Month: June 2020

Tom Koor

Why do startup CEOs fail? V4

The three-fold purpose of this article:

  • Help startup CEOs and founders understand themselves and identify potential fatal flaws.
  • Help investors, and others, assess startup CEOs and founders.
  • Help assess the CEO’s of traditional established companies.

The following is focused on software and high-tech startups.  Many of the concepts apply to other situations.  CEO failure results from an inter-related set of experience, skills, character, personality, values, morals, ethics, and luck.

You may download a PDF of this article from: Why do startup CEOs fail V4

Research regarding the most critical traits of successful founders.1

Founders with complementary skills sets tend to be successful. “The best founders know their strengths and weaknesses and recruit a complementary team.” Founders of all ages can be successful.  Age is not a predictor of success.”

There are three archetypes of successful founders:

  • Humble Operator: Exceptional at execution, extremely humble while confident in themselves. They are resourceful and gritty. People who worked with them before tend to follow them.
  • Agile Visionary: Usually first-time founders, they are young, visionary, and driven by a desire for greatness. They have a unique perspective on the market they’re going after and an intuitive sense of what their customers want. They test and iterate quickly to incorporate market signals.
  • Seasoned Executive: Experienced older founders, they often have 5+ years of management experience and deep industry expertise. They are intrinsically motivated to build a company. They may have started a company before.

There are three archetypes of unsuccessful founders:

  • Passionate Outsider: Usually first-time founders, they are humble and hard-working. However, they don’t have good founder-market fit and don’t have a complementary cofounder to rectify this gap.
  • Overconfident Storyteller: Charismatic, compelling, and have high confidence. They are likely to be solo founders and they are often not humble.
  • Stubborn Individualist: Slow to adapt to learnings from the market and not empathetic to what the customers want. They are not good at articulating a convincing narrative.

Successful founders have four superpowers:

  • Running her company effectively day-to-day, learning and adapting quickly
  • Results driven i.e. exploring many solutions to quickly finding the best one.
  • Customer empathy, which enables finding product-market fit.
  • Agile thinking i.e. able to iterate quickly based on market feedback, but at the same time persistently focused on the vision.

Successful CEOs have founder-market fit.

Founders with a deep understanding of the market have founder-market fit.  There are 4 signs of founder-market fit:

  • The founders are obsessed with the market. They are obsessed with market knowledge.  This results in them knowing everything about the market, what a day-in-the life of a customer looks like, the customer’s urgent problems, the competitors, et.
  • The founders’ personal stories. Customers are excited by personal stories which explain why the founders are obsessed.
  • Personality is the ability to build a network in the market and the market’s ecosystem.
  • Experience but not so much experience that the founders are constrained in their ability to disrupt, and to be able to see new and innovative ways of doing things. The degree of appropriate historical market/industry experience varies by market. e.g. Developing a new drug requires a degree of past experience.

The first point-of-failure is when the CEO is thinking of founding a company and becoming CEO.  Examine yourself.  Do you already have the characteristics of someone who is likely to fail?

  • Not able to clearly communicate on why starting the company and what the idea is.
  • Not having a very broad set of knowledge or being able to quickly learn a broad set. A startup CEO does it all without the infrastructure of a large company to support her.
  • Not relentless and able to overcome all obstacles.
  • Not able to do things quickly.
  • Not able to quickly learn from mistakes.
  • Not able to work long hours for many years. The average time for a SaaS startup to exit or IPO is 9 years.  But the vast majority fail.
  • Not willing to take risks. The majority of startup CEOs are forced to leave the company at some stage of funding.
  • Not able to minimize cash spending.
  • Not having the funds (personal savings, family, and friends) to live for a significant period of time without income from your company.
  • Not able to ruthlessly prioritize time e.g. who to meet vs who not to meet; problems which must be solved vs can be ignored.
  • Not having the personality and skills to build a broad set of trusted relationships with potential customers, suppliers, employees, advisors, investors, etc.
  • Not able to attract appropriate coaches, mentors and advisors. There are major differences between star athletes and star coaches.  The same person is rarely a star in both fields.
  • Not able to listen, and clearly understand what the other person intends to communicate.
  • Not willing to go all-in
  • Not extremely intelligent.

The second-point-of failure is when the CEO makes a poor selection of co-founder(s) and is not able to manage co-founder(s).

  • Not able to select co-founders with the range of experience and skills necessary for short-term team success. Co-founders should bring diverse experience and skills, resulting in the pool of capabilities necessary to create and launch the company.
  • Not selecting co-founders with similar objectives, character, values, morals, ethics, and time lines.
  • Not picking founders who have the personal financial resources to live until the company can afford to pay them or third-party investors can provide financial support.
  • Not having a common understanding of what each co-founder will contribute e.g. # of hours, capital, finding capital, creating the product or service.
  • Doesn’t have the skills to make the founders work well together.
  • Not being clear on how decisions are made, and who makes them.
  • Doesn’t ensure that the founders are physically located together and working together.
  • Unable to articulate and help the all the co-founders understand and support the higher purpose of the company. If the only purpose is to make money, the chances of long-term success are low.
  • Not having a common understanding of how much of the company the founders are willing to give up in return for capital.
  • Not documenting expectations and assumptions. This leads to future confusion and disagreements. “People forget 40%-80% of what they hear immediately.   Half the information people do recall, is recalled incorrectly”2

 Your next steps

Regardless of the situation, the CEO or founders need the capabilities to be successful in the next 24 months and to be competitively differentiated from the CEOs/founders of competitors.

  • If you are a startup CEO or founder: Assess your self and compare that to how others view you.
  • If you are an investor, advisor, someone planning to join the startup CEO: Review the above criteria and prepare your own list of criteria. Identify the deal-killers or fatal flaws and the criteria that are important. Assess the CEO or founders. You don’t want to be associated with a CEO or founders who will likely fail.
  • If you are the board of directors or major investor in a traditional established company: Prepare you own list of criteria. Identity the deal-killer criteria i.e. whether to terminate existing CEO, not to appoint a candidate as CEO or not to invest in the company.  Identify the criteria that are important. Assess the CEO. Boards should not a have a CEO who is likely to fail.  Investors should not deploy capital to CEOs who are likely to fail.

 Footnote

1 Basis Set Ventures, a San Francisco early stage fund, surveyed other funds to understand their opinion of the traits of successful vs unsuccessful founders.  https://www.basisset.ventures/founder-superpowers

2 Lindsay Wizowski, Theresa Harper, and Tracy Hutchings, Writing Health Information for Patients and Families 4th Edition (Hamilton Health Sciences, 2014), Page 5

Further Reading

How do  venture capitalists assess teams https://koorandassociates.org/selling-a-company-or-raising-capital/how-do-venture-capitalists-assess-teams/

 

Tom Koor

Startup investment memo

The purpose of this article.

The two-fold purpose of this article is to:

  • Provide an investment memo template for a startup investor, investment fund, or angel group.
  • Enable early stage startups to understand how they will be assessed.

This article is linked to “Due diligence questions for an early stage startup”1

You may download a PDF of this article from: Startup investment memo

There are three phases to an early stage startup.

Startup

  • A startup is a temporary organization designed to search out a repeatable and scalable business model. Lots of learning experiments are carried out. The focus is on getting some delighted cash paying customers.
  • A business model describes how a company creates value for itself while delivering products or services to customers. What are you building and for whom? What urgent problems and needs are you solving?

 Preparing to scale

The startup believes it has a business model which can meet the needs of a large number of cash paying customers. The focus shifts to putting in place cost-efficient and easily scalable technology, processes, and talent.

Scaling

The focus shifts to growing the:

  • geographies
  • marketing, sales, delivery resources and activities.
  • channels and distribution partners.
  • Customer segments.

The purpose of the Investment Memo .

Recommend whether or not the investment is appropriate to proceed to the term sheet stage. The Investment Memo is based on:

  • The answers from the early stage company to the due diligence questions.
  • Additional facts gathered from third party questions.
  • Analysis of the collected facts.
  • Investor judgement, based on a variety of criteria.

In an early stage fund, the investment memo is presented to the partners to explain why the investment should be made, or not made.

The investor will have used simple criteria to quickly filter out early stage companies before devoting time in due diligence E.g.

  • After spending less than 5 minutes reading an emailed application.
  • After a 15-minute phone call or meeting.
  • After listening to a pitch at an event.

A deal-killer recommendation.

Each investment fund will have some deal-killer criteria. If the startup-meets any one of these criteria, there is no deal.  The deal-killer criteria vary by fund.  E.g. market size is too small, founders are not trust-worthy, no potential customer interviews or surveys, etc. Deal-killer criteria could include not answering, or unable to answer, critical due diligence questions.

In this situation, the investment memo only one-page long.

Investment Memo with no deal killers – the process.

 The detailed structure of the Investment Memo follows the structure of the due diligence questions for the startup.

For each question, indicate whether the questions were answered, whether or not there are any issues, and what validation was done.  Validation can include: talking with 3rd party experts, doing independent primary and secondary research, preparing analysis separate from that submited by the startup.  I’ll indicate below some possible approaches to validation in each section of the investment memo.

There is a one-summary, which includes the recommendation.  Each section in the summary has 1-2 lines.

Recommendation: either proceed to a term sheet OR recommend not to proceed with the reasons why.

Each of the six sections in the one-page summary also contains: recommendation: yes or no and why, plus any critical read flags

  • How does the company create value for customers and itself?
  • What are the plans?
  • Investor specific
  • What is being asked of the investor?
  • Legal documents
  • Historical results.

Detailed report

Each section of the detailed report starts with the summary information from the one-page summary.

Each section/subsection of the report contains:

  • Indication of whether or not the due diligence question was answered
  • Indication of whether the answer was a “pass” or “fail”.
  • Any red flags.
  • Any input from third party experts.
  • Any input from the investors primary and secondary research.
  • Any results from the actions noted below.

#1 How does the company create value for customers and itself

Target Customers

  • Interview potential and current customers.
  • Assess market size determination (TAM, SAM, and SOM) and review sources cited.

Value proposition

  • Review some or all interview notes from potential or current customers.
  • Review some or all survey responses from potential or current customers.
  • Review analysis of interview notes and survey responses.
  • Interview potential and current customers

Channels

  • Review some or all interview notes from potential or current customers.
  • Review some or all survey responses from potential or current customers.
  • Review analysis of interview notes and survey responses.
  • Interview potential and current customers regarding their expectations.
  • Review detailed financial information to validate appropriate allocation of costs & revenue to: CAC (Customer Acquisition Costs) and calculation of LTV (Life Time Value)
  • Review calculation of the churn rate.

Key Partners

  • Interview current and potential partners.

Key resources

  • If patents, check with patent offices
  • If trademarks, run a trade mark check
  • If contracts, call third parties to validate
  • Have all required resources been identified?

Key Activities

  • Have all required activities been identified?

Cost structure

  • Assess whether the cost-drivers are in fact cost-drivers.

Charging customers

  • Review some or all interview notes from potential or current customers regarding value and pricing.
  • Review some or all survey responses from potential or current customers regarding value and pricing.
  • Review analysis of interview notes and survey responses regarding value and pricing.
  • Interview potential and current customers regarding their expectations regarding value and pricing.
  • What are competitors or similar companies charging?

Talent

  • Assess team bios for relevant skills and experience
  • Run a background check on the team.
  • Are the founders emotional or irrational under pressure?
  • Do the founders have empathy?
  • Are the founders unable to clearly and easily communicate their pitch.
  • Are the founders arrogant or overconfident?
  • Are the founders transparent and honest?
  • Are the founders fully committed or is this a part time effort?

#2 What are the plans?

  • Does the 24-month Gantt chart reflect the key milestones?
  • Is the 24-month Gantt chart plausible?
  • Review the detailed allocation of costs and revenues to validate the calculation of LTV and CAC.
  • How does the LTV to CAC ratio change in the cash flow forecast? How does it vary by customer segment, channel, and partner?

#3 Investor specific

  • Are the presentation decks (oral and standalone) consistent with the rest of the due diligence material.
  • What are the issues with the current and forecast cap table? Do the founders have enough equity.
  • What are the options for an investor exit?
  • How long has the fundraising round been open, what’s been committed, by whom?
  • Who is the lead investor and what is their reputation?
  • Are previous investors following on? If not, why not?

#4 What is being asked of the investor?

  • What are the issues regarding terms and valuation?

#5 Legal documents

  • Who has the legal right to make what kinds of decisions under what conditions? Review loan agreements, voting trust agreements, shareholder agreements, board of directors and committee mandate, delegation of authority to CEO, etc.

#6 Historical results

By target segment, by channel, by partner, by cohort.

  • Monthly growth rate in number of cash paying customers, and revenue.
  • New customer value achievement leading indicator (e.g. for Slack it was 2,000 team messages sent within 60 days).
  • New customer success metric (e.g. % of new customers achieving new customer value achievement indicator within 60-90 days).
  • NPS (Net Promoter Score)
  • How many similar competitors have failed in the past? Why? How is this startup different?

Next steps

Regardless of what type of investor you are:

  • Prepare your list of deal-killer criteria and deal-killer unanswered questions.
  • Prepare a one-page investment memo.
  • Customize the due diligence questions and due diligence report to reflect the specific nature of investor and the nature of the investment. The due diligence questions, due diligence report, due diligence cost and time invested will be very different for an angle investor contemplating a $25,000 investment in a pre-revenue company vs an investment funding contemplating a $10 million investment in a company that is scaling.

Footnotes:

1 Due diligence questions for an early stage startup: https://koorandassociates.org/selling-a-company-or-raising-capital/due-diligence-questions-for-an-early-stage-startup/

Further Reading

Definition of startup terminology and metrics: https://koorandassociates.org/selling-a-company-or-raising-capital/startup-terminology-and-metrics/

Red flags for any investor to consider:  https://medium.com/swlh/red-flag-list-for-vc-deals-9beea446270d