The best startup business idea for 2016 is one that matches your unique background, experience, and preferences with something that people need, want, and will pay for. It’s about you and your customers, not the idea.
Stare at a mirror and think about who you are, your resources, what you like to do, what you know how to do, and what you do better than others. Combine that with where and how you can give value to customers. What you love to do matters, but connect that to something you can sell.
You don’t have to do something new or different; just do something well. Millions of new businesses are start up every month doing something that’s been done millions of times before, but better, differently, or with more focus, or in a different place.
Bad ideas make bad businesses, but good ideas are infinite. What matters isn’t the idea but doing the work and giving other people value that enough of them want to pay for.
What causes startup failure? You may have seen my response to this – I say we don’t know because we can’t get good data – but I like what David Rose says here:
Since a startup is a new business that doesn’t yet exist, the default outcome is for it to fail. Everything has to go right for it to succeed!
David knows. He’s a super angel investor, founder and Chairman Emeritus of New York Angels, and founder of gust.com. I’m quoting from his Quora answer to why startups fail.
On the other hand, when startups are conceived around need, giving value, solving problems, offering something people want or need enough to pay for, then the odds of failure go down. I bet David would agree with that one. He’s been involved in, founded, and invested in dozens of startups that didn’t fail.
I will add, though, that a good look at this data reveals mostly what is already common knowledge. Startups fail for lack of market need, running out of cash, team problems, competition, pricing, poor product, and so forth. There’s no surprises there.
By the way, notice that the various causes here add up to a lot more than 100%. That makes sense to me because it’s no hard to really identify causes.
And also, please notice how much of those failures are about failing to do something people need and want. If I add up the totals for no market need, get outcompeted, poor product, ignore customers, and product mistimed, that’s 105%.
Here are 10 qualities I’d look for in a future business partner:
Integrity. The whole truth, not just the good news. Actually I want to know the bad news instantly; and the good news can wait. I want to work with people who never make me wonder what they are thinking or what they mean. Trustworthy is essential.
The kind of intelligence that respects uncertainty and not knowing. People who know things that they are sure of are often not realizing the other side of the question. I want to work with people who respect research and data but use it to spark discussion, not end it.
Somebody from whom I can learn. I want somebody different from me, with different background and experience, coming from different, not sameness. Let our resources be more when we’re combined than they are when we’re separate. That takes diversity.
Somebody who likes learning. I want an open mind. I want somebody who can change their mind, listen to other opinions, and be comfortable changing views when things change or they encounter new evidence.
Somebody who knows what they don’t know.
Somebody who questions best practices.
Somebody who doesn’t think anything is true just because a lot of people say it is true.
Somebody who can dive into crunch times and work like mad, but who also understands that it’s not always crunch times.
I like education. I think it opens people up to lifetime learning. I don’t like it when people evaluate education by correlation to earning power. I like people who like ideas, know how to listen. I think things like college degrees mean somebody has buckled down and done something hard for several years.
I want somebody who can take the harder route when that makes sense, and doesn’t back down from something hard just because it’s hard.
Much as I like TED, and respect Bill Gross and Idealabs, this recent TED talk bothers me. He analyzed several hundred startups, from big successes to big failures, looking for the most important startup success factors.
Startup Success Factors: Are These the Only Options?
He considers the idea, the team, the business model, the funding. I would never guess what he concludes. Before you watch his talk, what do you think? What is the most important startup success factors?
Timing? Seriously? I don’t believe it. I think it shows how you can analyze anything and come up with your own conclusions. What do you think?
Here’s some of his reasoning, in detail:
The number one thing was timing. Timing accounted for 42 percent of the difference between success and failure. Team and execution came in second, and the idea, the differentiability of the idea, the uniqueness of the idea, that actually came in third.
So take a wild success like Airbnb that everybody knows about.Well, that company was famously passed on by many smart investorsbecause people thought,“No one’s going to rent out a space in their home to a stranger.”Of course, people proved that wrong.But one of the reasons it succeeded,aside from a good business model, a good idea, great execution,is the timing.
So what I would say, in summary,is execution definitely matters a lot.The idea matters a lot.But timing might matter even more.And the best way to really assess timingis to really look at whether consumers are really readyfor what you have to offer them.And to be really, really honest about it,not be in denial about any results that you see,because if you have something you love, you want to push it forward,but you have to be very, very honest about that factor on timing.
Timing seems random to me, too much luck, not enough execution. And although I apologize for disagreeing with somebody who has the track record Bill Gross has, the reasoning seems to be based too much on after-the-fact accommodation.
I know that I love spreadsheets and analysis and I’ve done a whole lot of them. And, I confess, when I start putting subjective rating variables into a system – the 1-to-10 importance scale shown here, for example – it’s hard to keep my heart ahead of my head. I often end up with numbers echoing gut feel or opinion. Do you get what I mean? Is that what is happening here?
Shane was referring there to a post on startup equity I did a while back, highlighting the problems that happen all too often as founders fail to define their own functions and ownership, in writing, in time. The situation I described was a hypothetical. Here’s a quick summary of that post for you:
Parker comes up with a great idea for an iPhone application, and works on it for three months in spare time. … develops sketches and designs…
About three months into it, Parker has spent maybe 10 to 20 hours on it so far. [enter Leslie, programmer] … Leslie is excited, which rekindles Parker’s excitement. They agree to be partners in a new business based on this initial iPhone application.
Four months go by. Leslie … gets into the code … discovers Parker’s initial idea isn’t quite possible … revises the idea radically, makes it practical and develops a prototype. Parker meets with him three times, they talk, she accepts his changes begrudgingly. At this point Parker’s total hours have gone from 15 to 25, but Leslie has worked a lot, probably 120 hours, on the programming. … [they] … take the prototype to Terry, who has been through a failed startup, has a business education and is looking for a startup to do again … Terry does a business plan and networks with local business development groups to find angel investors. They win an opportunity to present to an angel investment group. Another three months have gone by. Parker has now put in more like 40 hours, Leslie 250 hours, and Terry 120 hours. Leslie wants to quit a current job and work full-time on the new thing but needs to get paid. Parker doesn’t want to quit a current job but wants to stay involved; she’s not quite sure how. Terry wants to lead the new company as soon as he can get financing.
I asked three questions at the end of the post. I asked, but didn’t answer them:
How would you suggest that Parker, Leslie and Terry divide up the 100 percent ownership of the company now, before they go to the angel investors. Who owns how much?What do you think of the management team here?
Leslie and Terry both want to work full-time on the business when there’s money to pay them. What titles should they take? How much salary?
How much of the company should these three offer to the seed investor for $250,000?
Pre-money Valuation
It was relatively easy to answer the third for Shane. I put it into a tweet:
@diffily so pre-money is just math. $500K = 50% left for founders, $1M leaves 75%. On that one, Founders get what they can negotiate.
“Pre-money” means the valuation for the transaction with the initial seed round investors. To clarify, “post-money” would be the valuation after new investment funds are received. So if “pre-money” was $750K, then the angel investors’ $250K would buy 33.3% of the shares and the founders would end up with 66.7% of a business values post-money at $1 million.
I can’t get more specific than that without filling in some value judgments about the relative value of the application, the presumed product-market fit, and the credibility of the team. If all three factors are positive, then I’d suggest starting the negotiation with a valuation of $1 million. That would give the angels 25% ownership and the founders 75%. That leaves enough equity for future rounds. Otherwise, if the deal isn’t that stellar, then the three founders would have to go down to $750K or even $500K, hoping to get some angel investment to develop traction and increase the valuation later.
For the sake of explaining dilution, I’m going to go with the $750K valuation for the discussion on dilution below.
Startup Equity
Shane then asked the much harder question:
@Timberry Thx so much. A lot ask – but what rough breakdown for Parker, Leslie & Terry wud you say is equitable? No worries if u’d rather not!
Keep in mind that I just made these people up and imagined an unspecified iPhone app without describing what it does for whom. In the real world it would take a lot more of understanding who these three people are and how credible their real skills. Here’s what I think:
First, Parker can’t have much equity because she hasn’t done that much. Her initial idea didn’t work. She has put in only 40 of the 410 hours (less than 10%) and her hours weren’t all that useful. Still, she was the originator, she came up with the market need, and she set the wheels in motion. So she should stay involved as long as she wants. However – also very important – Parker doesn’t even want a full-time job. I’d ask her to take 10% of the pre-investment 100% shared by the founders. And I’d give her a seat on the three-person early board of directors, with the assumption that she’s going to go off to make room for investors.
With Terry and Leslie, I’d put Terry in charge and at the top of the business, with a title like CEO or President or some such; and Leslie should be the technology/product development lead, reporting to Terry. I’d want both of them to take minimum possible full-time salaries as soon as possible, Terry’s a bit more than Leslie’s. Their salaries should be a compromise, enough to support them and their families, but less than market value because they have to keep the burn rate low. And I’d want to get their salaries up to their market value as soon as possible. In a real company, if it’s going to make it, the people it depends on get paid.
I’d want Leslie to take 50% of the founders’ 100%, and Terry 40%, bringing the total, including Parker’s 10%, to 100%.
Why? Obviously I’m making some assumptions on the unknowns. I assume that Terry has a credible background in startups and holds up as lead founder. I assume Leslie has a credible background in tech and can run the technology, even as the business grows. I assume Parker has knowledge and experience beyond just the idea, and can contribute to the business even if not an employee. I assume all three are there for the long term.
I confess to some bias here too. I don’t believe the original idea has much value without ongoing contribution. I do believe in product-driven businesses, and technology-driven businesses, which is why I end up giving Leslie more equity than Terry. And I assume Terry’s MBA is a healthy number of years in the past, which means (to me) that it has been tempered in the field and has more value.
Valuation and Dilution
After angel investors put in $250K, they own one third of the shares. Usually the legal work is done with preferred shares and more subtlety, but, for purpose of illustration, let’s assume this is all done with common shares and the total founders’ shares, before the angel investment are 1,000. That’s a small number because startup attorneys usually write up the original corporate documents with more shares, such as 10 million instead of the 1,000 I’m showing. I’m using these simple numbers because it shows how the founders are diluted when the angel investors join the ownership. Each of the founders retains the founder shares he or she has, but the additional shares mean that they end up owning less of the company than they did before the deal.
Where do young companies get money? I ran into this three-minute video over the weekend. It’s a great summary. If you’re not already up to speed on the range of startup options from personal savings to venture capital, just watch this:
My thanks to the Kauffman Foundation for providing this, and kudos to narrator Paul Kedrosky, a well-known expert on venture capital.
It does, however, skip over the influence of angel investment, which stands somewhere between friends and family and venture capital. Angel investors generally focus on seed money – early investment for startups at early stages of growth – for amounts less than $1 million. Several experts have different definitions of angel investment, on how many angel investors exist, and how much money they invest. As I write this, the latest available statistics come from 2013. Approximately 300,000 angel investors invested about $25 billion in 71,000 startups, mostly for seed financing and early stages. Venture capital invested about $30 billion that year, but in only 4,000 companies. (For more on that, here’s a link to a draft chapter from my latest book, on Lean Business Planning: Angel Investment.)
I wonder if that’s just to simplify the landscape as Kauffman explains it, or, possibly, because so many people bunch venture capital and angel investment together, as if they were the same thing.
And, changing the subject, I found this interesting number to reinforce what the video is saying. Wells Fargo Bank did a study of startups about 10 years ago and found that the average startup cost in the U.S. is $10,000.
Your business exists to make your life better. Not vice-versa. Don’t live to make your business better.
Obvious? Sure. But people forget.
Do you use what you “have to do” for your business as the constant recurring excuse for missing things that matter to people you love – soccer games, recitals, appointments, and so on? I’m sure you’ve heard the oft-repeated saying about people on their death beds not wishing they’d spent more time in the office.
I think the “have to do” factor for entrepreneurs, startups, and small business owners is essentially infinite. If you are one of us, then you can – if you want – always find a “good” business reason to not do anything but the business for the rest of your life, non stop, without anything else.
So you have to draw lines and set priorities. As I was building my business my wife insisted I be home for family dinner every night I wasn’t traveling. I objected at times, but looking back, with the kids all grown up. I’m so glad. And she set vacations and paid deposits months in advance, so we had them. I’m glad for that too.
You know this. But so did I, and I would have really screwed this up without reminders. So this is your reminder. Life is more important than business.
Here’s a key moment in a successful bootstrapping business startup. This is as an answer to a question I received over my ask-me form at timberry.com.
Back in 1993, Palo Alto Software had been mostly consulting with a stubborn insistence on software products that were not paying for themselves (yet). I was troubled with the risk and fixed cost of hiring people to help with my then-fledling software startup company. This discussion was about hiring somebody to answer the main phone. We were broke. We had no employees.
“Think of it this way,” my wife said, “you’re really buying your own time for her hourly rate. This frees your time for more important work.” And she was right. And very helpful.
We had started Palo Alto Software with just me doing the product, documentation, marketing, sales, administration, and support. For the first few years of it, the startup business was mainly my business plan consulting, while I worked stubbornly to develop software products so we could “sell boxes not hours.” (Boxes, by the way, because we started before the Internet made software downloadable.) My wife and I comforted ourselves with that as a mantra, while we signed liens on the house and piled up credit card debt.
And so it was this idea, buying my own time by paying other people to do things that I had been doing myself, that guided our hiring as Palo Alto Software began to grow, in the middle 1990s. I hired phone answering first, bookkeeping second, tech support, and then sales. In all cases I was keeping product development, strategy, and marketing for myself, and finding people to free me of the business tasks I didn’t like.
Hiring out sales was a big deal, and a huge relief for me personally. That started with somebody with amazing persistence to keep calling distributors who didn’t return calls. He left hundreds of voicemails with some distributors before they finally called back. I would never have had the patience for that. And then, better still, an outside sales representation firm that was entirely variable cost, meaning that we paid them a percent of sales they made, and only after we got the money from the channels.
The hiring out strategy paid off in 1995 when we grew from about $300K in annual revenue to almost $2 million. That year we replaced spreadsheet templates with the first stand-alone Windows application for business planning, Business Plan Pro. And that took me letting go of my spreadsheet macros, and getting professional development to create the application from the templates. I wrote only a third of the code of the first Business Plan Pro. I worked with a development company for design and development, on a cost-plus-percent-of-revenue basis.
So there were two themes to Palo Alto Software growth from consulting to product-based, and from single founder to dozens of employees. The first was “sell boxes, not hours.” The second was buying my own time back for myself by bringing on other people to take tasks away from me.
For some really good startup advice, and lots of good reminders, here is Guy Kawasaki’s Top 10 Mistakes Made by Entrepreneurs, on YouTube, courtesy of Stanford Business.
I don’t agree with everything Guy says here but I really like his being comfortable with his own opinions, and how he presents them as opinions, not fact. This is a really good one for startup founders and in a classroom situation, for teachers of entrepreneurship to share with students.
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(If for any reason you don’t see the video here, click here for the source on YouTube.)
