How to make your startup survive

[Original Post written @http://startupiceland.wordpress.com] 

The post is motivated by the answer I saw in Quora to a question that went like this "Where is this startup hype going to end?" The author went on to describe why he wants answers to the above question. His premise was that everyone and their mother is starting a startup and that is a clear indication of a boom and even people who know nothing about Internet are working on something. He was more interested to learn about How is this trend going to evolve, how is it affecting our society and where will it end up? All valid and relevant questions but these should be the least of the worries of any startup. The biggest worry should be how well you are iterating the Build-Measure-Learn cycle to improve your Product-Market fit and how quickly are you scaling up your customer base, market share and revenue, in addition, how efficient are you with the cash in the bank so that you can continue to extend you runway. 

Remember the biggest challenge a startup faces is Running Out of Money! the usual stuff. I really like the top answer on the topic as well. If you have time go read it, it is insightful but I don't really agree fully with the assessment that Interest Rates drives the engine of the startup world, sure it helps a lot when the cost of capital is low to be able to raise money but the biggest value while building a company is how cheaply you are able to run the business. 

The author to the answer refers to Paul Graham's Cockroach Essay. It is one of the classic essays from Paul Graham. I could not agree more to that essay, the reason a startup succeeds or fails is 99.99% dependent on the quality of the founders. This means "what matters is who you are, not when you do it. If you are the right sort of person, you'll win even in a bad economy. And if you're not, a good economy won't save you." The second point that Paul makes is how to make your startup recession-proof, it is "exactly what you have to do anyway: run it as cheaply as possible". The most important lesson in building a startup is getting into the discipline of bootstrapping and Paul puts it "be the cockroaches of the corporate world. The immediate cause of death in a startup is always RUNNING OUT OF MONEY. So the cheaper your company is to operate, the harder it is to kill. And fortunately it has gotten very cheap to run a startup. A recession will if anything make it cheaper still". Paul wrote this in October 2008, It is even cheaper today to run a company. 

I distinctly remember those days in October when the whole financial system in Iceland had just collapsed and I got fired, one of the most liberating and conflicting experiences of my life. I need to thank the one who decided that I am not worth being part of the "team". I did not do the conventional wisdom thing of either going back to school or trying to get another job. I did what Paul recommends that is be an Investor when the times of tough. I had no money, but found ways to raise the money convinced my partners that we should be building equity when the times are bad. The jury is still out on whether the decision was right or not. But we run a very tight ship with our operations, our partnership in my opinion has the lowest cost to run, it is about 0.6% of the capital we have invested. I know that we are cheaper in running our investment company than even Vanguard. This last couple of years has been a humbling lesson in building my discipline to endure the pain and sacrifice. I don't have any sympathy for anyone who wants to do a startup but does not want to sacrifice. Like they say it is like running a Marathon, there is no short cut.

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#BMD - Value Proposition II

This is the second of the posts related to defining the Value Proposition. The original post is here and the first post is here. I am using Startup Iceland as an example. Value proposition needs to address multiple stakeholders. The first post was the value we bring to the Entrepreneur, this post is going to focus on the Value to the Investors and Limited Partners (LPs) of Startup Iceland. We invest money on behalf of our investors and LP: What value do we deliver our Investors and Limited Partners? Traditional methods of measuring Return on Investment or Return on Capital Invested are good metrics, however the biggest value we bring is transparency. We plan to run the operations of the Venture Capital Fund in a transparent, inclusive and open manner. We clearly state our investment thesis, the timeline of investment, decision criteria for investing capital, our performance, time invested and effort in a team. Which one of our customers problems are we helping to solve? Mentoring, advising and creating an environment where the entrepreneurial teams get motivated to execute, win and be a world class company on a tough compressed timeline is a lot of work. We solve that problem for our limited partners and investors. Typical investors are passive and look at Venture Capital Asset class as risky, we asked the question ourselves why is that? the answer is it takes a lot of effort and handholding to make startups succeed. Eric Rise, the author of the Lean Startup defines Startups as an "Organization dedicated to creating something new under conditions of extreme Uncertainty". We strive to reduce the uncertainty through our disciplines approach, working harder and smarter, bringing the power of the network to increase the odds of success and following the time tested methods of building companies. We are entrepreneurs at heart, we have had experience building companies and we want to ensure that our experience gets translated into our portfolio companies. What bundle of products or services are we offering to each Customer Segment? Investors and LPs are always looking for avenues to invest their capital. We believe we provide a platform that is underserved. Venture based investments have outperformed typical asset classes over a 15 year period. A Venture Fund dedicated to creating valuable internet based companies out of Iceland is a unique value proposition. Our intention is to use Iceland as a good testing ground to validate the product quickly and help launch it in the global market place. We understand the world of Technology, being technologists, architects and geeks. We understand the direction the social networked world is moving to. A platform to invest in this new trend is the product and service we provide to the customer segment of Investors and LPs. Which customer needs are we satisfying? Diversification in capital allocation. High Return on Invested Capital and Being responsible stewards of capital. We want to earn the trust of our partners. We understand we do not exist without their trust. Our values of Integrated, open, transparent, fair and trusting relationships in building wealth and return to our Investors is our gospel. We don't just say it we live it every day. We will NEVER put our interest before that of our investors. We will measure ruthlessly our performance and we will be transparent about communicating our failures and wins. Transparent Governance is the core belief of our operation.

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Strategies to implement Validated Learning

The meetup yesterday on the Lean Startup was very inspiring, so I am following up the post with some more thoughts on how can we implement the validated learning concept on various businesses and scenarios. I strongly believe that the Internet and all the applications that have been built on this global network provide us with valuable sensors to touch, feel and understand the dynamics of human behavior. We can conduct experiments, collect data and learn from them. This is precisely what Validated Learning is from my perspective. The classic example is the concept of selling a car through the internet, when someone floated this idea 13 years back, the conventional wisdom was it will never work but I know various examples from Steve Blank's book as well as Bill Gross's interview on This Week in Venture Capital with Mark Suster show how they experimented and did validated learning. Bill Gross is a fantastic ideas guy, check out the full video but if you want to skip to the part about the Car Selling example it is at 0:31:41 in the video. The summary of it is they had just put a landing page with some images of Car with a price tag on it, they had no inventory or distribution or management team or any infrastructure to support selling cars but they did it anyway to learn if anyone would click on the "Buy" button and their idea was if anyone click on it they will have validated the idea a car can be sold on through the Internet, they followed that link to test further hypothesis will a user actually give their credit card information and personal details like address, phone number etc sure enough they put up a form that takes in the information of the buyer and the credit card information. They were surprised to see the orders start to come in, and when it did they physically drove to a Car seller bought the car and deliver it to the buyers. When you think about this, the buyer really does not care whether you are buying it from another seller or not, all he cares about is the convenience of being able to buy a car from his office. They found out that there were many buyers and once they had validated that hypothesis, they built the infrastructure to support growing sales. Actually, I think they took down the site in a day because they could not fulfill the orders that poured in, thats what I can a luxury problem.

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Valuation of a startup - the holy grail?

I have been getting a lot of questions related to How does one value Startups. The best reference for valuation goes all the way to Warren Buffet's teacher Benjamin Graham and his classic book Security Analysis, I believe the principles taught in those books are timeless ie. they don't fundamentally change what does change is our perception of value. More recently, Aswath Damodaran's work on Valuation is quite impressive and it is used by many professionals. He actually has most of his work available online. Value is such a fluid word, what is valuable to a startup when it is getting out of the door is not as valuable when it is looking into the abyss of the valley of death. I have written about the challenges in valuing startups and the uncertainty that always stares at you when you want to do this exercise. I personally think this is the reason Banks or Warren Buffet do not want to even look at startups because they don't understand the challenges of running a company that is creating value in an uncertain market climate. In some cases they actually create a market, it hard to calculate the size, market penetration etc.


I have been a student of looking at many of the prominent Venture Capital Investors like Fred Wilson, Brad Feld and Mark Suster, who share their thoughts and methods since I have become interested in investing in startups. Here is a list of blog posts that Fred wrote on Valuation, I have listed them in the order that I thought was relevant to me:

1. AVC.com : The Present Value of Future Cash Flows To all those Python hackers out there here is a link to code that was shared with everyone on this post by Chris Dixon. The code actually simulates equity payout values with anti-dilution preference etc, I have gone back to my roots of looking at code to learn a concept. I don't prescribe it to everyone but works for me. If you have Python installed give it a twirl, I love this way of looking at valuation.
2. AVC.com: Determining Valuation Multiples, there is a link in the article that goes back to a Internet Market place business valuation. I recommend that as well to be considered. In the comments section there is a reference to the baseline data published by Damodaran is also very useful. Check it out here
3. Brad Feld's post on valuation
4. Mark Suster's post on Want to know How VC's Calculate Valuation Differently than the founders

Considering the above 4 posts and the links they refer to and using the basis of valuing any asset from the classic method one can develop a model. We have developed that model, no it is not in a shape that I can share, when I have time will make it available in this blog.

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Vision without execution is Hallucination

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Thomas Edison said that and I just finished reading Steve Case's opinion piece on Washington Post, where he refers to that as well. The title of the opinion piece is "Give entrepreneurs room and they will grow the economy". What is interesting in Steve's note is that he alludes to how America is loosing its competitive edge in Entrepreneurship and what they are doing about it. A number of bills are being proposed in Congress to support Entrepreneurs, including allowing for Crowd Funding... can this concept work here in Iceland? What is being done in the Parliament to support Entrepreneurs in Iceland? I have the advantage of not being worried about what is discussed in the Parliament because if it was important and affects me, I will hear about it. Never the less, it begs the question. How can Iceland be more competitive in this space? If America the quintessential country for Entrepreneurs is worried about its leadership what should countries in Europe do? What do you think?

Here is what I think needs to be done, first things first, we need to get visibility to the Entrepreneurship community here in Iceland and we need to learn from those who have done this successfully before. It is not enough if we meet amongst ourselves and talk about family politics. We need to invite people who are not part of the system. I have been talking to a bunch of people about organizing a conference and to get my own validated learning I have a sign up page http://signup.startupiceland.com. My goal is to get 500 to 1000 signups then I know we can host a conference and bring prominent investors, entrepreneurs and thinkers in this space so we can learn from them. Couple of ideas on the table are to run a workshop on Lean Startup and Business Model Canvas, A Hack Day and a day of lectures and discussions. All those who have signed up, thank you. You should receive an email shortly requesting your input on a bunch of things. For those who have not signed up, please do and share it with your network, you never know there could be someone who has a job doing something they are not very interested to do but wants to try their hands on Entrepreneurship, it is a great way to start. Learn from the best and other entrepreneurs, find international mentors and networks and launch your dream.

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Iceland can create the next Google!

Or Amazon.com or Twitter or LiveProject.me, I believe it fundamentally, I am just not sayin it I am putting my money where my mouth is! I have been having debates with many people who keep telling me how following the TechStars model and just focusing on the Internet or Software related development will NOT work for various reasons like there is not enough people in the talent pool, number of people wanting to create companies in that space are too few etc Well, I beg to differ. Am I saying that it is going to be easy?... No. Is it going to take time? Absolutely. Again, this is my opinion does not mean it is right!

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Let me give some examples, I cataloged the list of innovative companies in Iceland and they were over 165 of them and 85 of them were in the Software/Internet/Media space this is even before there was any tangible funding and mentoring going in that cohort. If we can create a program, fund it and run it professionally... I believe with no doubt that we will have winners, it is not a question of IF it is more a question of WHEN. Let me list again why all acheivable:

1. It takes very little capital to start a company in this space with Google Apps, free Google AdWords, Amazon AWS, Twitter and Facebook distribution, Open source development environments, Tools and API that allow anyone to hack a simple solutions together over a weekend is not fantasy it is happening right now. Check out Startup Weekend movement.
2. The Internet has evolved, there are more devices connected now to the internet than any other point in time in addition, it has created a trusted environment. My facebook friends and twitter followers trust that I curate stuff that is relevant that brings with it an important transaction mechanism that never existed before
3. Creating a Million $ business from your garage or a remote part of Iceland is possible because people with similar interest find you and because you are selling digital goods and services you can trade. Ask the entrepreneur from Iceland who started dressupgames.com or 4x4offroads.com or guitarparty.com or liveproject.me. I have covered the first two here and here and I will write about last two soon again fascinating companies.

At the grass root level there is agreement but it is usually those who don't understand the changes that have happened in the last decade to the underlying infrastructure that don't believe it. You know what they say about Nay Sayers, First they say you are wrong, then they say why it wont work, until you are successful and then they say you are Lucky! so what is new! Nothing is going to stop my Vision from being implemented. I wish to dream and it is us dreamers and entrepreneurs who change the world! Whats your vision? How do you want to change your world?

2011 has been a record year in Iceland... for bankruptcies

I wrote about the GDP growth in Iceland and wondered where the growth was coming from. I was right, 2011 was a record year for Corporate Bankruptcies since the collapse of the financial system and we have data only until November. What is more interesting is that for the first time in the last 11 years the number of companies formed (1533) has never been closer to the number of companies that were insolvent (1427).
I think we should also look at wage and employment numbers to see if that is driving the growth. The second graph is the total labor force as can been seen that has dropped since the financial collapse. The third graph is the unemployment %, 2011 is my estimate as we have data only till the 3rd quarter of 2011. I estimate 7.25% unemployment for the whole year, please don't hold me to it because I don't believe in estimates. As can be seen the macro variables don't look all that great for a GDP growth but IMF, the Central Bank of Iceland and the Ministry of Finance all say there is GDP growth so we all just have to take their word for it. I can say one thing the sentiments are improving, I saw the following news published by one of the investment companies Eyrir Investment, that they have successfully convinced a Pension fund to invest in them and they have started a new venture capital focused fund called Eyrir sprotar slhf. This is very encouraging. 


"Eyrir Invest ehf. has today decided to increase the number of shares in the company by approximately 10% by selling 101 million new shares at the price of 24.25 ISK. The total number of shares after the issue is 1,108,681,220 each share is 1 ISK of nominal value. The new shares will be purchased by Lífeyrissjóður verzlunarmanna (The Pension Fund of Commerse).

The issue of new shares increases the investment capacity of Eyrir Invest. Simultaneously with the issue Eyrir has founded an independent investment company for investments in venture capital; Eyrir sprotar slhf. Eyrir sprotar will emphasise supporting promising ventures for international growth and value creation."

Although the skeptic in me says lets see what they do with the raised capital. They have raised almost $25,000,000 that is a decent size for Iceland if all the capital is going to be deployed in venture companies but I fear they will invest in companies that will take a long time to establish themselves like Ossur or Marel. I really would like to understand their investment thesis. I think what is needed are companies that are growing really fast outside of Iceland.

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List of Angel and VC investors in Iceland

I think there is dearth of Angel and VC investors in Iceland actually erase that there is no organized angle and/or VC investor group in Iceland. There are many investors who have been funding the startup scene in Iceland. I plan to create a list of Angels and VC investors here. If any of you have ideas or thoughts to organize the list please let me know through the comments. The problem is not that there are no investors in Iceland but they are small and not organized. None of the startups have angle funding most of them have the 3Fs or one of the Government sponsored funds or Grants. I think there is sufficient capital available in the local market but it is not channeled into venture investing. It is understandable why they are not organized as the investor community used to use the local banks to invest but now that the local banks have lost all credibility it is hard to convince the investor community in participate again in the market. In addition, there are no vehicles to channel the investment. 

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Project Genesis

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Project Genesis is an initiative to establish a $50 million venture capital fund in Iceland focusing on innovation in specific field where there is a unique social, biological, ecological, environmental and geographical advantage. For example, Icelanders are ranked 3rd in the world for life expectancy by the United Nations and Iceland employs renewable energy to power the entire country. Both we feel are social, ecological, environmental and geographical advantages of Iceland.

Our initiative is to invest in the ideas, leaders, people and teams by finding entreprenuers who are trying to create valuable solutions for the Global market from these unique advantages inherent in the country. Iceland is a fertile ground for venture investments. The advent of the financial crisis has created several opportunities for investment in Iceland. There has been no point in time than now where Icelanders have had to reinvent themselves more rapidly and broadly, this we feel provides a unique opportunity as well as timing. With the young demography and the affinity of icelanders to live in this island, we believe will motivate the population to find new ways to solve issues that are global in nature.

History has been good to Iceland, Icelanders transformed themselves from one of the poorest nations in the Nordic region to one of the richest in less than half a century. They acheived this by utilizing the resources, namely fish, geothermal and hydro energy that were available in their natural environment and through innovation. If we extrapolate this to the new Iceland which has one of the best infrastructures in the world, abundant renewable energy and highly educated workforce, what can be created can be as broad as our imagination.

The fund will focus on all areas where there is a unique advantage in Iceland. The goal of the fund will be to look at the next phase of technology, information and renewable energy usage, expanding the value chain of renewable energy usage. All products and services produced in Iceland use renewable energy sources, which means all of these end-products are Carbon Neutral. We believe that there is demand for products and services that are produced using renewable energy and this trend is going to grow. The energy utilized in Iceland to make these products and services are one of the cheapest in the world. In addition, energy remains one of the most volatile factor inputs in the production process since oil became the energy source of choice. We believe that products and services produced from renewable sources will have stable factor cost and thereby enabling pricing that is corresponding to the value of the product and not driven by the price of fossible based fuels.

The typical timeframe of investment for the fund is 7 years. The goal of the fund would be to provide active mentoring and leadership to its portfolio companies in the areas of business strategy, internationalization, product and service development, branding, marketing, legal, financial and operational process development. The fund will run an active 3 month long business accelerator centre for entrepreneurs. The accelerator will be very selective, top 0.5% of business plans will be accepted into the program. These companies get up to $18,000 in seed funding, three months of intensive top-notch mentorship, and the chance to pitch to angel investors and venture capitalists at the end of the program. The fund will be given a 6% equity by the companies that are selected by the accelerator program. The accelerator will solicit the support of successful entrepreneurs across the globe and bring a world class mentorship program to Iceland where typical startup and business development challenges are solved faster by tapping the vast resource of knowledgable Zen Masters of business. The intention of active mentorship is to enable entrepreneurs do more things faster. We believe that with the current state of technology and communication, world class companies can be built faster. Facebook and Twitter did not exist 10 years back, Google did not exist 15 years back. We rest our case!

The fund would provide returns to its limited partners in 3 ways, (i) Initial Public Offering (IPO) of its portfolio companies, (ii) portfolio company acquired at a higher valuation by another company and/or (iii) the portfolio company transforms into a well run dividend paying company. Venture Capital funds have a unique investment return profile, our fund will aspire to multiply the investment in our portfolio companies many times over and our philiosphy of investing is not anchored on exit. We believe in patient capital as world class products and services take time to build but we believe we can squeeze more juice out of this time with the right platform.

Categorizing the Sales team

Interesting post by Mark Suster, on the money on defining a sales person and categorizing one.

10 things Great Companies and Great Investors do...

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Given that I have been thinking about starting out a Venture Capital company, I have been reading the blogs of veteran VCs
and Entrepreneurs. I like Fred Wilsons blog and here he talks about what 10 things great companies do, to counter that Matt Blumberg has written about what 10 things great investors do. I thought both were worth noting.

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VC fund allocation and Conditional Probability

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I had a very interesting discussion with a friend of mine yesterday. I was suggesting to him that Venture Capital funds should allocate funds such that 15% of the capital goes into VC companies, 5% goes into growth companies (i.e companies that have stabilized the products or services, are generating cash and have broken even) and 80% should be cash or cash equivalent.

He made an argument that an investor wanting to invest in a VC funds would not choose the above allocation. I asked him to ellaborate and he said that the investor will not get the total bang for his buck... he said that if the above fund´s VC allocation returned say 100% of the allocated capital the investor would only get 15% of that 100%. Sounds logical but this is precisely the problem with our view of the world and our ability to calculate probabilities. We think about only the success scenario, we don´t think about failure and the proabilities of failure.

Lets do a thought experiment of comparing two funds:

1. A fund that invests all the capital into VC companies

2. A fund that does capital allocation similar to the one described in the first paragraph

We need to think of alternative universe of outcomes to calculate the expected return from the above two funds, lets conjure one for simplicity:

VC companies return 100% of capital invested with a probability of 50% and return -100% (i.e you loose all the capital) with a probability of 50%. Growth companies return the capital invested and Cash returns the same at the end of the investment time for simplicity sake.

Given the above outcome what is the Expected return for the above two funds, say for an investment of $100m?

Expected Return = P(success) x Return + P(failure) x Return

Fund 1: 50% x $200 + 50% x (-$100) = $50m

Fund 2: 50% x $30+ 50% x (-$15) + $5 + $80 = $92.5m

Even the above simple payoff matrix gives the second fund a return higher than the all VC fund. However the real world is much more complex and the payoffs and probabilities are much harder to calculate. In addition to the above when we do capital allocation there are time frames, return expectations and conditional probabilities involved, this further skew the results.

The above payoff matrix gives us different results when we add conditions to the problem:

What is the probability of Fund 1 giving a lower return than Fund 2 given VC companies all return 100%? or we can flip the question

What is the probability of Fund 2 giving a higher return than Fund 1 given VC companies all return 100%?

The above question needs us to calculate the probability of a VC company being a success or a failure and the distribution for VC success follows a Power Law. I think most VC fund managers understand that but I don't have data to prove it. My fear is that maybe fund managers do not compute probabilities using the Power Law but the Normal Gaussian Bell Curve, when we do that all the above analysis and results are incorrect.

My previous post about ISK

I started writing a blog entry about the ISK on Friday and completed it only today, but while I was doing that I found an interesting link through Zemanta, a tool I use with blogger. It was a question posted by Fred Wilson, in his blog:

Does Venture Capital funds fall within a power law?

I have been thinking about that myself and maybe his question and analysis needs to be revised again. He is analyzing the exits by VC funds and trying to figure out what is the exit percentage and size... it is an interesting problem as VC funds are often made to justify their existance with their return rate and sucess rate.