FIT: The Most Important Thing in Business?

I can't recall how the topic came up, but the other day someone asked me if it bothered me to lose clients.

My answer: "it depends."

If the loss is due to poor service quality or slow response, I hate it.  Fortunately, this has been rare, mainly because my staff works hard to make sure that any problems that arise get fixed ASAP.  We also do root cause analysis to figure out ways to prevent it happening again.

But if the loss is because our services are a poor fit with a client's needs, then I'm fine with losing them.  In fact, at some point, if our clients are successful, their needs outgrow our ability to provide effective service.  Rather than attempt to hold onto them or expand our services, we encourage them to "graduate" which usually means helping them hire their own, dedicated staff as our replacements.

In terms of new customer acquisition, because we aren't under pressure from investors for fast growth, we don't try to work with everyone.  Instead we focus on determining if there is a good fit between what we can do vs. what the client needs.  I estimate that I end up declining (or referring where possible) about 25% of the prospects who approach us because of poor fit.  "Poor fit: doesn't mean that the client is bad (although "nice people" is one of our fit criteria).  It means that after 5+ years doing this, we have a pretty good idea of who we can help vs. who we can't and have experienced the consequence of working with clients with whom we were poor fit. So while it means we may be giving up revenue, it also means we give up:

• Conflicts with clients who have different expectations about the work being done.
• Overextending ourselves into areas where we lack expertise.
• Arguments about our fees.

We look for fit along the following dimensions:

• Fit to our standard offerings vs. having to develop custom capability. 
• Fit to our flat fee revenue model vs. traditionally hourly billing
• Fit between our people and the client (i.e. we don't work with people we don't like)
• Fit between our response time capabilities and the client's response time expectation
• Fit between our quality levels and the client's expectations

And I don't think it actually has hurt our revenue growth.  For the past three years, we've actually grown our business at rates even a VC would find acceptable.  In fact, paradoxically, our focus on fit may have actually contributed because:

• Our sales cycles are short because we have a sharp focus on the value we can provide and what we cannot. We try to be clear telling new prospects what we do, and more importantly to them, what we don't do.
• Our standard operations are tailored to deliver that value making it easier to scale.
• It allows us to focus on improving adding new capabilities valued by the majority of our clients (vs. one offs) in a way which is clear to both parties that these are *WARNING* new services.
• We have high client satisfaction and loyalty which fuels referrals.  In fact we are at the point that over 95% of our new business is by client referral.  This is actually one of the metrics indicative that a business has achieved product/market fit.

In order to adopt a focus on fit, you first must accept the fact that not all revenue is good for your business!  That's tough to do when you are short on sales.  Then you must have an idea of what  your target customer profile is AND what value you provide.  For specifics on how to do this, see two earlier posts:

• Developing a Customer Profile
• Applying the Customer Profile

Thrice Around the Block Top Blog Posts of All Time!

The nice thing about blogs is that viewership can grow even when you neglect it.  Having only recently returned to blogging after an 18 month hiatus, I was pleasantly surprised to find that the average monthly viewership rate had doubled.

In any event, I thought it might be interesting to share what people have been hitting.  Here are the Top Nine Posts on Thrice Around the Block:

1. Developing a Customer Profile
2. How to Set Prices:  Pricing Strategy
3. Applying the Customer Profile
4. How to Set Prices:  Tangible Pricing Methods
5. The Growth Mystique: A Silicon Valley Parable
6. Education for the Small Business Entrepreneur
7. Process vs. "Product" People
8. My Top 25 (and counting) Business Books
9. How to Set Prices: Revenue Models and Pricing Mechanisms

Enjoy!

The Good Problem (is Still a Problem)

I'm back! (I think...)












Since my last "real" blog post in March 4, 2012 (Pushing Past the Growth Plateau), I've been dealing with the "good problem" of rapid growth.  For Silicon Valley startups, these are the good times, and for my company - which provides services to startups - it's been challenging to keep up!  In the last 18 months, we've doubled in size, launched an entirely new line of marketing services, and entered a new customer segment.  It's a good problem to have, as everyone likes to remind me and which I wholeheartedly agree.

But it's still a problem!

How can growth be a problem?

• Growth consumes cash:  In a seminar I give to entrepreneurs on cash management, one of the more eye opening exercises is where I show how fast growth can drive them straight into bankruptcy even when the P&L says they're turning a profit.  (I also show them simple steps they can take to reduce this.)
• Growth strains systems:  This in turn, leads to service problems, which can quickly stall growth.  Memory is no longer good enough to track the exploding detail.  Processes have to be defined to ensure all the bases are covered, in the proper order. 
• Growth strains your people:  And hiring actually increases the strain on your people.  New hires have to be trained and fixing the inevitable newbie mistakes creates more work.  Relationships shift and confusion increases as job duties are shifted away from existing staff to new people.
• Growth can lead you off track:  New customers can place new demands on the business.  It's easy to drift into new products and services in the name of customer service.  Whether this is positive or negative depends on how well they align with the startup's vision.  Not all revenue is good revenue!

So what are the keys to overcoming this?

• ADD:  Automate, Diversify, Delegate.  See my previous post, Pushing Past the Growth Plateau.
• Focus on Fit:  The first step is to acknowledge that not all revenue is good revenue.  So what is good revenue?  It's revenue which your company is designed to deliver and comes from adding new customers that meet your target customer profile, which means you have to know what your ideal customer looks like.  While this sounds simple, what makes it challenging is recognizing when off-target revenue represents an unanticipated, lucrative opportunity or is merely off-target and a drain on resources.  I'll have more to say about fit in a future post.

Stay tuned!

A NEW Shameless Pitch: BUS26 Building a Successful Service Business

This Wednesday, January 15th, 2014, I'm launching a new course for the Stanford Continuing Studies Program, BUS26:  Building a Successful Service Business.  The course runs for six Wednesdays from 7:00pm - 8:50pm.

With 55 students pre-registered and two guest speakers, it promises to be a stimulating time.  Hope to see you there!

Fourth Time Shameless Pitch: BUS213 is Now a Featured Course!

It won't go away!  For the fourth year in a row, I'll be teaching BUS213-Principles of Product/Market Fit at Stanford Continuing Studies this Fall.  Now featured as part of the "Mastering Marketing" track, this six week course starts on September 25, 2012 and is held Wednesday evenings from 7:00-8:50 pm.

Signs ups are happening now.
(https://continuingstudies.stanford.edu/courses/course.php?cid=20131_BUS+213)

Pushing Past the Growth Plateau

It's been five months since my last blog post. I'd like to say that I've been on holiday skiing in the Sierras, but in fact, I've been working overtime to clear away the obstacles keeping my business plateaued and hindering growth. Those of you who have grown businesses know what I mean. This growth plateau results when a successfully growing business outstrips the processes and people needed to service it's existing customers. It's more than just a simple capacity problem; pushing past a growth plateau usually requires a phase change in a company's processes and/or people.

Some of the signs that you've reached a growth plateau:

• You and your team have stopped trying to do anything not critical and urgent. All tasks not critical and urgent, including many which are investments in the future have been sidelined (e.g. like networking and blogging!)  
• You and your team are working over capacity, both in terms of time and energy, for weeks at a stretch. You are in 100% reaction mode; you no longer have time to think.  
• Your cash resources are inadequate to hire more people. But to bring in more cash,you have to add customers, which you can't do because you don't have the people. Catch-22.  
• Worse, if you are able to add people, it actually makes the resource crunch worse because of increased coordination, training, and management time. This is a clear sign you've overloaded your systems.  
• Errors start to rise as your existing systems can no longer cope with the volume of work and the bandwidth of your people to compensate for process deficiencies disappears.

When this happens, you have three options (and maybe only two):

• Stop growing - In other words, stop accepting new business. In our case we put a 60-day moratorium on accepting new clients; not doing so would have compromised service to existing ones. For a service business like ours, this is the kiss of death.
• Hire more people - But this requires money. If the money is not available from cash from operations, then this means external financing, either debt or equity. In our case, debt financing was not readily available and we are committed to self-financed growth. This means no outside investor money.
• Rework processes - This often means changing the fundamental nature of the workflow to strip out unnecessary steps. In our case, this was where we spent most of our efforts because only by doing this were we able to free up the people time needed to change systems and increase work capacity without increasing costs.

A BIG Caveat
I mentioned that you might only have two options available. If you are in what Tony Seba calls a "Winners Takes All" market - characteristic of many high technology and web based businesses - "stop growing" may not be a wise option. If you stop accepting new customers, your competition is likely to capture this market share, possibly permanently if the switching costs are high. In this case, you must hire and scale processes ahead of the growth, which almost always means outside investor money.

In our case, being in professional services, this is not the nature of the business, and provided that we can keep up with the demands of our clients, we are able to pursue a controlled growth strategy.

Pushing Past the Plateau
In order to push past the plateau and break the resource barrier, you need ADD. No, I don't mean Attention Deficit Order (which is how your business will act if you don't take these steps).  In this case, ADD stands for Automate, Diversify, and Delegate.

• Automate - Look at your existing processes and strip out every marginal activity you can. Figure put how to break complex steps into simpler ones. Then automate the simple ones. If you can get software or a SaaS service for this, great. But at the most basic level, automate simply means being able to script a process with enough specificity that a lesser trained person can follow the recipe and get the results. With this in place, you should be able to free up existing personnel time and cost to take the next step which is...
• Diversify - In the beginning, startips by necessity need "T-shaped" people. These are specialists that can act as generalists too. However, the generalist tasks may not be handled particularly well. With a simplified process, you should be able to access a broader and more efficient (i.e. cheaper) pool of specialists to handle the routine. Pull out your "T-shaped" people and redeploy them towards the new and complex tasks that will fuel the next round of growth.
• Delegate - Ideally you want to delegate tasks away from your most "expensive" people to the "cheapest" specialists you can. Keep in mind "cheap" and "expensive" does not just refer to salary but rather the whole job. Using a $100/hour person who takes 2 hours to do a job is cheaper than using a $25/hour person who takes 5 hours. And don't forget opportunity cost; take a look at who your bottlenecks are. Chances are there is a high opportunity cost that can be eliminated in unburdening these people.

Learning to push past growth plateaus is a critical skill that must be mastered by anyone seeking to grow their business. The fact is growing business will experience multiple growth plateaus. The ones that can reinvent themselves thrive. The ones that can't stagnate or die.

My business is still making the push off the plateau. I'll be back with another post; I just can't tell you when it might be.

Wall Street vs. Main Street Negotiations

I was recently asked by an entrepreneur what my advice would be on how to handle a contract negotiation between his company and a large, Wall Street financial services firm.  He was a bit concerned by the rather one sided terms being proposed by in the initial draft of the contract.  He was also getting annoyed that every time he tried to push back, he inevitably found himself arguing with their lawyers instead of the principals themselves.  And for the past week, they had stopped returning his emails and phone calls altogether.  Needless to say, the entrepreneur was concerned that his push back had soured the deal.

I told him to take a deep breath and relax, while I acquainted him with the realities of a Wall Street Negotiation.

At the risk of grossly stereotyping, it has been my experience that there are two fundamental negotiating styles.  One I call Wall Street Negotiations, the other I call Main Street Negotiations.  Now I'm a Main Street kind of guy so in the descriptions that follow, my biases should be pretty easy to observe.

Wall Street Negotiation
This type of negotiating style is based on the premise that one has a fiduciary duty to get the most out of any deal for one's shareholders.  Leaving money on the table is bad and indeed might even get one sued.  Every term is crucial and advantage can be found by having the best specialists (i.e. lawyers and accountants) on the team.  The assumption is that the other guy is thinking exactly the same way, there is an understanding by both parties that the negotiation is just business (not personal), and no matter how contentious the negotiating process, once the deal is inked, bygones will be bygones and we'll all be able to work together going forward.

Wall Street Negotiators, as a rule like, to put out the first contract draft, heavily biased in their favor to establish the base position.  This puts the other party in the position of having to pull the contract back towards center.  Wall Street Negotiators will make lavish use of teams of high powered attorneys and accountants to (a) insure they have the best experts able to scrape every penny off the table and (b) to "cover their a--" in the event someone unhappy with the final outcome decides to sue.

To many Wall Street Negotiators, the negotiation is a challenging and stimulating game and where the money is made.  One uses feints, posturing, and signaling to drive towards the most favorable position.  Need to make the other party sweat?  Delay returning those calls for a few days.  Or make sure you have people to play "good cop/bad cop".  Need to buy time?  Have the lawyers make a mountain out of a molehill on some minor term.  One can always cave in later if doing so is to one's advantage or one needs to change the tenor of the negotiations.  Brinksmanship can be good and remember to feign indifference because the perverse thing about negotiations is that often the person able to extract the most concessions is often the person who is perceived to care the least about whether the deal goes through or not.

Main Street Negotiation

Almost at the other end of the spectrum, this style is based on the premise that a good deal must be "win/win" and if a deal is fundamentally sound, there will be plenty of money on the table so focus on the dollars and don't sweat the pennies.  Main Street Negotiators are more interested in executing on the deal;  the negotiation is just something to be gotten through so one can get on with the business.

Therefore, to save time and legal fees, the first draft of the contract will tend to be start somewhere in the middle, the rationale being that that's where everyone will end up in the end anyways.  Also, the fewer contestable points, the smoother the negotiation is likely to go and subsequently the better the feelings during the negotiation process.  The tenor of the relationship is important because once the deal is done, one has to work with the opposing party to execute. Also, for many Main Streeters, especially entrepreneurs, business is not "just business", it's their life and there is quite a bit of personal involved.

For Main Street Negotiators, deals are not an everyday event and the money is perceived to made not by the deal but by the operational execution afterwards.  They don't perceive the process as a game;  they just want to get to the end so they can get onto the real work.

Clash of Expectations
Now when a Wall Street firm negotiates with another Wall Street firm or a Main Street firm with another Main Street firm, there generally isn't an issue.  Both parties are working off the same expectations and things usually work quite well.  The issue comes when a Main Street firm finds itself negotiating with a Wall Street firm.  With completely different negotiating styles and expectations, things can turn sour quickly, usually for the Main Street firm which is not used to the more rough and tumble style of Wall Street.

So who tends to practice Wall Street Negotiations?  Investment banks.  Private equity firms.  Venture capitalist firms.

The latter is what makes cynics of entrepreneurs.  Used to a win/win atmosphere, if they haven't been in a Wall Street Negotiation before, they can sometimes feel bullied and at a disadvantage during a term sheet negotiation.

So what can you do if you find yourself in a Wall Street Negotiation?

• First off, realize that you ARE engaged in a Wall Street Negotiation - That means expect the first draft contract to be skewed.  Expect that you will have to fight to bring it to the center.  Don't concede minor points too quickly; you might need them as bargaining chips later. 
• Get your own attorney and CPA - This will tend to mitigate the gamesmanship and give you someone on your team who talks the lingo of the other sides attorney and CPA.
• You deal with the principals;  let the lawyers deal with the lawyers, CPAs with CPAs - You should drive the business terms.  Let your lawyer negotiate the legal terms.  Let the CPAs fight out the financial model assumptions.  Use the professionals to put some emotional distance between you and the negotiation and keep you out of the minutia and focused on the key points.
• Don't let the emotions drive you - Don't vilify the other party.  They are not the spawn of Satan.  They're just doing their job which is to extract the most favorable terms for their firm.
• Don't be afraid of pauses and silences - Don't read the worst into failure to return email or phone calls.  Don't feel like you have to fill every silence with words.  For some reasons, Americans hate silence;  I've seen several deals with Japanese firms where the Japanese won concessions just because the American negotiator couldn't shut up.
• Try to establish a personal connection with the other party - Go to dinner, meet for drinks, play golf.  The more you can bring relationship into the picture, the more you can shift it towards a win/win direction.
• Know your walk away points ahead of time - Make sure you know up front under what conditions you would walk away from the deal.  This also helps keep the emotions down and also makes you appear less eager, strengthening your position.

Vacation: A Management Tool

I'm finally back after a two month blogger's holiday. Three weeks of that was spent teaching high school students marketing and entrepreneurship. The last three weeks was spent on a family vacation overseas in Korea with no voicemail and limited email. During the last three weeks, I was pleased to find that other than a few minor issues, the office didn't fall apart and our staff did a great job of keeping clients supported in my absence.

Chalk up another win for Vacation as Management Tool.

I'm not talking about the mental health benefits of vacation downtime, which are well documented. Rather I'm referring to a practice I started years ago whereby I deliberately absented myself from my job for two to three weeks in order to test how well I had done the following:

• Trained my staff
• Created processes and systems
• Delegated routine operational issues

Two to three weeks seems to be about the right time for any weaknesses in the above to show up but without letting them blow into full fledged crises.  These become targets for improvement.

As a corporate executive, I would use the vacation test to evaluate how well the managers working for me were doing.  While the first criteria was departmental performance, in my book, one of the key jobs of a manager/supervisor is how well they train their people to work without them.  Weak managers tended to be too involved in the day-to-day which deprived their people of development opportunities and left the organization vulnerable to a single point of failure (themselves).  It also limited their advancement opportunities by making it difficult to move them to new positions.  Also, I've found that if you let it, work will expand to fill all available hours;  weak managers tended to be so busy with tasks that could and should have been delegated that they never had the time needed to think about new opportunities or how things could be improved.

Now lest my startup readers think that delegation does not apply to them (after all delegation assumes that there is someone to whom work can be delegated), I would counter with this question:

"How are you expecting to scale?"

Of course the answer is you hire or you contract out.  Either way, you only scale by bringing in people...

• ...to do specialist tasks for which your team lacks the skills
• ...to do tasks that someone else can do more expertly and/or efficiently
• ...to unburden "bottleneck" specialists of tasks that can be done by others (usually cheaper)

When you hire you usually need to develop processes and procedures to enable them to execute and/or train them.  Then you need to delegate the job to them and figure out how to monitor the results.  This is called management* and it is harder to do than it looks.  In a startup, their never seems to be enough time to train;  it's often easier to just do the task than explain and train.  And setting up processes?  Not only is flowcharting out and documenting all the little steps time consuming, it can be BORING, especially to many entrepreneurs who enjoy the excitement of deal making and creation.  And the darn processes are constantly changing!

Nevertheless if you plan to scale, training, process development, infrastructure development, and delegation are necessary.

I run into this issue with entrepreneurs all the time.  Many startups begin with the entrepreneur and a couple of technical guys to do the development.  Initially, when cash is lacking, the entrepreneur/CEO (Chief Everything Officer) is forced to handle everything else from fundraising to key partner negotiations to bookkeeping.  But as money starts to trickle in, while some entrepreneurs can readily relinquish things they are not good at and are necessary but not generating value (e.g. bookkeeping), others have a tough time letting go.  We often have to remind the latter that the value of their enterprise is not going to depend on how detailed their bookkeeping entries are.  Rather it will depend on how well they've demonstrated product/market fit, landed paying customers, and established strategic partnerships.  Any time spent on the former rather than the latter is not time well spent.

The nice thing about Vacation as Management Tool is that if forces one to figure out how to make sure that things don't fall apart in your absence.  You actually have to do the training, establish the process, and delegate the work.  And as an added bonus, the time spent away will hopefully leave you refreshed, renewing your capacity for creative thought and new insights about your business.


*  I sometimes get the smug question from an entrepreneur "why would we ever need managers?"  My answer: "You don't provided all your people communicate with each other perfectly, they self-coordinate tasks seemlessly, all play together well, and they all know the mission and understand the implications of that mission for their own tasks."  In my 20+ years of managing people, I'm still looking for those people.

The "Other Stuff"

This week has been a whirlwind of activities associated with my son Alex's graduation from middle school.  We've had final performances, award ceremonies, and, of course, the graduation itself.  Maybe it's an East Coast/West Coast thing or maybe the times have just changed, but I don't recall any of this hoopla when I finished 8th grade.

What I found most interesting this week was the awards ceremony.  There must have been fifty different awards given out over a wide range of activities - music, art, leadership, drama, science, math, spirit, community service - the list went on and on.  I was quite impressed by the diversity of opportunities offered by the middle school, all chances for a student to find their passion and place where they might excel in their own unique way. And I understand the high school offers even more!

And from the whispered comments amongst the students, I think this took some of them by surprise as well.  I kept hearing some variation of "XXX?!  How did XXX get that award?  They're not that smart!"

I found that type of comment very interesting.

You see, in Silicon Valley, brains and achievement are practically objects of worship.  In fact, brains are almost automatically linked in the minds of many with achievement in a mathematical relationship that looks like this:

SUCCESS = ACHIEVEMENT 

where ACHIEVEMENT = f (BRAINS, knowledge, other stuff )

But in my experience, while being smart and educated are no doubt an asset, they are a helpful yet insufficient condition for achievement.  (And I'm not willing to equate success with mere achievement.)  Instead, what I've seen is that it is often the "other stuff" that accounts for why someone who is less gifted intellectually can achieve as much or more as their high IQ peers.

What is the other stuff?  While obviously not an exhaustive list (and in no particular order):

• Capacity and willingness to work hard - A big part of achieving something is be willing to do the work that needs to be done.
• Determination - In almost every challenging endeavor, there is a roadblock or two or three.  Those with the will to keep at it often find a way over, under, around, or through it.
• Resiliance in the face of setbacks - And in the process of overcoming roadblocks, there are many blind alleys and unforeseen setbacks.  Those willing to press on and not succumb to despair are much more likely to achieve their goals.
• Courage to try - The first step on the road to achievement is just putting yourself out there.  The journey of a 1000 miles isn't happening if you're afraid to step out of the house.
• Being able to relate to other people - While individuals are often the catalyst, it is difficult to achieve things without the help of others.

And that's what I saw at awards night.  While there were definitelymany awards aimed at scholastic excellence, there were just as many celebrating endeavors where the other stuff was just as, if not more important, to success than sheer brainpower.  What a great lesson for the students.

Over the next three weeks, I'll be taking a three week blogging holiday until mid-July. The reason?  I've again been given the privilege of teaching high school students about business as part of the Stanford Educational Program for Gifted Youth (EPGY).  These are some of the meta-lessons I hope to convey.

The Employee to Entrepreneur Transition

I work with a lot of startups and to me, one of the most fascinating journeys of personal growth to watch is the transition from corporate employee to entrepreneur.  While there are many who believe that "entrepreneurs are born not made" and that an entrepreneurial personality is completely antithetical to being a good corporate employee, my experience, supported by a 2009 Kauffman Foundation study⁽¹⁾, has been that this distinction is not so cut and dried.

According to the Kauffman Foundation study, there are two types of entrepreneurs.  The first, whom they label "early entrepreneurs" fits the classic Silicon Valley stereotype:  college educated, twenty-something single male who may or may not have graduated, technically oriented, iconoclast with a strong independent streak (e.g. Bill Gates, Larry Page).

However, the second more typical entrepreneur is a 40-year old married male with children.  About half had over ten years industry experience working for other companies before starting their first company.  Nearly half had either zero or negative entrepreneurial aspirations.  The majority were good students in high school and college with 95% of these holding at least a Bachelor's degree and 47% holding an advanced degree.  In short, these were people who fit the mold and in many cases performed well as corporate employees.  So it is possible to become an entrepreneur after having a corporate background.

Having said that, there is a definite transition that has to occur for a former corporate employee to become a successful entrepreneur, one that I've personally experienced.  And as you might expect, some are able to make the transition quickly and easily, while others not at all.  In my case, it took fifteen years (but I tend to be pig-headed and somewhat resistant to change).

So what does the employee to entrepreneur transition look like?

• Defined Program =>Undefined Program:  As an employee, you job is to execute the program.  Your time, priorities, and, in many cases, even the means are defined.  This is true even if you are CEO.  As an entrepreneur, it is up to you to create the program.  There is no one telling you what your priorities should be or how or when you should spend your time.
• Predictable Income=>Variable (initially zero) Income:  As an employee, you contribute your time, skills, and knowledge in exchange for a regular paycheck.  Base salary typically doesn't vary with how the business is doing (unless it is very, very bad in which case even the pay cut is pretty predictable).  As an entrepreneur, assuming that you get to the point of revenue, your income will often scale up, down, and sideways depending on the cash needs of your business.  Need a raise?  Then you have to find a way to raise profits.
• Safety Net=>No Net:  As an employee, most companies often some form of benefits from health to retirement. Lose your job?  You can apply for unemployment.  As an entrepreneur, you may not be able to afford the luxury of benefits.  If you're lucky, you might be able to get medical.  Forget about a 401(k) plan.  And if your venture goes under particularly if you are classified as self-employed, you can't apply for unemployment.
• Infrastructure=>No Infrastructure:  As an employee, its amazing how much office infrastructure one takes for granted until you become an entrepreneur and don't have it.  Payroll?  Copy machine?  Printer?  IT support?  Travel arrangements?  These are somewhat lacking when your office is the local Starbucks.  This can be particularly jarring for senior level corporate executives turned entrepreneur used to having an executive assistant.
• Specialist=>Generalist:  As an employee, good corporate practice is to have a well defined job description with clear lines of responsibility.  Your value is in your "technical" skills whether that skill is JAVA programming or HR compliance.  And therefore your employer wants you to focus on doing your specialty well.  As an entrepreneur, you need to be able to handle many things outside your area of expertise, because if you don't, it won't get done.  Your value is in crystallizing and communicating a vision, motivating your team, and securing resources via your network.

It's important to understand this transition to avoid two common pitfalls that can sabotage your startup:

• Spending money in areas you can't afford:  When you're doing a startup, your number one job is to get to product/market fit with a viable business model.  Any money spent on things not directly impacting this reduces your chance of success.  Now is not the time to spring for life insurance benefits, remodel the office, and hire an executive assistant to schedule your airline flights.
• Hiring the wrong founding employees:  Silicon Valley is rife with horror stories about founding teams hiring the big company executive with the great connections but who can't seem to operate without support staff, won't extend outside their comfort zone, insists on 9-5 hours, and can't afford to skip an occasional paycheck.  Screen for this.

At the end of the day, the source of the pitfalls is fear.  When you're forty-something with a spouse and kids, not having a paycheck is scary.  Not having health insurance is scary.  Not having enough staff to handle the details so that you know balls are being dropped is scary.  Not having an executable road map is scary.

Which brings me to the defining characteristics of every successful entrepreneur:  courage driven by vision.

Footnotes:
(1)  Wadhwa, Vivek et.al, "The Anatomy of an Entrepreneur,"  The Marion Ewing Kauffman Foundation (2009).

Education for the Small Business Entrepreneur

About six months ago, I wrote several posts (see below) about the differences between small business vs. scalable entprepreneurship and the implications for an educational curriculum.  Silicon Valley, for the most part, is geared towards scalable startups (i.e. the companies that seek to be the next Google).  As a result, programs in entrepreneurship offered by Stanford, UC-Berkeley, etc. tend to be oriented towards entrepreneurs with the big ideas.

But what about entrepreneurs with more modest ambitions?  While organizations like SCORE have long sponsored clinics for small business people, there doesn't seem to be the same effort geared towards educating small business entrepreneurs. Yet, it's a well publicized fact that 45.6% of people employed in the U.S. work for companies with less than 100 people and that these firms make up 99.6% of U.S. companies.  It is also a well known fact that the rate of small business failure is high.  And while I don't have hard facts to support it, based on what I've seen working with small business people, it is my hypothesis that much of this failure could be prevented by educating small business entrepreneurs in the tools and concepts they need to make better decisions.

Since I wrote this post, I've had the good fortune to become connected with educators and business people who feel the same way.  I've been part of an advisory group working with West Valley College in Saratoga, CA.  Under the leadership of Heidi Diamond, Dept. Chair for Business Administration and Real Estate, West Valley has created two new offerings in entrepreneurial education geared towards the needs of the small business entrepreneur.  The first, called the Entrepreneurship Academy starts July 12 and is directed towards budding small business entrepreneurs.  The second, called the Small Business Academy starts July 9 and is geared towards more experienced small business people who have gotten their businesses off the ground but are looking for the knowledge to take their ventures to the next level.

For those of you who may be interested or know someone who may be interested, I encourage you to check it out.  You can link to the West Valley College course website on either of the two links above or by going to http://westvalley.edu/trainingsource/.

Related Posts:
Education, Entrepreneurship, and Employment
The Creative Economy
Small Business vs. Scalable Entrepreneurship

Task "Triage"

Lately its been so busy that I've had to move into "task triage" mode where it's no longer an issue of IF something is going to be left undone.  Rather it's WHAT is going to be left undone.  I first learned this lesson as a product manager, which is one of those jobs where it's absolutely impossible to do everything that needs to be done.  Most product managers learn a couple of lessons quickly:

• How to say "no"
• How to prioritize the critical from the "nice-to-haves"
• That sometimes good enough is the best you can manage

Saying "no" has the obvious benefit of cutting down the "to do" list.  But it took me awhile to get over the guilt of turning down requests, especially where they represented future opportunities.  Ultimately sleep deprivation taught me that the consequences of saying yes all the time were more painful than saying no in most cases.

Good enough comes from recognizing that in many cases, especially in project management and business development, getting something out there, even if it wasn't perfect was better than getting nothing out there because it wasn't perfect.  This is tough on perfectionists (of which I am not).  This trait is probably why I'm a pretty good general manager, business development person, and troubleshooter, and was at best a mediocre engineer, would starve as a designer, and is a good thing for society that I'm not a surgeon.

With respect to prioritizing tasks, the best framework I ever learned was from Stephen Covey's Seven Habits.  Specifically:

1. Important and urgent tasks:  Do them.  But first ask, am I the only person who can do these (by virtue of my position or special skills) or can they be done by someone else (even if I can do them better)?  If the former:  do them.  If the latter:  train and delegate!
2. Important but not urgent tasks:  Schedule time for them or they don't happen.  Interestingly, these are usually the tasks that allow me to get rid of the next set which are...
3. Urgent but unimportant tasks:  See step 2 above.  These are usually candidates for delegation or outsourcing.
4. Unimportant and not urgent tasks:  I.e. time wasters.  Will playing Angry Birds for the 12th time really change my life?

Of course deciding what is important depends on knowing what your goals are.

But even with this framework, there are times when the task load ramps to the point where clearing through category 1 tasks takes all my time.  So be it; such is life.

Hows that for rationalizing why my blogging has been erratic lately?

The "A-Player" Myth

"DirtPud.Ding, a ground-breaking, mobile, digital media, clean-tech, social networking app developer seeks a world-class, ROCK STAR software developer.  Must have a proven track record developing high profile, killer iPhone applications, be a team player, pro-active self-starter, and willing to work for equity only.  Candidates should have worked in a startup that successfully exited to Google and know Mark Andreesen on a first name basis."

Sound familiar?  Just another Silicon Valley job posting by some startup seeking an "A-player" for peanuts.  After all, it's a given that for a startup to succeed, everyone you hire must be an "A-player," right?  Get the team right and everything just flows!

Maybe.

Now don't get me wrong, there is nothing wrong with trying to hire "A-players."  One should try to hire the best talent possible.  But how realistic is it to expect that you will be able to hire WORLD CLASS, ROCK STAR talent for all of your positions when you' haven't even reached Ramen-profitability and your office is the local Starbucks?  What if you can't?

If your expectation is that you MUST have all "A-players" to succeed, your startup will fail.

So what's an "A-player?"  Most people would define an "A-player" to be someone who:

• Is Rhodes Scholar smart with state-of-the-art working expertise in their professional field whether that be software programming, sales, or accounting.
• Has sufficient experience to apply those skills, identify and anticipate issues, troubleshoot ambiguous situations, creatively problem solve, and guide the startup in the proper direction.
• Is a team player, one who can fit their activities into those of others, subordinate their own interests as needed for the common good, and still has great interpersonal skills at 3:00 am in the morning.
• Is self-managing, setting priorities in line with overall company goals, disciplined enough to keep their tasks on track, coordinates them with others, communicates well, and makes minimal demands on management attention.
• Has a can do, positive attitude uplifting to their team mates.
• Is ethical, of outstanding person character, and free of excessive ego.
• Has the dedication and energy to put in the extra hours and effort required, when the startup needs it (which is pretty much 24/7).

In short, an "A-player" is the model human being (let alone employee).

The fact of the matter is that these people are (a) very scarce and (b) in incredibly high demand. Economics 101 tells you that this means that even if you can find them, they are likely to be gainfully employed as someone else's highly compensated employee or making a living (i.e. they charge) as a very well paid independent.

The other fact of the matter is that most of us fall short in one or more of the areas listed above; we're NOT Charlie Sheen (as he perceives himself to be) but Mere Mortals.  So at the risk of offending someone, this means that most likely, most of the people working in your startup are Mere Mortals and not "A-Players."

This does not mean that you can't have an "A-Team."

An "A-Team" is more than just a collection of "A-players."  An "A-Team" is one that blends the strengths of all its members, both "A-players" and Mere Mortals,  in such a way that overall team strength is maximized and weaknesses mitigated resulting in high performance.  Characteristics of an "A-Team" are focused direction, a high level of work quality and quantity, high energy and esprit de corps, an almost intuitive level of communication between team members, creativity, confidence, and an optimistic approach to challenges.

The advantages of the "A-Team" approach are as follows:

• The recruiting pool is deeper - The simple fact is there are more Mere Mortals available.  This does not necessarily make recruiting any easier (see below).  But recruiting now becomes an issue of determining fit vs. being an issue of pure availability.
• The business is more robust and more scalable - A business that depends on the unique skill sets of just it's "A-Players" is more vulnerable and harder to scale than one based on a team.
• "A-players" thrive too - If you create an environment where Mere Mortals can thrive, its likely to be friendly to "A-players" too.

So with these advantages, why do so many entrepreneurs focus on "A-players" instead of an "A-Team?"

• Belief that "A-players" don't need to be managed or led - In my experience, in any team with >2 people (some would say >1) this is false.  There is no such thing as perfect coordination without some management.
• Belief that people come "hard wired" - This is the belief that one either is or is not an "A-player."  In reality, management studies show that performance is often context specific.  It has been my experience that people can change and be trained;  why else do we have teachers and mentors?
• Many entrepreneurs are lousy people managers - Let's face it, some of the most visionary entrepreneurs are terrible at managing people or even outright jerks.  It takes a certain level of empathy and patience to lead people well and create an "A-Team" environment.  (Also note that being a good people person is not a requirement to being an effective visionary leader.)
• Because they should - Part of the job of being CEO is recruiting key talent.  You do need "A-players."  You just don't want to build your business on the basis that everyone has to be one; your business will come to a grinding halt when you can't fill the positions you need.

How to Create an "A-Team"
So let's say that you want to create an "A-Team."  While there is no formula for this and a lot depends on the skill of the management team and group as a whole (after all we are dealing with messy, quirky, people who don't behave logically), one of the best books written on the subject is Hidden Value:  How Great Companies Achieve Extraordinary Results with Ordinary People, by Charles O'Reilly and Jeffrey Pfeffer.

Here are some practices common to all "A-Teams."

• Hire A-players for key, value proposition critical positions; hire Mere-Mortals elsewhere - This means that you must have a good understanding of what your business's key value propositions are and what are the key resources needed to deliver them.  For example,you may not require a Rock Star in accouting...unless you are an accounting firm.
• Hire for fit - Fit to what?  Values and culture.  Which means you have to know what your values are.  Values should tell people what priorities are important to the company, how the company will treat people, how decisions are made, what the company stands for and what lines the company won't cross.   High performance teams take time to build which means you have to hire for commitment.
• Share knowledge - Information is the lifeblood of an "A-Team."  If you want to engage your employees' brains, both "A-players" and Mere Mortals, they must have access to detailed information about what the company is doing and attempting to accomplish.
• Team based systems and rewards - To foster collaboration, knowledge sharing, and build esprit de corps, rewards should be based on whether the entire team wins or not.
• Training - "A-Teams" invest in improving the capabilities of all their members.  Particularly in a rapidly changing environment, it is important to provide the training needed to keep employees current.

By all means, seek to hire "A-players" but build your business on the back of an "A-Team."

Dealing with the Nitty Gritty: Resources and Wrap Up

Part 6 and final post in a series in Startup Stages

Co-founders.  Suppliers.  Employees.  Customers.  Government.  So what are the compliance and risk management resources available to a startup?

• Do-It-Yourself Resources – There are a host of websites, guides, and other resources supplying legal templates, HR compliance kits, on-line payroll management etc. While inexpensive in terms of dollars, this route can be very time consuming, requiring the entrepreneur to learn about, select, integrate, implement, and manage all of the separate pieces.
• Attorneys, CPAs, and Other Professional Outsource Firms – Legal, accounting, HR, and other compliance professionals can be hired on an outsourced basis, greatly simplifying the management burden on the entrepreneur and increasing the quality of compliance and risk management. But these professionals are very expensive, need to be actively managed, and in the end, you the entrepreneur will need to integrate it all together. In addition, these professionals are advisors, not operating people, and are often more risk averse than the entrepreneur needs them to be, resulting in unnecessary expense.
• CFOs, CAOs, HR In-house Staff – Of course, you can hire your own CFO, CAO, or HR staff who will be able to take care of many of these issues directly, thus minimizing the use of the more expensive professionals.  They can also manage the professionals when more complicated issues arise, reducing the time burden on the entrepreneur. But it may be the case that you don’t need these positions staffed on a full-time basis, in which case hiring internal staff may not be the most cost effective solution.

In Summary…
While the startup must manage a number of compliance and risk issues, the main ones are liability protection, tax compliance, and employment law compliance. In terms of summary practical guidelines, the startup should:

1. Organize formally early to put in place basic liability protection and establish the most favorable tax treatment for the business.
2. Define intellectual property strategy and processes early in order to maximize the value of the startup’s intellectual property and minimize the risk of infringement.
3. Do the appropriate trademark searches, and register your domain names and trademarks early on, to minimize the risk of having to change your name after brand equity has been built up.
4. Be aware that hiring employees is a significant step up in legal compliance requirements and insurance overhead that the startup will need to bear and should have the processes in place to handle beforehand.
5. Delay leasing dedicated space, with its attendant addition of long term liability and insurance overhead, as long as possible. Consider hosted office space as an alternative.
6. Be aware that customer contracts will introduce an additional step up in potential liability and insurance overhead. The startup should have the processes in place to handle this before accepting a contract.
7. Select the appropriate resource/cost for the level and complexity of risk.  Do-it-Yourself resources are fine for simple, more mechanical processes, while ill-defined or complex issues, like intellectual property strategy, should be handled by the appropriate specialists.

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups
Startup Stage:  Buying Stuff and Independent Contractors
The BIG Risk Trigger:  Hiring
Space (and) The Final Frontier

Space (and) The Final Frontier

Part 5 in a series in Startup Stages

In this post, we deal with the last two pre-institutional funding risk triggers.

Leasing Space
One mistake startups make is leasing dedicated space too soon. In some cases this is unavoidable (e.g. if you are a manufacturing company handling hazardous materials or requiring heavy equipment). But for software, Internet, or light hardware development, there may be more cost effective options.

Leasing can add considerably to the cash burn, administrative overhead, and risk of a startup. While the NNN lease rate may be low, required insurances, taxes, utilities, common area expenses, and maintenance can easily double the rate. In addition, landlords often require multi-year (3-5) agreements with security deposits, tying up or committing limited cash.

On top of this, there are upfront costs associated with tenant improvements, furnishing, and permits.

New compliance issues include:

• Local fire department regulations/ inspections
• Insurance policies: property and liability ($1-3 million policy coverage required by most landlords)
• Worker health and safety including evacuation plans, notice postings
• Special operating permits depending on the nature of the business (e.g. environmental, hazardous materials)

Additional overhead:

• Utilities (electric, gas, water, janitorial, alarm service)
• Facility maintenance and repair (don’t assume the landlord covers it)
• Facility safety

Really think through whether you need to lease space. While employees create value, furniture does not.  If you must lease space, take a look at which employees really need to be physically co-located and which do not. (It’s amazing how space efficient a person with a laptop, Wi-Fi and a cell phone can be.)

As an alternative, consider hosted office space (also called executive offices). While at first glance, base lease rates are more expensive than dedicated space, total operating costs may actually be cheaper. Hosted offices usually come fully furnished with utilities, are available on one year or shorter leases, don’t require insurance, and have a range of amenities including kitchens, meeting rooms rentable by the hour, office equipment charged on a per use basis, and reception desk services.  Just watch the notice period requirements for cancellation; they can be as long as three months!

The Final Frontier:  Accepting Customer Purchase Orders
Congratulations! You're no longer pre-revenue; you’ve closed your first sale! The P.O. or contract just hit your email… and with it a new set of legal obligations.

A purchase order is a legally binding contract and by its acceptance, the startup is obligated to perform in accordance with the terms and conditions negotiated. In addition to price and delivery, terms to be negotiated should include:

• Product or service acceptance criteria (specifications to be complied with or other conditions that allow closing of the contract and subsequent invoicing)
• Warranty terms, indemnities, and other liabilities
• Damage exclusions
• Title risk transfer
• Payment terms

In order to avoid reinventing the wheel for each contract, the startup should have its own standard sales T’s and C’s covering these. If the startup doesn’t furnish its own T’s and C’s, it could inadvertently end up agreeing to the customer’s T’s and C’s.

Assuming the startup has the associated operational infrastructure for sales order processing, development, production, quality control, and shipping, the additional administrative overhead required includes:

• Sales terms and conditions
• Accounts receivable, invoicing, and collections
• Insurance policies: product liability and/or errors & omissions (services)

If the startup uses distributors or sales representatives, it will also need the appropriate agreements defining the commercial relationship.

Next and final post in the series:  Dealing With It

The BIG Risk Trigger: Hiring

Part 4 in a series in Startup Stages

The hiring of employees is probably the most significant compliance and risk trigger for a startup, (especially in the State of California). This includes the case where the founders are placing themselves on the payroll as employees, rather than compensating themselves as partners. Beyond the risk issue, to attract and retain employees, the startup may need to offer benefits and stock incentives, each of which has its own set of compliance issues.

Knowing this, some startups try to minimize their employer obligations by treating everyone as independent contractors. Unfortunately, Federal and state laws restrict the degree to which this can be done and businesses that run afoul of these guidelines can find themselves owing serious back taxes, benefits, and penalties.  (See my prior post on this subject.)

Compliance requirements now include:

• State of California EDD (or equivalent) Filings:  DE-1, DE-34, and Employer Account Number
• Federal and state laws governing wages and hours, discrimination, and wrongful termination
• Federal and state withholdings for various payroll taxes
• Worker’s compensation insurance coverage (mandatory in California, different by state)
• Benefits provider rules
• Federal and state securities laws with respect to stock options and/or restricted stock grants

(A detailed discussion of employment law compliance is beyond the scope of this blog post.)

The step up in administrative overhead can be quite significant. New policies and processes need to be put into place to ensure compliance, manage risk, and lower insurance costs. These include:

• Payroll and taxes
• Personnel management policies and procedures covering hiring, evaluation, retention, and termination
• “At Will” offer letters or employment contracts
• Worker health and safety
• Insurance policies: worker’s comp, employment practices, general liability
• Benefits administration
• Stock option/restricted stock grant program
• Intellectual property protection (see earlier post)

Of these, payroll and taxes can be readily outsourced, with a wide range of third party payroll processing services available. With respect to the art of managing a workforce, the best generic risk management advice is: think once, twice, thrice before hiring and do the reference & background checks! Believe it or not, there is one thing worse than not filling a critical vacancy and that is filling it with a problem employee.

Firing is not fun.

Next post:  Space!

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups
Startup Stage:  Buying Stuff and Independent Contractors

Startup Stage: Buying Stuff and Independent Contractors

Part 3 in a series in Startup Stages

So you think the purchasing of products and services from is straight forward?  While generally true of the former, the hiring of services, particularly that favorite of all startups, the independent contractor, can expose the startup to significant liability.  Let's take a look at the issues surrounding third party purchases by the startup.

Purchasing by the Business of Products and Services from Third Parties
Once a business entity exists, the founders need to shift the purchasing of supplies, equipment, and services from their personal accounts to the business, in order to take advantage of the limited liability benefit.  Keep in mind that goods and services paid for by the founders (i.e. via personal credit card) do not automatically belong to the business.  They must be transferred in.  The easiest way to do this is via some form of expense reimbursement policy.

Still assuming no employees at this stage, three additional compliance issues must be met:

• Ensuring that independent contractors (if any) are not de-facto employees under Federal or state work rules.  Just because your service provider is willing to be an independent contractor, does not necessarily make it so.  The government has a say in this.  (For more details, see my post.)
• For tax purposes, properly classifying inventory, depreciable assets, and expense items
• Obtaining a state resale certificate in order to avoid paying sales tax on items purchased for resale

In terms of risk management, overhead necessarily increases and involves:

• Executing independent contractor agreements with contractors
• Filing/issuance of IRS 1099-MISC and California EDD DE-542 forms or your state's equivalent (if independent contractors)
• Setting up a business checking account
• Creating accounting controls with respect to purchasing, expense reimbursement, and payables to reduce the risk of fraud and monitor cash burn
• Establishing purchasing terms & conditions
• Obtaining personal property and casualty insurance (if there is a high value to inventory or capital assets)
• Protecting intellectual property (see last post)

For the hiring of services, a well written independent contractor agreement is key. At a minimum, it should (a) define contractor status, (b) assign to the business any intellectual property the contractor creates, (c) spell out contractor responsibility for withholding taxes and insurance, and (d) define the financial terms of the relationship.

Personal property insurance may not make sense unless the startup has expensive capital assets or a high value of inventory (both of which the startup should ideally avoid by outsourcing or building to order).The same goes for establishing purchasing terms and conditions (“T’s and C’s”), although unlike insurance, this costs almost nothing to set up. Having your own set of purchasing T’s and C’s will ensure that you are not inadvertently agreeing to the vendor’s T’s and C’s.

Next post:  The BIG Risk Trigger:  Hiring.

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups

Intellectual Property Creation and Startups

Part 2 in a series in Startup Stages

The underpinning of most technology based startups is the creation of intellectual property (“IP”) in the form of patents, trademarks, and trade secrets (including proprietary designs, software, process recipes, etc.). Yet surprisingly, many technology startups manage this poorly. Management must be diligent in avoiding IP risks, which include:

• Loss of IP rights through failure to obtain proper assignments
• Loss of IP rights through failure to adopt or enforce a lab notebook policy
• Disclosing too much proprietary information in provisional patent applications
• Loss of trade secret rights and foreign patent filing rights through disclosure of the startup’s secrets without an effective non-disclosure agreement
• Breach of non-disclosure obligations through disclosure of a third party’s trade secrets to outsiders
• Misappropriation of the trade secrets of others, especially prior employers
• Infringement of patents and trademarks owned by others
• Having to change the name of the company or its products after brand equity has been built up, due to trademark infringement

The administrative overhead required to manage these risks include:

• Non-disclosure and invention assignment agreements and the associated business processes for their execution and tracking
• Business process for the keeping of lab notebooks, mining of patentable inventions, review of invention disclosures, and filing and prosecution of patent applications
• Employee education regarding the creation and protection of intellectual property
• Patent “clearance” searches prior to significant investment in new products
• Trademark searches to ensure that company and product names do not infringe the trademarks of others

Because trade secret law requires that the owner protect the confidentiality of its trade secrets, it is particularly important to have non-disclosure agreements in place before discussions with key vendors, independent contractors, and employees. In the case of vendors and contractors doing custom work, those vendors and contractors should execute, in advance, agreements assigning to the company any IP they create in connection with their engagement. Don’t assume that because you paid an engineering design firm to do contract work for you that you own it; you’d be surprised what the fine print might say.

A Cautionary Note About NDAs
Did you know that signing a mutual non-disclosure agreement can potentially:

• Impair your ability to commercialize your own inventions?
• If used indiscriminately, impair your ability to claim trade secret status for your legitimate trade secrets?

To minimize this risk, be selective with whom you sign NDA’s and use one-way non-disclosure agreements where possible.  For more about the ins, the outs, and the limitations of NDAs, see my post on What Every Entrepreneur Should Know About NDAs.

So what's the best way to deal with these issues?  If intellectual property is an important element of your startup, hire a good lawyer.  This is not the place to pinch pennies nor does it necessarily mean using one of the big law firms.  Look for an intelletual property lawyer with domain expertise in your technology area.

At this stage of the startup’s life, the compliance and risk management issues are relatively straightforward to manage. However, these escalate significantly in terms of complexity and downside risk as the business begins to issue contracts and hire people.

Next post:  Purchasing Goods, Services, and the Thorny Issue of Independent Contractors.

Related posts in this series:
The "Nitty Gritty" of Startup Formation 

The "Nitty Gritty" of Startup Formation

Part 1 in a series in Startup Stages

I'm often asked by first time entrepreneurs what's involved with setting up a business.  Do I need to incorporate?  What do I need to know about hiring?  Payroll?  Do I need a CPA?  How do I register my business?  Why do I need to bother with any of this at all?

The fact of the matter is that for most entrepreneurs non-core activities like filing DE-1 forms and negotiating insurance rates are at best a necessary distraction to the value added tasks of creating product, finding customers, and building a team.  At worst, they can be a confusing labyrinth of rules, regulations, and risks which if ignored or mismanaged can hurt your business.  Unfortunately, business does involve some non-core, administrative overhead that cannot be ignored.  And what you don’t know can bite you.

Compliance with regulatory requirements and contractual terms is a risk-mitigation matter that must be properly managed. While entrepreneurs are often comfortable managing technical and business development risk, they are often less comfortable at managing the legal, financial, and insurance risks.

Poor execution in these areas can hurt a startup’s chance of success in several ways:

• Subject the startup to legal sanctions or other penalties
• Unnecessarily increase overhead cash burn, the lifeblood of a startup
• Jeopardize intellectual property rights
• Impair the startup’s ability to obtain downstream funding
• Cut into an entrepreneur’s most precious resource: TIME!

Large companies can afford the legal, accounting, and other risk management specialists to the degree required (i.e. $$$) to ensure compliance and minimize other risks. But unless you’re a lawyer or CPA or you have an exceptional amount of startup capital, it is unlikely that you’ll be able to do the same.

However with some upfront planning and an understanding of what to look for, it is possible to ensure regulatory compliance and mitigate the largest risks while minimizing cash burn and the impact on your time.

Understanding Risk/Cost Tradeoffs
Using the example of a prototypical technology-based startup in California with eventual plans to seek institutional funding, let's trace its evolution to show how compliance and risk management requirements increase as the business grows.

For most startups, the burden of compliance and risk management increases when the business begins undertaking specific activities that trigger new levels of risk.  The main risk triggers are:

• Formal Organization, “Friends & Family” Funding, and Issuance of Founders’ Shares
• Intellectual Property Creation
• Purchasing by the Business of Products and Services from Third Parties
• Hiring Employees
• Leasing Space
• Accepting Customer Purchase Orders

Let's start by looking at the very first stage leading up to formal organization.

In the beginning....
Prior to the creation and registration of a formal business entity the founding team is informally affiliated, with each person contributing time and money on a voluntary basis and with each individual responsible for his or her own expenses. At some point, as the startup begins to gain momentum and both time and expenses mount, there is usually a desire for the founding team to organize formally so as to limit the founders’ liability to third parties. The founders may also be raising seed capital from “friends and family,” most of whom will be passive investors unfamiliar with the day-to-day activities of the startup.

Formal Organization and Issuance of Founders’ Shares
Corporations and limited liability companies are artificial constructs which serve to limit shareholder and employee liability to third parties. To achieve this, one must comply with the governing laws. In addition to limiting liability, formal organization as a corporation or an LLC defines the following:

• How the economic benefits and risks are to be shared amongst the founders and investors (i.e. shares, share classes)
• How those benefits will be taxed
• The rights and responsibilities of the parties involved
• The compliance requirements to keep the entity in good standing

For startups, the most common business entities chosen are:

• Limited Liability Company (“LLC”)
• IRS Sub-chapter C Corporation (“C-Corp”)
• IRS Sub-chapter S Corporation (“S-Corp”)

The decision as to which business entity to select will have the following implications:

• Tax treatment
• Eligibility for financing from institutional investors
• Administrative burden(least for an LLC, greatest for a C-Corp)

There are tradeoffs associated with the above that need to be considered. While there are a number of “do-it-yourself” books available to help you select and register the proper entity, an attorney is usually the most cost effective way to ensure this is done correctly.

At this stage, assuming there are no employees, compliance requirements are low and involve just a few items:

• Filing Articles of Incorporation or Articles of Organization with Secretary of State
• Board adoption of Bylaws and organizational resolutions (in the case of a corporation) or execution of Operating Agreement (in the case of an LLC)
• Issuance of shares to founders in compliance with Federal and state securities laws
• Securing of a Federal Employer Identification Number (“FEIN”) from the Internal Revenue Service
• Filing a fictitious name statement if the business will be conducted under a name different from the name stated in the Articles of Incorporation or Articles of Organization

Even if there are no employees, an FEIN is usually required by registering agencies and frequently needed for setting up bank and supplier accounts.

Commensurately, ongoing administrative overhead is low, involving:

• Filing annual Statements of Information with the state
• Filing annual Federal and state tax returns
• Basic accounting and record keeping throughout the year adequate to support the tax filings
• Execution of annual written consents reflecting actions of the shareholders and Board, including election of Board members and appointment of officers
• Periodic updating of minute book share registry to reflect stock or option grants

It is advisable to keep the share registry updated, especially as the startup approaches the professional funding stage. There is nothing more frustrating than preparing to close a multimillion dollar funding deal and not being able to get cousin Bobby’s signature because he’s moved to Timbuktu, address unknown.

At some point, the startup may raise funds from “friends and family” or angel investors. As part of the financing process, it will have to make certain representations regarding financial and legal matters. So compliance with these matters will greatly facilitate the financing process, while compliance gaps will complicate it.

Next post:  Implications of Intellectual Property Creation

Process Overkill

I just got off the phone with potential new client, the CEO of a pre-Series A startup.  I feel bad for him because the poor guy just wanted to get his financial accounts in order.  So he hired a well known, reputable accounting firm.  60+ billable hours later, his accounts are still not in order.

Instead, it sounds like a great deal of effort has been expended to automate and integrate his accounting, payroll, banking, and payables systems.  It sounds like the accountants burned through some of the 60+ hours trying to set up ACH electronic transfers between vendors and the company and linking in a SaaS bill pay system instead of just posting entries.

All this for a less than five person, pre-revenue bootstrap startup that probably does less than twenty purchasing transactions a month, most of which are on the company credit card.

Another victim of process overkill.

In a different case, one of my current clients, a thriving $20MM+ revenue business, is just now upgrading from Quickbooks to a conventional ERP system.  As part of the implementation, they are putting in place a formal purchasing process.  The process owner has a common sense approach.  For her, the purpose of the process is to contain costs by reducing redundant buying.  She's scoping the process to facilitate the most common buying situations, not to cover every situation.  She wants the process to be easy for people to use; no massive purchase requisition forms.  And most refreshingly, she knows that she will have to handle exceptions to the process.

Part of startup conventional wisdom in Silicon Valley is that one should build ahead of where you plan to be. Planning to be a $100 million revenue company in three years?  Better get that SAP or Oracle ERP system in place now!

But in my experience, to avoid process overkill, startups would be better off if guided by a different principle:  scale appropriate.

Scale appropriate means working with processes set at the level you are currently at.  Still trying to validate your business model and build prototypes?  You don't need an ERP system.  You don't need elaborately defined purchasing requisition and approval processes.  You don't need ISO9001 level ECO (engineering change order) controls.  And while nice, you don't need your online banking system integrated with your accounting software.  Quickbooks plus a bookkeeper doing manual entries with an occasional account review by a CPA should be suitable for financial tracking.

So how do you determine when it is time to upgrade process and infrastructure?

• Routine tasks are increasingly getting dropped
• Increasing error rate on routine tasks
• High personnel cost associated with the people running the processes (either because you need a lot of people or you need highly trained ones who are really expensive)

Process Implementation Guidelines
So how do you go about implementing scale appropriate processes?  Here are a few of my guidelines:

• Know the Objective - It seems obvious, but before implementing any process, be sure you know what the end goal is.  Is is error reduction?  Workflow simplification?  Scope expansion (i.e. enabling less skilled people to perform the task)?  When you document your process, this should be the first thing at the top of the page!  Why?  Because over time, the purpose for the process will be forgotten and the people who put it into place may be gone.  Soon the process takes on a life of its own and you end up with mindless bureaucracy.  Don't believe it?  During my first turnaround, at an ISO9001 certified company, in forcing a review of every ECO process we had, we discovered one that had never been used in the ten years it had existed, but was driving 25% of the data collection fields for the entire ECO process.  Why had it been implemented?  It was a what/if scenario.
• Set the Metric(s) - Once the objective is set, make sure you have a way of measuring whether the process is being effective  This way, you can determine whether future changes to the process are helpful or harmful.  Frequently, this will help prevent process overkill.
• Evaluate Whether Existing Processes Can Be Pushed Harder - Before implementing a new process, see if the existing processes or infrastructure can be pushed harder.  While I know this is going to go against the advice of every business process person out there, don't fall prey to the "blank paper approach" siren.   This especially goes for evaluating  a new ERP system.  You'd be surprised how hard you can push a legacy ERP system.  And while pushing a legacy system can seem like a lot of useless work, be sure to compare it against the disruption of transitioning to a new system.
• Design for the 80/20 Rule - If you do need a new process, design it to handle the 80% most common work outcomes, not the 20% exceptions.  Designing a process to handle 100% of the contingency situations that might arise is the path to process overkill.  It's usually simpler and more effective to let a person handle the 20% exception cases.  Be very careful listening to the "what if?" person in the room!
• Don't Over Automate/Integrate - While it is tempting to want to automate and integrate all your various processes and systems together for push button convenience, there can be a price to pay as well.  Integration to improve data transmission accuracy or eliminate multiple or complex manual steps that can lead to errors may be worthwhile.  However, the more processes are interlinked, the more you may run into unintended consequences particularly if changes to any of the independent processes are made.  This can lead to a situation where one is spending more time troubleshooting and fixing processes than performing a manual step once in awhile.

One of the biggest sources for process overkill that I see comes when someone attempts to design a process to eliminate a human being.  For all except the simplest processes, this rarely works.  In my mind, it's better to design a process to leverage the capability of a human being, not eliminate them.

Establishing highly integrated and automated processes comes with a price.  Where transaction volume is high, complex in nature, or the consequence of output error is high, it may be worth paying that price.  There is a reason that large multinational corporations, financial institutions, and government agencies tend toward these type of processes.  But they also spend hundreds of millions of dollars with fairly large dedicated IT staffs for the privilege.

For small businesses and startups, the focus should be on effectiveness in getting the job done.  Whether it is done by people, processes, or a combination should be secondary.

Related blog post:  Process vs. "Product" People