-founder. You're getting married to this person, so make sure you trust him or her, have great mutual respect, and can speak openly at all times. Drama is your enemy. Ideally, you should have high overlap in your view of the world, and only partial overlap in your skill sets.
Seek blue water. Do something innovative enough that nobody else is even trying. This is the best way to get around scale advantages that others have over you. Since you don't know what you're doing yet, it's better if nobody else does either.
Ignore capital markets and industry analysts until you are ready to exploit them; they are rear-view mirrors. If you are doing at start-up phase what the capital markets say is valuable, you're usually too late. You have to do what they say is stupid now (or are just not thinking about now).
In several years, you will either be proven wrong (in which case, they will say "told you so"), or you will be proven right (in which case, they will shamelessly ignore their prior opinions). It's nothing personal; it's just their business model.
Plans are basically useless, but a small amount of planning before you start can be valuable. A good business plan is done in Excel, not Word:
-- See if you can (A) make a list of the companies that might buy your offer, (B) estimate what each would pay for it. Multiply A by B. This, not "the CRM market" or whatever, is how to think about market size.
-- Guess at how many people at what comp level by person you would need to provide some early version of this offer. Gross up the headcount by a simple factor for rent and other costs, plus any other very expensive capital equipment you need to make a simple cash flow statement.
-- Figure two years of this cost run rate with no revenue, then some time with revenue at a loss, to get to break-even. This cumulative total is your capital requirement. Double it. This is still probably an under-estimate.
-- See if it looks like revenue might be greater than cost at some kind of a rough, early steady-state.
-- Always assume an average amount of luck in the long-run, and terrible luck in the short-run.
Fund it yourself for as long as you can stand it. Use your own money. Get some kind of revenue coming in the door to offset costs partially, but at least as important, to demonstrate that this is a business, not something on a cocktail napkin. However, don't make the mistake of becoming a consultant doing fee-for-service work, and not really become a technology company that can scale.
The more you are able to go to VCs with a business, rather than an idea, the less equity you will give up. This difference in A-round dilution is massive. Early dilution is the lever that moves the world. If you really are pursuing blue water, the slower time to market will be worth the trade-off.
Venture capitalists only provide money. I had a very good relationship with my VCs. I wasn't looking for a friend, strategy adviser or corporate recruiter. They gave me money, and I gave them an exit with a very good IRR. If Board members and investors can know better than you what should be done when they spend 1 - 2 days per month at the company, then you shouldn't be the CEO.
Always retain operational control. Your world will be complicated enough as it is. Keep things simple internally.
Don't trade equity for third-party services. It's so tempting to do this when you're cash-constrained, but you will regret it later.
10 TIPS FOR THE NEXT FEW YEARS
(1) Don't fantasize about your prestigious Board members, or partnerships, or being acquired, or anything else saving you. These can be very useful tools, but unless you win the lottery, they will help on the margin. You're on your own.
(2) Spend every nickel like it was your last one ...
(3) except for people. The team with the smartest guys usually wins. Pursue people quality beyond the point of apparent irrationality.
(4) Org charts, budgets and plans are mostly a waste of time at this stage.
(5) If you can't describe somebody's job to your mother, find something useful for this person to do.
(6) Run the business as if you are going to own 100% of the shares forever and live off the dividends.
(7) Ignore supposed competitors, whether incumbents or start-ups; ignore external advice; ignore time to market; ignore people like me; ignore capital markets. Focus on delivering value to customers at a foreseeable profit.
(8) Treat revenue and (especially) profit are the best possible feedback on your ideas.
(9) To a first-order engineering approximation, the only financial metric that matters is Free Cash Flow. Cash flow breakeven is the most important milestone your company will ever achieve. Your whole world becomes totally different when this happens. This will not necessarily be the view of your VC investors. Remember that they have chips all over the roulette table. You are the chip on 17 Red.
(10) If successful, the company is likely to end up focused on something different (and usually narrower) than you first thought. The trick is that this focus will only be discovered after 6 - 18 months in the market. This transition will be brutal. You need to be decisive about it, and some of the people there at the beginning won't make it.
My prediction for your new venture: Pain.
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