Early Valuations are Bets on People

Early stage valuations of start-ups are just bets on people – the underlying assumption being that a good team can figure out a product-market fit more easily.

In the early days, when the product is not concrete,  the initial idea can pivot, morph or get completely overhauled within a span of as little as 3-4 months. The initial team is the most crucial element of this, since the composition of the initial team will determine what direction the product takes. Swap the initial founder out with someone else and you will have a completely different product.

When it comes to markets – they should be large/have the potential to be large or you are not in the right space. If they are large, expect them to be crowded with people still trying to “crack it.” Within this large market, your product needs to “fit” into a specific area. An example is how Twitter and Facebook “fit” into the market. Facebook is more for a personal network, while Twitter is more of an information broadcasting service. Though both are in the social networking space, they are still fundamentally very different in how they “fit” within the same market.

Figuring out how your product fits into a market is called achieving product-market fit (… duh!) – arguably the only thing that early stage start-ups need to focus on. This means that initial teams need to iterate, learn, unlearn and relearn, where the initial product basically embodies all the skills, knowledge and experience of the founders to successfully fit into the market.

In the early stages for investors, when both the product and the market are not clear, it just boils down to the founders. Have they done this before? How do they think? Can they build it? Will it get traction? Will users keep coming back? Will it make money? Is it a sustainable business? and countless other issues/risks.

So, this means that if you are a first-time entrepreneur, you often need to go further before you can raise any/much capital. You will probably need to show a working product with some traction before a venture round, whereas someone who’s done it successfully several times before probably just needs to make a phone call with an idea.

Disruptive Strategies for Crowded Markets

Markets that deal in essential or everyday goods are typically described as being ‘cut-throat’, ‘plagued with rivalry’ and ‘being hard to innovate in’ just given the sheer number of competitors present. A company in the business of food, clothing, real-estate, jewelry or any other commodity is typically going to be a price taker- where the prices set are dependent on the market. In this scenario, growth is typically slow and limited – simply because it is hard to differentiate yourself from the crowd. As a result, startups like these are not too attractive to venture capital.

However, despite common convention, there is still scope for massive innovation in crowded markets, where startups can choose to be price setters – i.e. dictate prices for their products even in the midst of several competitors. Using technology, startups in these markets can experience phases of rapid growth, comparable to hot silicon valley startups. This is especially true given that incumbents in commodity markets are laggards when it comes to adopting technology as opposed to other industries – leaving the space ripe for disruption.

Permutations and combinations of business models are becoming more innovative with technology, specifically with the rise and adoption of mobile, social, local, and e-commerce. There are several opportunities where you can splice and re-apply innovative business models to traditional industries:

1) Printer-ink cartridge– Nespresso is a classic example of a product where Nestle used the printer-ink cartridge business model and applied it successfully to coffee. Nespresso is basically a form of premium coffee, where they sell the coffee machine for a very low markup/almost at a loss and then sell coffee pods at a lot higher markup. With several patents, they ensure that only their coffee pods are compatible with the machines. With this, they are able to tap into the home markets at almost a 5-10x markup compared to competitors.

2) Group Buying– With the rise of Groupon, group buying has become mainstream. Using the same principle of group buying, companies like Kickstarter are taking the concept and applying it to investments in creative projects. Plukka is doing the same for jewelry manufacturing – and we should still just be scratching the surface.

3) Social News – Reddit and Hacker News use their users to rank their articles/posts based on what is most popular to the community. The same concept can be applied to e-commerce, manufacturing etc. Not sure of what to produce and sell? Why not let your users create and organize it for you! A great example is Chloe+Isabel for jewelry. C+I lets people sign up as ‘merchandisers’ and then it helps them organize ‘trunk shows’, encouraging hosts to invite their friends, family and colleagues attend their shows to buy jewelry.

4) Discovery – There are several startups trying to do discovery. Discovery of apps, music, videos, news, and movies. Now, the issue in crowded markets is that it is hard to identify the true ‘hidden gems’ that would be perfect for you – specifically. How about  taking hints from the business models of Pandora, Spotify, Netflix and the various other innovations like geo-fencing to re-apply them to discovery in crowded markets – for buying homes, groceries, jewelry, medicines, cultural arts and crafts etc. The process of ‘discovering’ what is right just for you – is among the big trends already catching on.

5) Personalized/Made to order – With access to better software, manufacturers are able to individually personalize products on a mass scale. Diamondere is a great example where a manufacturer is able to completely personalize each piece of jewelry. Users can change individual gemstones on any design, change the gold color and quality and even get their purchases engraved. Using software that virtually renders each permutation, the site is able to give a ‘futuristic’ experience of personalizing jewelry. There are already several companies that personalize t-shirts, business cards etc. on a mass scale for individual consumers, but this concept is still in its nascent stages.

Business models are becoming creative – ‘I have x and you give me $ to buy it’ is getting old. How about ‘We will make and sell you either x, y or z depending on what you and your friends want’ or ‘You bought x and y, here’s z’ – but that said, try not to be too creepy about it!

‘Obvious ideas’ are never obvious in the beginning

Guess what.. The obvious ideas are always taken – this applies to any industry – tech or outside it. Big companies don’t get big by going after obvious ideas. The founders initially have ideas that are completely ‘ridiculous’, ‘insane’, ‘crazy’, ‘that will never work’ – and go after them to make them work. By the time people realize the sheer potential of that ‘odd-brained idea by that weird guy’ – the company is already well entrenched in that space.

The obvious ideas are never obvious in the beginning. When they are thought of, they are almost always dismissed as being completely worthless.

Case in points:

1) When Google started back in the day, it was not the first search engine. Larry Page and Sergey Brin were rejected 3 times to sell Google for under $1million. In fact, Vinod Khosla was thrown out of Bell’s office at Excite for going back to pitch Google for a second time.

2) In 2004, imagine a kid who comes up to you and says, “I’m working on an online people’s directory.” With that phrasing, initially you think of something like a phonebook put online, and are left thinking – ‘why would that have any value?’. Then he builds it, calls it thefacebook and you use it for the first time, you’re left wondering, “this is actually addicting!”. (Describing Facebook as a ‘People’s Directory’ is how Mark Zuckerberg referred to it in the IPO in their investors proposal – the link to which has been taken down.)

3) Twitter was spun out of a failed company called Odeo. Even then there were several people wondering would they want to use twitter? By the time the ‘obvious’ functions of real-time conversations, trends and giving voices to people became apparent, Twitter was already well entrenched in the space.

4) IKEA was founded by 17 year old Ingvar Kamprad. The self-assembly concept was born 13 years later, more as a consequence of having competitors pressure suppliers boycott IKEA. Having the customer assemble furniture himself now seems like a great idea, but back in the day when every furniture shop available was assembling it for you – not so much!

5) Google bought a company called Dodgeball, a location-based social service back in 2005 and had the founders join it. However, given Google’s neglect of the service, one of the founders, Dennis Crowley, soon quit and restarted with a company called Foursquare. If Foursquare was the obvious idea, Google would have paid a lot more attention to it rather than trying to play catch-up several years later.

Paul Graham’s post talks about several other examples where “best ideas initially look like bad ideas”.

So, when you are working on your startup and people tell you ‘no one is going to use it’, ‘you are insane’, ‘this will never work’, ‘this seems like a terrible idea’ – you just might be onto something ginormously big!

The thing with VCs and early investors

The thing with VCs and early stage investors is: they are gambling!

It is just the way their business model works. Venture Capital is a ‘hits’ based business. Investors will typically invest in about 100 startups, out of which upto 75 of them will return very little or no money and 95 of them will miss their targets – in other words – 95% of them fail. The 2-3 that do succeed will return several orders of magnitude of the initial investment, which basically pays for the entire portfolio.

At the angel stage, the odds are even worse, where funds like 500 Startups, Kima Ventures etc. need to resort to a model of ‘Spray and Pray‘ – which basically means ‘spray money on a bunch of startups, and pray a couple of them succeed.’

What does this mean for the entrepreneur?

If you are one of the companies that has been ‘sprayed’ money on, what does that tell you of your investor’s belief in how well you will do? – Not much!

This applies even to top, highly selective funds like Y Combinator, which has graduated about 1000 startups (“The total value of the companies we’ve funded is around 10 billion, give or take a few. But just two companies, Dropbox and Airbnb, account for about three quarters of it.” – Paul Graham)

For the entrepreneur – the process of getting the investment really does NOT mean anything! It is just an extension of your life-line. If you have traction, then traditional VC investing metrics like strong teams, great products etc. become irrelevant in comparison. So, my belief is don’t focus too much on what Angels or VCs want but rather focus on what your users/customers want – you need to focus on building a viable business that solves a real problem – and less so on building something that investors would like to invest in or something where the VC community is ‘hot’ in.

When your ideas are unpopular

I came across this article by William Deresiewicz – Solitude & Leadership <http://theamericanscholar.org/solitude-and-leadership/>

I couldn’t agree more with the following paragraphs in it:

“No, what makes him a thinker—and a leader—is precisely that he is able to think things through for himself. And because he can, he has the confidence, the courage, to argue for his ideas even when they aren’t popular. Even when they don’t please his superiors. Courage: there is physical courage, which you all possess in abundance, and then there is another kind of courage, moral courage, the courage to stand up for what you believe.”

and

“The position of the leader is ultimately an intensely solitary, even intensely lonely one. However many people you may consult, you are the one who has to make the hard decisions. And at such moments, all you really have is yourself.”

When your ideas are popular, you don’t need to do anything, since someone else can come along and implement them for you. It’s when your ideas are unpopular – that’s when you are especially needed to see them through implementation because no one else is going to do it – and this can be a terribly lonely process.

Thomas Edison – “I didn’t fail. I just found 2,000 ways that did not work”

When your idea is unpopular, you will be told of 2,000 ways where your idea will not work, but with enough persistence, you should be able to find one way where it does work – and that is all you need.

Entrepreneurship Material

So, a friend had asked me how to get started with the entrepreneurship process. He said that he would come across a couple of ideas and get really excited, but was not sure what to do to actualize it. I sent him a bunch of links/talks that if he went through, he should be comfortable enough to get started.

Here they are:

Books: 

Crossing the Chasm, Founders at Work, Venture Deals, Four Steps to the Epiphany, & Innovator’s dilemma.

Videos:

http://www.youtube.com/watch?v=n-H7TAcqGko

http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2735

http://startupdigest.com/marc-andreessen/

Reid Hoffman (LinkedIn founder) – http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2768

http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2329

On ecorner, also see – Jack Dorsey (Twitter & Square), Drew Houston (Dropbox), Marten Mickos (mySQL), & Guy Kawasaki

http://www.ted.com/talks/simon_sinek_how_great_leaders_inspire_action.html

Design Thinking:

Design thinking is a field pioneered at Stanford. Design thinking classes are the most over-subscribed courses and it is pretty difficult to land yourself a spot in the courses. I took Design Thinking Bootcamp and it was simply amongst the best courses I have taken at Stanford.

What is it? Design thinking isn’t thinking about designing a pretty dress or doing interiors of a house. It is about finding solutions to ill-defined problems. A large part of it focuses on figuring out exactly what problem to solve.

Here’s the virtual crash course video: http://dschool.stanford.edu/dgift/

The First Post

For a while, I was thinking of writing a blog about random tech entrepreneurial musings. Finally, I managed to get around to it.

A bit about me/what I’m upto:

I’m Anish Godha. I’m originally from India, currently in Palo Alto, CA. I recently got my MS degree from Stanford, have a BS degree from Northwestern and went to high school at the Cathedral & John Connon School in Mumbai.

For the entrepreneurial process, I’m founder & CEO of MochaMeet – a group planning startup that exists solely because I wanted a way to stay in touch with my friends after graduation, but could not find anything available that was ‘it’. There has been a tremendous amount of learning and a lot of my future blog posts would draw on my experiences with MochaMeet. I’ve spent about 2 years on the concept, pivoted away from an earlier direction and recently, our revamped web version went live!

I’m also co-founder of a made-to-order jewelry e-commerce company called Diamondere.com – a spin-off from our jewelry manufacturing family business in India. Diamondere is a concept where any piece of jewelry can be personalized to suit the user’s style – change gem stones, change gold color/quality & even engrave for free. Given our manufacturing background and proximity to the source (India processes about 92% of the world’s diamonds), we are able to price this at about 30-50% cheaper than other retailers.

Needless to say, I keep myself fairly occupied. Since both startups are so different – team, market, product, business model etc, I’ve been able to get quite a varied experience in a fairly short amount of time.

So, I intend this blog to be something more along the lines of random, ‘Thoughts, Musings & Erratic Ramblings’ – though most of it would be fairly focused on tech entrepreneurship.