Internet Startups Best Practices

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network effects, it has also become possible to scale ventures to profitability in record ... Still, just because it is a good time to start a business does not mean it is ...
Manuel Stagars, CFA, CAIA, ERP [email protected]

Internet Startups Best Practices Small Internet-based businesses have a bright future ahead. Never in the history of the Internet, have more tools been available for entrepreneurs to test and execute an idea as fast and as inexpensively as today. Because of network effects, it has also become possible to scale ventures to profitability in record time today. While there is a lot of information about “How to make money online”, this is not what I mean: We focus on disruptive technology that embraces the Internet by cutting out all physical product; Technology that displaces existing market structures and eventually makes them obsolete. There are many ways to approach an Internet or software startup, some work better, and some are more prone to failure. This short guide summarizes the most important points that I have seen to matter in my own startups and in Internet ventures in general. Let’s get started!

1 When to Start Start as soon as possible. It does not matter what the current economic environment or your personal situation looks like. In many cases, it is actually advantageous to start new businesses in seemingly adverse times. Just remember the dot com boom 1.0 in the mid 90’s. Those who missed the boat to capitalize on it are often thinking, “Had I only […] in 1995 on the Internet, I would be a billionaire.” The reality of entrepreneurship is very different. In a declining economy (not a booming economy), entrepreneurs actually find the most opportune time to start businesses. There are several reasons for that, the most prominent being: 1. Constraints are an entrepreneur’s friend. This is elaborated later on. 2. Because every dollar matters, consumers seek ways to replace expensive existing technology with new technology that is easier to use. 3. There is less venture capital available and less hype, so you can stay under the radar and build your startup quietly. 4. If you are coming right out of college in a down period, it is much more difficult to get a comfy six-figure job in middle management at a consulting company, so you have to go out and do something on your own and will not get addicted to a corporate lifestyle. Still, just because it is a good time to start a business does not mean it is easy to start a business. It never is.

Internet Startups Best Practice – © September 2011 Manuel Stagars. All Rights Reserved. http://innovation.bernsteyn.com

2 Undo Business School Deformation What business schools teach hardly has much to do with what is important for a startup. Management theory seldom directly applies to building a product, pleasing customers, and making profits as a small scalable business. A thorough sensitivity analysis or a report on Porter’s five forces may matter for a large corporation and their management, but customers could not care less: They are only interested in the immediate advantages your products give them. Most successful entrepreneurs actually have no formal business training, but an innate sense of doing business. This is in many ways an advantage because they approach a new venture with a fresh perspective based on a need they identify for a product. I have seen MBAs, economists, and PHDs fail miserably at building successful firsttime startups because of their professional deformation.

3 Planning = Guessing No startup needs a five-year or, even a ten-year growth plan. If there is no product yet, how do you know what’s going to happen in year five? For a big corporation, long-term thinking is important because it’s a stable business, but not for a new business in a new industry. For a small startup, planning is actually harmful guessing. “Projections” are wishful thinking with no grounds in reality. The same is true for business plans. Some may say, “Every company needs a business plan as a guideline, and you later change it anyway.” If that’s how you approach things, then you should spend no more than one hour on your business plan and spend the rest of your time implementing your idea right away. I have rarely seen a passionate entrepreneur who needed a written document to remind him of his idea and execution. I really believe that the most you should plan ahead in a startup is two weeks. Planning further out has very little impact on what you do today, because decisions in a small business are temporary. More important than planning far ahead is actually just starting. Many first-time entrepreneurs forget that and waste a lot of time on tweaking their business plan and projections ad infinitum even before the first line of code is written. Why do they do that? Because they think they need external investment or VC capital, and when they will sit in front of the VC, he will want to see a business plan and good-looking numbers. I look much for at the founding DNA of a startup and what has been executed on a shoestring, not the skillfully worded pitch deck.

4 Avoid the Venture Capital Route (If Possible) In my experience, with small Internet businesses, software, etc., accepting venture capital can be very detrimental. This does of course not mean that VCs are the devil in all cases. For many later stage businesses or companies in other industries, venture capital and mezzanine funding is the most important growth driver. Beside the capital alone, a good VC firm will also contribute their expertise as board members, which can open doors for strategic partnerships.

Internet Startups Best Practice – © September 2011 Manuel Stagars. All Rights Reserved. http://innovation.bernsteyn.com

For small Internet businesses, however, taking external cash sounds like a good idea at first because it pays for expenses and overhead of its founders. If you get $5M, you can spend other people’s money for a sustained amount of time, so venture capital will give you a runway of three to five years. The worst possible thing that could happen then is that you spend down the money and have nothing to show for it at the end of that period. Much worse than worrying about how to make rent next month or coding in your parents basement for a while is wasting five years of your life with nothing to show for it. This would be the case if the VCs end up owning your company and have pushed the founders out, which is much more common than one might think, especially in the Internet space.

5 Start On A Shoestring If you have an idea, you should put it into practice as soon as possible. Do that with whatever means you have available at the time. You should put a very early version of your product online, and you should get at least some early adopters or fans using the product or service. This will provide you with important data about what does not work, what is unnecessary, and what can improve. More often than not first executions tend to try to fit too much into the product: Too many features, which will inevitably not all be functional, too much compatibility, or too wide a target audience. It is actually not very interesting if an early version of a product will please ten out of ten people. Much more promising are ideas that please one or two out of ten people, fear not to scale your product down as much as possible and serve it to a narrow customer base at first. “But once we started small, we should quickly scale up in order to build the next billion dollar business, right?” Wrong, in most cases. Please read on.

6 Small Is Good Many entrepreneurs have the misconception that “small” is just a stepping stone, that a small business is a path to the billion dollar business. Most VCs will not be happy with a business that throws off $1M in capital, they prefer in excess of $100M. In the real world, $1M is a lot of money, especially when it goes straight into your bank account. If you can build a small business with a few million dollars in profits per year, you are very well off. What do you think the odds are to build a billion dollar business against a million dollar business? The answer is obvious. If you shoot for small business success, you have much more of a chance because you are not relying on the buyout lottery where random timing and luck wins over skill. The problem is that there are just enough overnight-success stories to get entrepreneurs addicted to the buyout lottery. Who would not want to invest $50K and get $200M back? This mindset creates a hit-driven business model: VCs invest in 20 businesses with the expectation that one succeeds and will pay for all the other 19 failures. Failed entrepreneurs fall by the wayside while the VCs celebrate.

7 Constraints Are Your Friend Constraints are good when you start an Internet business. With constraints, I mean a scarcity of time and lack of funds. The key problem that occurs if you spend other people’s money is that you care much less about what you Internet Startups Best Practice – © September 2011 Manuel Stagars. All Rights Reserved. http://innovation.bernsteyn.com

spend it on, which dilutes your focus. Let’s say you raised $5M in VC money: Do you care so much about who you will hire, or do you just hire people to fill up the org chart? If you are forced to spend your own money, you want to make more of it faster, so you will be hard-pressed to put out a product without a price. As we all know, “eyeballs” or other meaningless KPIs will hardly pay your bills. You need an actual product, with an actual price, so you can make actual profits. The sooner you get to this point, the better. The worst thing is to have no constraints: You will make terrible decisions and waste time because there is no sense of urgency. I have worked across seven time zones for years with companies. Because there was only a small window where working hours overlapped, we could not hold pointless meetings, there was no time to waste “around the water cooler”, and we actually had to communicate by showing work. I know a designer who deliberately uses only a netbook for programming and UI design. The most powerful driving force for entrepreneurs is constraints.

8 Tragic Misconception: You Have To Be a Workaholic This is entirely not true. Just with money, constraints in time are another great motivator for entrepreneurs, and I do not mean the 24 hours that exist in a day. Many successful businesses emerged in spare time, next to work, or out of college, and not by working 80 hours a week. If you work that much, you are in a hamster wheel and you fail to realize what really matters. If you have 20 hours per week available, you have to be much more focused on what you do with your time. Being a workaholic is never a guarantee for success, and by no means required. The glorification of the workaholic grounds at the beginning of the industrial age: If you work in a factory and spend x time to make one widget, you can just spend 2x time to make two widgets. Not so with software: The great idea matters, less execution matters, more efficient and elegant code matters, and all these come from a well rested mind. It’s almost comical when entrepreneurs brag about how little they sleep; What they actually do is announcing how incompetent they will be in the days ahead. When you are not well rested, you will not be able to produce a great product at concert pitch. Worse yet, your performance and lack of sleep are not correlated linearly: If you sleep half, your work is not going to be 1/2 as good, but in the neighborhood of 1/100 as good.

9 Work Smarter Than Your Competitors When you constrain yourself you have no choice but to cut corners somewhere. You are not going to be able to put in more programming hours than a Google or a Microsoft, and therefore, you can’t go head to head with them. Constraints force you to do less and to do it in a different way than your competition. You cannot build a better Microsoft Word in 20 hours per week, but you can build a product that is vastly different. Customers love all the things that have to do with doing less. If you do not have too much time on your hands, you will inevitably cut out all the fluff: There will be no 300-page manual, and no training classes, but if successful, the product will be quick and intuitive to use.

Internet Startups Best Practice – © September 2011 Manuel Stagars. All Rights Reserved. http://innovation.bernsteyn.com

10 There Are No Overnight Successes Most so-called overnight successes have actually been ten years in the making. Malcolm Gladwell wrote an interesting book on the topic, called “Outliers, The Story Of Success”. He investigates the thesis that expert knowledge can only be achieved by spending at least 10,000 practice hours, and that apparent luck is based on a cascade of favorable circumstances. There is the occasional YouTube, but such stories are extremely rare, just as hitting the jackpot in the lottery. Most companies take a long time of “doing the right thing at the right time” to get to something good. If you can spend five years on your startup at a sustainable pace where you own your company at the end, you can succeed. It’s never a sure bet, and the odds are still against you, but at least you have them stacked less against you than if you have no constraints, a lot of VC money, and unlimited time.

11 Scalability Is the Trump Card Internet-based and software businesses have a great potential to be scalable, if done right. In a scalable business there is no inherent correlation between revenues and employee count, no causal connection between a certain amount of policies and procedures in a company and revenue growth. These things are often concurrent because big successful businesses do have middle management and a lot of policies, so smaller companies think they also have to implement these in order to be successful. Scalable means there is no 1-to-1 correlation: You can multiply the revenue by 100 and not hire anybody new or spend any more money on development. If the business is designed that way, it’s scalable. How to do that? Start by avoiding the pitfalls of basing revenue on product creation or other dependencies, such as time or capital invested. This of course is easier said than done.

12 Call to Action I hope reading this will encourage you, whether you have not yet started with the execution of your idea or your Internet venture is already in full swing. It is deceptively easy to lose sight of your goal once things start to evolve, and it is important to always check if you’re still on course with your business goals and your values. Many great entrepreneurs started out with lots of promise just to end up sabotaging their business later down the road. If you have any questions, comments, or concerns, please email me. I will do my best to get back to you. Here’s to your success! Manuel Stagars [email protected]

Internet Startups Best Practice – © September 2011 Manuel Stagars. All Rights Reserved. http://innovation.bernsteyn.com

13 Guidelines and Books Building successful startups is a controversial subject with a welter of conflicting information. Business and management theory will only go so far, since you eventually have to put your plan into action. As I stated above, learning by doing will often yield the best results. In addition, some interesting books about the topic are listed below with links to Amazon:

Internet Startups Best Practice – © September 2011 Manuel Stagars. All Rights Reserved. http://innovation.bernsteyn.com