Q&A on Digital Transformation

In August I presented The Challenges of Executing Lean Startup at Scale, generously hosted by Rangle.io in Toronto, Canada. Rangle is the premier digital transformation consultancy, founded on Lean Startup principles and achieving impressive growth – a really great success story. I spent some time with Nick Van Weerdenburg, Rangle’s CEO, discussing Digital Transformation.

Some of the topics covered in the conversation include:

  • Solving customer problems is more important than rigorously following a process
  • The challenges of being on an agile team while working with or being part of a non-agile organization
  • Successful agile transformation requiring a culture change before a toolset change… most organizations get this backwards
  • How to choose metrics that are meaningful to your business

I hope you enjoy the video:

If you watch the video I would love your feedback! Please leave a comment below telling me what you think I got it right and what you think sounds crazy. 

 

Know Thyself – Startup or Small Business?

There are plenty of good businesses that fail because they are convinced they must be great businesses.

When an entrepreneur asks me for advice for their company, the two most common questions I end up asking are, “what do you want to get out of this?”, and some variation of “do you really want to run a Startup, or would you be happier running a Small Business?” It’s not uncommon for people to make the mistake of thinking these types of companies are basically the same.

What’s the Difference and Why Does it Matter?

When you look at all of the new companies being created, the majority of these are Small Businesses. There are a few reasons for starting these, from following your passion, to having a reliable income, to perhaps creating a family business that will provide work for future generations. These companies are generally funded with family savings, small business loans, or personal loans. In almost all cases, the goal of these businesses is to be cash-flow positive and, if there is company growth, it is usually constrained by actual cash coming into the company, not spending ahead of revenue. As such, a Small Business will have revenue very early after starting, quickly as months or weeks. Owners are typically rewarded by the longevity of the company, a share of the profits, and sometimes a sale of the company.

While you couldn’t tell from a survey of Silicon Valley, but only a very small percentage of new companies are Startups. These are companies that have a vision to discover some radical innovation, in a product, a process, or a service, that has the ability to win a huge market. Since this is an exercise in discovery, the path of a Startup is one of uncertainty and high risk, with 9 out of 10 of these companies failing. The uncertainly means Startups need risk capital (usually multiple infusions) and can take years before they have any revenue. The most common source of funding for these companies is Venture Capital. Proving a repeatable business model and massively scaling business is the goal of Startups. Owners (shareholders) are rewarded by a liquidity event where stock in the company is converted to cash, typically through an acquisition or by having an IPO, and trading stock on the public markets.

The differing goals, and the financing dynamics mean that Startups and Small Businesses operate almost opposite of each other. With cash being a critical resource in a Small Business, business decisions are typically risk adverse. In most cases the better decision will be one that keeps the business at break even rather than risk negative cash flow, even if that decision has a small chance of a huge positive change.

In contrast, since 9 out of 10 Startups fail, that last 1 has to not only deliver economic wins for itself, it has to carry the weight of the 9 others that didn’t (since investors actually want better than market returns over the several-year life of the fund, the real increase in value for a win needs to be closer to 30x). What kind of decisions lead to a 30x return on investment? Not the conservative, sane ones you want protecting the existing value of a Small Business. Investors need big returns and that means they need the company to take big risks.

Crossovers are Rare

Occasionally you will hear about company being run as a Small Business that is super successful has the outsized success of a Startup. More common is the Startup that has crossed-over to being a Small Business… in almost every case the crossover to Small Business represents a failure for investors, where the company established a sustainable business but not one that could generate liquidity. These companies are sometimes referred to as “zombies” by investors… won’t die, but the stock will never turn into cash. For Startups it is way more likely that they fail completely, burning through all cash in high-risk attempts before discovering an actual business. The lucky ones can become acquihires (where a company “acquires” the team as employees, but no real cash is spent). Acquires can be a decent outcome for some of the team, but it a failure for investors.

Know Thyself

And this gets back to my question to many entrepreneurs, “what do you want to get out of this?”

Too often an entrepreneur has shared his company with me and I’ve seen a good business – one that can pretty reliably grow at 10-15% per year, provide jobs for many grateful employees, have lots of happy customers, enable taking decent amounts of cash off the table as it grows, not require 60+ hour weeks to manage. That’s a pretty good outcome, but it is a Small Business, not a Startup.

A lot of entrepreneurs (especially in Silicon Valley), see Startup as the only option.

And, Startups are great, too! They change the world (usually with the intention of making it better), they risk death doing the crazy things that occasionally produce amazing results. And for those very few entrepreneurs that make it through the gauntlet, successfully deliver a revolutionary business, they are rewarded with substantial financial rewards and, occasionally, hero-like status. They’ve created a great business.

My advice to any entrepreneur starting the journey of building a company is understand what you want to get out of the company, from quality of life to financial reward, and understand if you want to build a Startup or a Small Business.

 

I would really like to have more great Small Business stories! If you are part of a Small Business or you know of a great Small Business, please leave a comment!

Avoiding the Perils of A/B Split Testing

A/B testing is widely used in product development, popularized as a fundamental component of the Lean Startup  framework, and providing a scientific way of validating product and business improvements. The concept is simple… put some customers in the new experience, compare the results against customers that didn’t get the new experience, and better metrics validates the improvement. In reality, this process of validation is very complicated and there is no shortage of hazards leading you to poor outcomes.

Creating Information out of Data is Hard

IMVU had a culture of data-validated decisions from almost day one, and as a result we made it easy for anybody to create their own split test and validate the business results of their efforts. It took minutes to implement the split test and compare oh so many metrics between the cohorts. All employees had access to this system and we tested everything, all the time. A paper released in 2009,  Controlled experiments on the web: survey and practical guide, reinforced that split testing was the undisputed arbiter or truth. We were clearly on the right path. 

While the ability to self-assess progress created a very empowering culture, we were largely ill-equipped to understand the nuances of what the data actually meant. Years later we would start to better understand, we don’t know how much we don’t know.

First Know Why

The first opportunity to make a mistake with split testing is deciding to test in the first place. When creating a split test has a very low barrier, it is easy to err on the side of just testing everything so that you can have the data if you need it. But every test has a lot of hidden costs than come from false-positives, clarification of data, shiny-object distractions, inconsistent customer experiences, and additional opportunities for introducing bugs.

Recognizing that being a split test packrat has a real cost, there should be some requirement for incurring this cost. Are very least, answering the question, “What are the significant changes that will be made as a result of this test?” Additional pre-test work to specify what will be measured, and what results will determine success or failure can also go a long way towards ensuring time spent testing is valuable.

Test Implementation is a Project

IMVU had a great framework to make test implementation a seemingly simple task, with a few lines of code of creating a branch for the test experience, and leaving the current experience as the control. Again, this made creating tests seem deceptively easy, and left openings for measuring the wrong thing.

Often a split test is a cross-functional effort, with an engineer handling the implementation and the customer being any combination of a product manager, acquisition team, marketing representative, revenue officer, or generally interested party. In some cases, the interpretation of test data is done by another person altogether. Correctly understanding what the internal customer wants to know, capturing the right data, and converting that data into information ends up with many points of communication that must be accurate to deliver a valid test.

For example, the acquisition team wants to test a new landing page, simply reordering the registration fields because they think it will improve the registration completion rate. The engineer realizing this is a no-brainer takes the 15 minutes before lunch to create the quick test, two paths and the test is running. However, the registration page has both manual registration and sign in with a social network account, so the test is including a lot of users that are social logins, irrelevant to the registration fields. This subtle nuance means that the impact of the registration field changes will likely be lost as the irrelevant data acts as a damper. What the customer wanted to know isn’t what the test is answering, and it’s likely that nobody on the project knows there is an error.

The ease of creating a split test should not be conflated with delivering quality results from a test. Doing it right is a project and requires investment of resources consistent with any other project.

WTF Do These Results Actually Mean?

Assuming you were diligent in your experiment design, you captured all of the relevant data, and you avoided some of the common errors of A/B testing, you now need to make sense of the data. In the best cases, you’re looking at something like “the registration landing page increased conversions from 1.83% to 2.01%”, in the worst cases you find something like “customers are engaging with messaging feature 17% longer… but their lifetime value has dropped by 4%”, and now there is work to put together a narrative that explains the perplexing results.

In 2012 I read a paper, Trustworthy Online Controlled Experiments: Five Puzzling Outcomes Explained, and I had what I like to call an, “oh shit” moment. Highly controlled experiments, run by companies with world-class, dedicated analytics teams were getting perplexing results that required substantial research to understand what was actually happening. What chance did we have of getting this right when we are running 15+ experiments a week with training consisting of a one page internal wiki version of, “A/B Testing for Dummies”?

The tl;dr summary of the paper, without deep consideration for the “why” behind the change in metrics, positive results may be antithetical to what you are actually trying to achieve.

The up-front work to limit the scope of the experiment and how it will be measured / interpreted can help, assuming you have the self control to ignore the data outside of scope. Often these perplexing results require follow-up experiments to better isolate cause and effect. I also highly recommend talking to customers – often qualitative insights from hearing their experiences can often help make sense of what the quantitative results were hiding.

You’re Biased. No, Really, You Are

I’m sure there are a lot of great reasons we humans are wired to think the way we do, and this wiring probably served us very well in many situations. However, humans also come standard with cognitive biases, built-in tendencies to make irrational decisions. Unfortunately, putting a bunch of effort into building something and then getting a giant pile of metrics is a perfect enabler for a cognitive biases and craptastic decisions.

While numerous biases are working against you, with a buffet of metrics one of the most common is the Texas sharpshooter fallacy, in which the all of the test metrics that are improvements over the control metrics are used to demonstrate the success of the test. With a 95% confidence rate, 1 out of 20 metrics tracked are expected to show a false positive improvement, so even an A/A test (two separate cohorts with identical experiences) would likely show “improvements”. Before we eliminated the practice of metric-sniping at IMVU, it wasn’t uncommon to hear somebody say something like, “my pet project to streamline registration didn’t change registration, but it does deliver a 5% improvement in [the completely unrelated] customer lifetime value, so we should keep it.”

There are process controls that can help reduce the potential impact of various biases, in particular around defining and constraining each test. However, being aware of these biases and encouraging a culture consistent with the dialectical method can help make better product decisions, even beyond interpreting test results.

Talk to Your Customers!

One of the biggest risks that come from over-reliance on split testing is seeing it as a more convenient method of getting customer feedback. Why spend 30 minutes on the phone with one customer when you can simply measure the actual actions of thousands of customers?

Looking at data and sending surveys may seem like an efficient use of time, but that highly structured approach is unlikely to surface critical customer insights. Metrics and surveys will often answer the “what”, but almost always miss the “why”, the most critical driver of valuable insights. There is no substitute for talking to your customers.

In the words of Steve Blank, “Get Out of the Building.”

 

I’m interested in hearing other stories where split testing has made an impact, either positive or negative. Please share a comment if you have one!

Your Agency is Hurting Your Chance of VC Funding

Early-stage venture capital firms have high deal flow and very little time to assess each company, so understanding key assessment criteria will help you get your deck from the “no” bucket to the partner discussion. A common reason many companies fail to get past “no” is they are agencies.

Is Your Company an Agency?

In an agency, value created by the company is unique to each customer. As a result, the company revenue reflects more of a work for hire relationship. The problem with this model is, while an agency can still be a very good (or even great) business, it is hard to scale and typically doesn’t improve margins when it does scale.

When asked, entrepreneurs don’t always recognize that their business model is an agency… they may see the unique customer work provided as building support in the underlying platform, or a way to help onboard early customers. While all possible, it’s unlikely, and VCs that have looked under the hood of hundreds of companies will understand the signals indicating this is an agency:

  • A majority of revenue comes from additional work provided, not from the product / service
  • Work performed is applicable to a specific customer (e.g. content creation, integration, customization)
  • Customers largely came from relationships, not from a repeatable sales process
  • The company is pivoting from a consulting business

What if My Company is an Agency?

So, what do you do if your business looks like an agency? Well, it depends on what you want for your company. If you’re happy with a potentially good (or even great) business that may grow at a reasonable rate, be a source of employment for a bunch of people, and maybe never have an exit, skip the VC and run your business (of course, you have to run cash positive or get loans to get you there). And, the lack of an exit doesn’t preclude a payout… I’ve met several owners of “lifestyle businesses” that, on top of a good salary, pull substantial amounts of money out of their company.

If you do want to go the VC route and have a VC-sized exit, you’re going to either prove your business is the exception (unlikely), or make some fundamental changes to your business to achieve some combination of the following:

  • A consistent shift in revenue away from unique customer work and towards your product or service
  • A convincing process showing the unique work for each customer is scalable (i.e. not limited on the supply side)
  • Margins improving with growth   

Pivoting to a new business model is usually easier written than done. And, if your agency model is working for you, a pivot away from a working business model can be risky. The again, if you’re the type of entrepreneur that is excited by building VC-backed businesses, you probably eat risk for breakfast.

 

 

Less Minimal, More Viable – Creating Better MVPs

I had the exceptional luck to work with Eric Ries at both the company that was his inspiration for The Lean Startup, as well as the company that was his catalyst for the change needed to build companies differently (and I hope someday I can convince Eric to release his insightful yet unpublished manuscript “The Bloated Startup” – maybe your tweets can help #EricPleasePublishTheBloatedStartup).

One of the fundamental ideas from The Lean Startup embraced by startups is the Minimum Viable Product (MVP), a product strategy that minimizes investment while maximizing learning and market validation. And while MVP is a great and seemingly simple concept, many startups fail to execute it successfully.

There was a time not too long ago when startups regularly burned many millions of dollars in years of stealth mode, building massive projects anticipating the use cases for all of their future customers, and the concept of releasing anything that wasn’t robust being heresy. A combination of those companies spectacularly imploding, investor expectations that companies achieve validation faster,  and the embrace of accepting failure while chanting the mantra “fail fast”, made the pendulum swing the other way.

The most common criticism of MVP is too often it is actually Mvp, where minimal is emphasized and viable is highly subjective, but leans towards not viable. It’s not that MVP is a bad concept, it’s simply difficult in practice. As a result, others have looked to redefine MVP – Jason Cohen proposed the SLC (Simple, Lovable and Complete), and Laurence McCahill proposed the MLP (Minimum Loveable Product), both emphasizing the importance of delighting customers to being “viable”, and reducing the opportunity to simply ship a broken experience to customers using “learning” as an excuse.

Rather that create another TLA, I’m offering guidance to make the implementation of MVPs more effective:

  1. The MVP Delivers Your Value Proposition
  2. The MVP is a Functional Product
  3. The MVP Provides Validation or Valuable, Intentional Learning

Let’s dig into each of these a little more..

The MVP Delivers Your Value Proposition

The MVP must deliver the customer value proposition for a subset of customers that will be early adopters. Delivering on your value proposition may seem obvious, but in the interest of trying to achieve the minimum investment, it can be overlooked.

Core to IMVU’s value proposition was connecting people through expressive avatars, which was initially delivered via a 3D client on the PC. IMVU had an early mobile product that connected customers by enabling messaging from their phone, and while we called it a mobile MVP, it wasn’t. Specifically, the messaging was text-based, so it didn’t deliver on avatars or expressive communication. Since it didn’t include avatars, it also didn’t test the business model, which involved selling items to stylize an avatar. Many existing customers liked the functionality provided, enabling them to perform some basic functions while not at a PC, but nobody would become a new customer on this product – is was simply a helpful add-on.

Later IMVU built a real mobile MVP, starting with the very basic set of functionality that enabled expression via your avatar, and the ability to purchase items for customization (also important to expression). Knowing the PC offering, the mobile MVP felt pretty bare bones, didn’t include 3D (something we knew customers wanted), but the customized avatar was present, enabling self expression. We gained new customers that only knew of IMVU as a mobile experience, and we validated that the business model worked. Eventually full 3D was added with a lot of other features that did an even better job at reinforcing the value proposition, but it was a pretty humble beginning.

The MVP is a Functional Product

The need to be minimal yet completely functional is where great product design comes in, recognizing that the best products are fully functional without being complex – simplicity delights customers.

The test I’m proposing is, without adding additional functionality, does your MVP continue to deliver value to your early adopters? Asking another way, can you imagine walking away from the MVP and seeing your early adopters still using it in 24 months?

When it comes to applying MVP to new product functionality for an established product, this simple but complete requirement is even more critical. I witnessed many MVP projects that shipped in half-done limbo as some customers liked it sort of, but it was broken, but not valuable enough to finish… the result is many rough edges and missed opportunities to delight customers.

The MVP Provides Validation or Valuable, Intentional Learning

One of the most disappointing results to hear from a failed MVP is, “we learned it didn’t work”. Aside from the obvious desire for projects to be successful and delight customers, this result represents a failure to intentionally learn. A great indicator this is happening is a product manager presenting data harvested after the fact, hand picking metrics that were not identified before the product was built, creating learning theater.

The MVP should reduce uncertainty, either by validating previous decisions or providing information necessary to make specific future decisions.

When building the MVP, there should be a clear hypothesis, identification of the metrics that will be used to gauge progress, the ability to capture those metrics, and an understanding of the critical decisions that will be influenced by the results. In addition to creating a discipline around honest assessment of progress, these requirements guide the team’s product development decisions.

 

Have you learned something valuable from building a MVP? I’d love to hear your story! Please leave a reply in the comment section.

Congratulations Successful Entrepreneur: You’re Fired

Most startup entrepreneurs understand that the odds of success are not in their favor… only about 1 in 10 startups will survive. Of course, most startup entrepreneurs don’t believe they fall into the 9 out of 10… a healthy amount of self delusion is required to go down down the startup path in the first place. But there is that 1 in 10 that does make it… and, if you are lucky enough to be the CEO that delivers that success story, the odds are you’ll be fired.

Before explaining why being fired is the most likely outcome for a startup CEO, it’s necessary to explain the startup journey…

Your Mission as a Startup

Investment-backed startups are created to discover scalable businesses, usually by inventing a new product or service that can become a large business, or by creating substantial efficiencies that take customers away from an existing large business. There is no clear, obvious path to doing either of these, otherwise success would be the expectation, not the exception. So success requires reasonable self delusion that you will succeed, as well as experimentation / rapid iteration necessary to adjust to the challenges of discovering the successful business. In practice, this can often manifest itself as the CEO coming in with the crazy idea of the day saying, “let’s try this… can we ship it by tonight?” If you like the excitement that comes from working through challenges with great uncertainty, this process can be a rewarding experience.

Through this process of discovery, a few things can happen. If the company runs out of money before a scalable business is discovered, most likely everybody loses their job, although it is possible that the board still believes in the company but sees execution or leadership as the problem, fires the CEO, and then puts in new money to support a new leader. From the CEO perspective all of these paths lead to the same place… you’re effectively fired.

But wait, Brett… those are failure scenarios… I’m that 1 in 10! I discovered product market fit! I delivered on my mission! I found the scalable business!

You’re probably fired anyway.

It’s Not Us, It’s You

You’ve done something truly amazing… you’ve lead people down a crazy path, likely engaged in some mixture of know-how, magic, luck, skill, and insanity, and came out the other side with a scalable business. It takes a particular type of person to do that successfully.

Unfortunately, that particular type of person is usually the exact opposite of the particular type of person you want growing a scalable business. Growing a scalable business is more about efficiencies and optimization, much less about discovery. That same crazy idea of the day behavior that miraculously lead to discovering the scalable business is exactly what derails the consistency a company’s organizations need, and what customers will expect. As the organization grows, process and management becomes necessary to handle the challenges that come with simply trying to get hundreds of people to work towards the same goal. The needs of operating a scalable business probably contributed to the CEO quitting their previous job and creating the startup in the first place.

The board has a responsibility to driving shareholder value (including their own investment) and, seeing how maximizing the value of the business now requires a different expertise, likely determines that it’s time to get somebody best for that job. It’s possible that the startup CEO has the rare set of skills to transition, or it’s possible that the board will bring in supporting executives to help. In these cases the same end result is usually just delayed.

Of course, getting fired doesn’t happen every time… you can look at examples like Mark Zuckerberg, Drew Houston, Jeff Bezos, and Steve Jobs and, using that healthy amount of self delusion, say “I’ll be like them” (forgetting, of course, the first run of Steve Jobs at Apple). But if you look at all of the companies in the valley that scaled successfully, you’ll find most had the founding CEO “step aside”.

Yikes! How Do I Prevent This?

Your gut response as a startup entrepreneur is likely something like, “I’m going to make sure that doesn’t happen to me.” However, I encourage looking at it a different way… this happens, you’re probably going to be replaced, and that’s probably okay. It’s better to prepare for the possibility rather than assume it can’t happen. You may find being replaced is actually be the desired outcome if you prefer building new things rather than optimizing existing ones.

The most reliable way to avoid being replaced is by not giving the board (or anybody else) the power to replace you. In practice this is usually only possible if you don’t take outside investment… venture capital investors will usually take board seats and almost always retain the ability to replace the CEO. The tradeoff you make for getting extra cash to accelerate your progress comes with the price of forfeiting some control.

Assuming you’re taking investment, the best path is likely making accommodations for a transition as part of that investment. Address things like an ongoing role post-handoff (operational and board), vesting of stock, participation in success rewards, and your treatment for liquidity events (acquisition, IPO, secondary offerings). Also account for variations to the plan… while you may want to maintain a significant operating role after a transition, it may be determined that the new CEO can’t be successful while employees still look to their founding CEO hero for direction.

Finally, if you do get to the point where you are being fired after successfully delivering on your mission, make sure you recognize your truly amazing accomplishments… you knowingly engaged in a difficult challenge, with all odds against you, and you were a success. Many people, employees and customers, will be better off because of what you built.

Congratulations.

 

This posting was greatly inspired by over 20 years of stories from many friends that have been founding CEOs, and by Steve Blank’s great presentation, Why Accountants Don’t Run Startups.

 

Have you been a startup CEO and been through this journey? I’d love to hear your story! Please leave a comment.

Joining Social Starts as a Venture Partner

My short-lived backpacking career is in jeopardy… I’m a Venture Partner at Social Starts.

Why a Venture Partner Role

Most recently I spent several years growing a company from startup to millions of customers. In each role of the company, from technical executive to CEO, I needed to spend time deeply understanding the technology and markets related to the business (social, expressive communication, VR, avatars, communities, virtual goods, scalability, digital currency, and virtual economies). While being able to get a deep understanding of subject matters was great, it left little time to explore the breadth of ideas powering innovation, and I missed that.

So, one of the ways I’ve spent my down time over the last few months is getting exposure to a wide range of companies doing things I’ve never done before. In addition to some advisory work for startups, I went to a few sources of amazing entrepreneurs with great ideas. Steve Blank generously invited me to sit in on his Lean Launchpad class at UC Berkeley’s Haas School of Business, where entrepreneurs formed and iterated businesses around IoT, energy management, and medical devices. I also spent some time at Obvious Ventures getting exposure to some really impressive companies in areas ranging from consumer packaged goods to gene therapy and wellness.

I found I really enjoyed the exposure to new companies, especially those outside of my fields of expertise… seeing how people are applying new technology towards opportunities drove my natural curiosity to research topics that were new to me.

I also found satisfaction in my advisory work, helping startups by sharing what I’ve learned, both from my successes, and my failures. Surprisingly, many companies deal with the same patterns of challenges – it’s great to help people get past those so they can move on to newer, more exciting challenges unique to their situation (I wish I could write “eliminating challenges”, but businesses just move from challenge to challenge… you’re fortunate when you’re working on the challenges with possible outcomes ranging from “good” to “great”).

When the opportunity came up to research and help fund all sorts of great startups while providing me with the flexibility to work more deeply with a few companies, I knew this role was right for me.

Why Social Starts

There are many reasons I joined Social Starts, and two factors that most greatly influenced my decision are the team and the deal flow.

In regards to deal flow, Social Starts focuses on very early stage funding, from moment of inception to Series A. The closer you are to the top of the funding funnel, the larger the pool of companies to consider. And, Social Starts considers a lot of companies… it’s been named the top fund under $100M since 2013, the 5th most active early stage fund worldwide of any size in 2015, and the 6th most active early stage fund in US tech in 2016.

For any organization I would join, it’s a requirement that I respect and appreciate the team. In my discussions with partners, I experienced many characteristics I value, including candor, humility, thoughtfulness, and pragmatism. As a bonus, the COO is a friend that is on my short list of “people I would work with at any company, any time”.

Let’s Work Together!

If you’re working at an early stage company in fields like VR / AR, health care technology, AI, work platforms, internet of things software, mobile commerce, blockchain, security, content, wellness, analytics, or human-brain interface, I’d love to hear more about your company.

I also have some availability for advisory / consulting roles for companies that need somebody with executive-level experience successfully scaling startups, helping execute through the challenges that come with growth.

Fairness in Employee Intellectual Property Rights

Silicon Valley is still in the Jurassic age when it comes to employee intellectual property rights.  It’s not that Silicon Valley has lagged behind others in this regard, but there has been no innovative leadership while there is ample opportunity to set an example for fair employee policies.

Before I was the CEO of IMVU, I was SVP Engineering, and in 2011 I drove an initiative to change the company’s policy regarding the ownership of employee side projects. At the time my basic argument was we were actively looking to hire employees that are builders, creators, tinkerers and then had a policy (like every other company) that oppresses the same qualities we actively sought.  The new policy created a path for employees to have guaranteed ownership of their side projects and be protected against any future claims from the company.  I detailed the outcome in my article IMVU’s Employee-Friendly Policy on Side Projects.  My hope was other companies would embrace and improve on this first step.

6 Years of Progress!

In the 6 years that followed,  there has been a massive wave of companies acknowledging that some of the best employees they can recruit are passionate builders that actively contribute to open source and hack on pet projects to feed their creativity and passion for learning new skills.  These same companies have changed their culture and employment agreements to support these employees by recognizing that traditional intellectual property assignment agreements are over-reaching.  Actually, none of that happened.

For the most part, the state of employment agreements and employee intellectual property rights hasn’t changed.  Many companies still have policies with far-reaching claims on anything the employee creates, at any time, even if not directly related to the business and whether or not company resources were utilized.  It doesn’t matter that some of these claims are not enforceable (in particular, California has much more employee-friendly laws), many employees would simply give up rather than incur the legal costs to defend their rights.

The result of the continued inconsistency between company policies and employee behavior is an awkward cultural and legal situation, where employees have side projects and sometimes kind of keep them secret and the company sort of doesn’t acknowledge the side work when it knows about it… a wink wink, nudge nudge arrangement until it isn’t, and the company decides it owns the employee’s thoughts.

I’ll take a moment to call out (and praise) a recent exception… GitHub recently introduced a policy to let employees keep their intellectual property.  GitHub’s policy is called Balanced Employee IP Agreement (BEIPA) and recognizes that the employee has rights to projects that are not related to the company business, and also that “free time” and “company time” is fuzzy (the policy doesn’t explicitly state that employees can use company resources, but it also doesn’t claim rights either).

The Challenge of Change

As I went through the process of changing an industry-standard policy, I gained a much better understanding of the challenges. Ultimately the challenge of innovation in these policies comes down to no perceived upside for the company with fear of embarrassing failures from the innovation

Standard Employee Agreements (which include assignment of intellectual property) are heavily weighted in favor of the employer and, since they are pretty much the same at every company, there is no competitive market and little reason to change. The company’s fear of losing out on an amazing invention can also come into play, with concerns that the company will forfeit rights to what could have been a game-changing development (who wants to be the idiot that let go of the billion dollar idea?). And finally, lawyers… corporate counsel provides tried-and-true boilerplate Employee Agreements, and the same corporate counsel that reviews the policy change is typically risk-averse, seeing rights-releasing changes as mostly downside with unknown benefits.

I found that most of the challenges in changing this policy were key stakeholders taking a “why we can’t” approach instead of a “how can we” attitude.  Now having 6 years of experience with the policy, I can unequivocally state that it resulted in no downside for the company and only goodwill for the employees.

Getting to Fair Employee IP Rights

I believe the first critical step in getting to fair employee intellectual property rights is bringing awareness that change is desired and possible.  Without a push from employees, it’s too easy for employers to just keep doing things the way they’ve always been done.

If you are an employee that would value a more equitable arrangement around intellectual property rights, let your employer know!  As a starting point for what is possible, point them to the improvements made at IMVU or GitHub.  Make an offer to your employer to promote the company’s leadership in this area and use it as a recruiting tool for creative talent.  If you are interviewing with a company, ask about employee IP rights – if this becomes a common topic from candidates, HR (recruiting) will see the value in making a fair policy be a benefit.

We’re seeing progress in other areas that have similar challenges around change… I am excited that some Silicon Valley companies are establishing or updating their policies to consider employee fairness around stock option plans that actually help employees keep the rewards from their contributions.  As these companies intentionally make the choice to not just do the same thing every company has done before, I encourage them to use that same open-minded process to examine their employment agreements and create policies that are fair to the employees they strive to attract.

This guy wrote your boilerplate IP Agreement

As a leader in a company, consider whether the policy you have today was intentional, reflecting the culture and values of what you are trying to build, or if the policy is just a generic hand-me-down from the corporate dinosaurs of the past. If you experience too many challenges around making sweeping changes, at least make incremental changes and try to use them as a differentiator for your company (really, go on Quora or Hacker News – potential employees looking for companies with fair IP policies are left with almost no good examples… your company could stand out).

As more companies show that employee fairness is a differentiator that attracts and retains great talent, it will push others to do improve their policies to be competitive.

 

Know of other companies that have great Employee IP rights?  Think Brett is crazy and giving away all of a company’s value?  Leave a comment!

More Things You Don’t Know About Stock Options

I’ve generally found that every time I have dealt with stock options I’ve learned something new, and usually in somewhat painful ways.  It’s one of the few areas where I actually hope I’ll someday understand every aspect and stop learning, but changes to how options are handled and complicated (and changing) tax laws promise to make stock options a topic that will never be mastered.

In my most recent experiences, I learned a few things that I don’t seem to be common knowledge, even by many people that have been in the stock option rodeo for a long time.

Companies Can Outlive Their Stock Plans

The stock options granted to employees, directors, advisors, or other parties are done so pursuant to a stock plan that is typically created around the time of incorporation.  When one receives an option grant, the grant will reference the stock plan and a copy of the plan should be made available to the recipient of the grant.  These stock plans have a lifetime, with 10 years being pretty common, and the ability to exercise options typically expires with the stock plan.

And for what I’m guessing is more than 99% of Silicon Valley companies, the 10 year life of the stock plan is irrelevant because, within 10 years the company most likely fails or has a major restructuring of the cap table (making the options worthless), gets acquired, or goes public (resulting in some conversion or liquidity of the options).  In almost every case the stock options either get flushed down the toilet or become liquid within 10 years.  But, there is a less common scenario… a company substantially increases in value and remains private and independent, celebrating 10 years and outliving the initial stock plan.

In this situation, most people granted options under the original stock plan need to exercise or forfeit their stock (there is typically a way to handle current employees as a new plan is adopted).  And, that’s the big gotcha.  When granted stock options, a lot of people will chose to not exercise their options until there is a liquidity event, so they don’t risk any up-front expense and only purchase when they can immediately sell the stock for the gains (this strategy eliminates up-front risk, trading for a less favorable tax liability later, assuming the company doesn’t fail).

So let’s put some numbers behind this… Ned joins the advisory board of a startup company during the seed round and gets 100,000 options valued at $0.01 (one cent) each, so Ned can purchase these 100,000 shares for a total of $1,000, but doesn’t do so at the time of the grant.  Against all odds, the startup does well, survives 10 years without a liquidity event and the shares are now worth $1.25 each – 125x return!  Ned gets a call and is told that the stock plan is about to expire and he must exercise his options or lose the grant.  The good news is, $1000 to get $125,000 in stock is a pretty good deal.  However, that purchase is going to be a taxable short-term gain of $124,000 (10% – 39.6%, depending on Ned’s total taxable income, so up to $49,104 to be paid in taxes).  But, the company is still private so there is not necessarily a market where Ned can get liquidity, so in rough numbers Ned just spent $50,000 in cash to buy $125,000 in stock that can’t be sold – that doesn’t sound all that bad, but there are a lot of factors that prevent it from being an easy decision.  Another big rub for many is, instead of the company getting the money from the stock purchase, it goes to the government.

While there are plenty of stock option scenarios that present a similar dilemma,  the stock plan end-of-life scenario is unique in the lack of flexibility – even if the company and grant holder want to find a solution, there isn’t a clean way to update paperwork or give extensions for exercising at the end of the stock plan’s life.

There is a very easy way to avoid this early on… if Ned exercised when he received the grant, he would have paid $1,000, the fair market value for the stock, with no tax consequence, and 10 years later he would already own that stock, now worth $125,000 (but still not liquid).

My best advice (worth everything you just paid for it, so consult a lawyer or tax expert before following it) is to exercise as early as possible, especially in a startup where the stock barely has value.  Your time is the most valuable thing you have, so if you’re willing to bet on the startup by investing your time, you should be willing to bet some cash, too.

Most Job Seekers Don’t do the Math

At this point in my life I’ve overseen more than a thousand job offers, and one aspect that surprises me is how frequently prospective employees don’t ask for the information necessary to understand the value of the stock options offered as part of their compensation package (sometimes as a very material component of that package).  I’ve had conversations where job seekers told me another company offered them twice as many options as I was offering (seeking more from my offer), but they didn’t know the total options in either company or recent valuations, so they didn’t understand the percentage of ownership (if you’re offered 1 share of Berkshire Hathaway or 1000 shares of Apple, you’ll make $117,000 more taking the Berkshire Hathaway).  Seeing so many people not doing this math has lead me to joke that my next company will start with one trillion shares of stock so that I can offer more stock than every other company.

Employees not understanding this component of their compensation creates an interesting challenge for an employer… I believe companies should help employees understand the value of stock options and the various nuances of how options work.  However, I also believe that it wastes a limited resource to provide stock options when an employee doesn’t value them.  I like everybody to have a stake in the outcome of the company, but options should be weighted so they are the most valuable to the recipient, and other forms of compensation should be used when options are not valued.

If you’re interested in the details about understanding stock option compensation and what questions to ask when comparing offers, there are some detailed guides I reference below.

Small Business Stock Capital Gains Exclusion

Another (very pleasant) surprise I learned about was Section 1202,  which excludes from gross income at least 50% of the gain recognized on the sale or exchange of qualified small business stock (QSBS) that is held more than five years.  The latest amendment to Section 1202 provides for 100% of any capital gain (up to $10 million) to be excluded if the small business stock was acquired after September 27, 2010.

Section 1202 is surprisingly not well known – four Bay Area tax advisors I contacted were unaware of it when I referenced it.  Fortunately it was mentioned in Piaw Na’s book, An Engineer’s Guide to Silicon Valley Startups, where the talented and helpful Chad Austin discovered it and shared the knowledge.

I won’t go into details, but if you sell startup stock that you held for 5 years, this can be a material tax savings for you.  This is yet another reason to exercise early, since you need to hold the stock, not the options.

Great Resources for Learning About Stock Options

If you’re looking for a comprehensive overview of stock options – I suggest the very excellent Introduction to Stock & Options by David Weekly, or the also very excellent The Open Guide to Equity Compensation by Joshua Levy and Joe Wallin.

 

 

Did I get it wrong?  Is there another stock option gotcha that I missed?  Please leave a comment!

In Defense of Not Doing a Startup

Recently (and quite accidentally) I talked an entrepreneur into abandoning his year-old startup.  That wasn’t my intention – we had planned an hour long meeting where I was acting in an advisory role on the product and pitch deck, but the meeting ended up taking over three hours and getting to a very hard question, “why do you want to do this?”

The pivotal moment in our discussion was when it became clear to me that the CEO saw the company as a way of obtaining some short term financial success, and that the startup demands were unlikely to be compatible with what he expressed and being important to him for his personal success.  After walking through the various likely outcomes and startup life expectations, he recognized there were better ways to achieve the personal success he wanted.  The discussion was tough – it’s hard to confront letting go of a dream, especially after sacrificing a year of sweat equity, but as we concluded our discussion he shared that he felt a great sense of relief.

All Hail the Startup

In most of the news and feeds I follow the startup is celebrated, almost so much that it can feel like the act of creating or being a startup is disproportionately more important than the significance of achieving a successful business.  More importantly, the glorification of startup life can lead people to feel discontent with a career path that may actually be far better for delivering personal satisfaction.

Startup Cheerleaders

For the most part we recognize and celebrate successful startups, and with the exception of the startups that have a prominent rise and fall, the majority of startups that exist, struggle and fail are below the radar.  It’s pretty easy to read industry news and think everybody with a startup is on the fast track to a win.

There are also several blogs and speakers working as cheerleaders for those that would take the risks to change the world.  Most respected in this group are serial entrepreneurs that have had the good fortune to have a successful exit from a previous startup, which becomes a shining example that success is possible, and the reason they continue the startup path.  These thought leaders are great for inspiration, but it is also good to have the context that the previously-successful entrepreneur risk is substantially different than the new entrepreneur, both in terms of their chance of success on their next startup, and the likelihood that they are risking a small fraction of their wealth.  If you are new to starting a company, you are likely “all in”.

A Startup is Not a Reliable Path to Wealth

It is easy to look around at the stories of the startup millionaires (or even better, billionaires) and think that starting a company is a good way to ensure a retirement in your twenties.  If the ability to retire is your goal, you’re probably better off working at established companies.  If your goal is to retire with a billion dollars then yes, a startup (or lottery ticket) provides that opportunity, with very slim odds.  Looking at my contact list, almost all of the people that are financially well-off got that way by joining companies well past the startup phase.  However, my very few contacts with obscene amounts of f-you money did obtain it from being very early at companies with large liquidity events.

As an example, one friend easily ranks in the top 5 engineers I’ve encountered in my career and any company would want him as the technical founder.  After four years of doing the startup grind of 60-hour weeks, he ended up with a lot of great experience and a bunch of stock that was worth pennies.  He made the decision to join a very large, more well-established company and forgo the dream of vast riches for continued technical growth and reasonable work-life balance.  What he didn’t understand at the time, but told me later, was how much a big company would pay for good technical talent.  For people of his caliber the total compensation is well over a million dollars a year and as a result he has a reliable path to retirement in his early forties.  His story isn’t the glamorized Silicon Valley success… you won’t see him featured in a PR-driven TechCrunch article, but you might see him enjoying life on a beach with his family.

In contrast, another friend lived the entrepreneurial startup life for 15 years, is well-known and highly regarded in the startup community (yes, you know his name), and most people assume he’s achieved financial success as a result.  Two years ago he had a company that came very close to being favorably acquired, but the acquisition fell through.  The company was later dissolved and over a dinner one evening he expressed the frustration of being in his mid-thirties, driving a 15-year old car and not being able to afford a house.  He has since joined a large Internet company, owns a house and is even able to comfortably support two children and some relatively expensive hobbies.

But wait, Brett… so you have a few friends that did better taking a traditional career path, but I see all of these Silicon Valley 20-something millionaires all over the Interwebs… what makes you think that won’t be me?

It might be you, and I am sincerely happy for anybody that is able to achieve financial success by building a company.  Let’s look at the (extremely general and simplified) math to see expected outcomes…

Some Quick Startup Lottery Math

To make things simple, we’ll assume your startup is just you and a single co-founder, so you each have 50% of a company.  And using this Quora response as reference for founder equity, after completing your Series B, you and your founder share 40%, making your ownership 20%.  The average price of successful liquidity is hard to assess (many sources suffer from survivorship bias, excluding many failed startups) but $30M at Series B would probably be considered generous (there are many examples way higher, far more examples way lower).  A $6M piece of that pie is pretty appealing.  Now we adjust for the risk… again, 90% startup failure rate is generous, especially considering Y Combinator companies representing the hand-picked cream of the crop fail at 93%.  Risk adjusted, you’re now looking at $600K as your upside, so assuming you’re able to go from zero to liquidity in three years, it’s $200K per year (of course this is on top of your well-below-market startup salary).  That doesn’t sound too bad except when you remember, you have a 90% chance of ending-up with only your well-below-market startup salary and your chair.  Again, these are generous assumptions and there are plenty of examples of successful acquisitions in the hundreds of millions where founders received substantially smaller percentages of the purchase price.

Google Director Salaries

And let’s compare that to the alternative, joining a large Silicon Valley company…  It’s fuzzy math, but I’m going to assume that the person that is capable of leading a startup with the generous odds in their favor also has the experience to get a good leadership role at one of the big companies.  According to Glassdoor, the average Director at Google has a base salary of $247K and total compensation of $399K (on a side note, most colleagues I talked to believe the Glassdoor compensation is extremely inaccurate based on first-hand observations, and Directors are frequently making 2-4x what is presented).  Using the same 3-year time frame we assumed would get to liquidity at the startup, the expected outcome is closer to $1.2M.  There are a ton of arguments to adjust these assumptions, but none are going to change the lottery-ticket nature of achieving big liquidity from a startup.

So yeah, the odds of financial success may be working against me, but what about getting to experience the glamorous life of a startup founder out to change the world?

Startups Overshadow your Personal Life

For everybody that asks me what it is like to run a startup, I tell them to read The Struggle, by Ben Horowitz.  I first read The Struggle as part of Ben’s book, The Hard Thing About Hard Things, and I immediately handed the chapter to my wife and said, “you always ask what it’s like to run a company… it’s this!”

A day in the life of a startup founder

A startup is a significant commitment and your business is typically dealing with an environment of extreme uncertainty; startups are either creating something new or believe they can do something better than an established business.  In this environment, and typically with limited resources, working longer and harder provides more opportunities to eliminate the uncertainty.  Assume working nights and weekends are sort of a regular necessity.

And as a leader in a startup, you will always have another challenge or problem driving head-on towards you.  The world owes you nothing, plenty of other companies are fighting hard to take the market that you need to succeed, and the odds of survival are very much not in your favor.  This means business will almost always be imposing on your mind share that you would normally dedicate to things like dinner, sleep, exercising, vacation, relationships, family time, and bathing (assuming you are able to work any of these into your startup life).  Your startup will permeate all aspects of your life.

Finally, there is the emotional toll of a startup.  The successes feel amazing, but they are typically few and far between the challenges and setbacks.  Failure is the expected outcome, and each failure wears you down a little bit, creating uncertainty and making you second guess your capabilities and fitness as a startup leader.  You feel the weight not just for yourself, but for the people that follow you, also making the sacrifices.  And, if you’re unlucky enough to be the CEO, you’re in the lonely position where there is almost nobody you can share your struggles with… you can’t push things down into the company and frequently the board above you is a bad choice as a counselor for issues of personal uncertainty.    

After writing all of this out, I am beginning to understand how I accidentally talked somebody out of their startup.

But… There are Many Great Reasons

I don’t hate startups.  All of my career I have either created startups or joined them at or near founding, and I expect to do it again.  I would hate to feel responsible for taking passionate entrepreneurs and shuffling them into beige and gray office spaces in corporate America.  If you understand the likely financial outcome, and you are in a place where your personal life can sustain the needs of a startup, and you are emotionally prepared for the struggle, there are great reasons to do a startup.

If you are early in your career, the economics and life impact may make more sense.  Your ability to get a job at one of the big name companies may be more difficult, and if you do you’re probably looking at the lower end of the salary spectrum.  The difference between your startup pay may not be that significant in your day-to-day life (especially if you are fine eating rats and ramen).

Startups are also a great way to learn before you earn.  Large companies have established processes and roles that have been optimized for business performance, you are less likely to get a breadth of experience or have an emphasis on innovation.  Startups frequently require everybody to have multiple roles and find innovative solutions to problems.  Learning how to deliver results with limited resources in environments with great uncertainty is a skill that will be valuable for a lifetime.

Working at a startup (even a failed one) can also often allow faster career progression than just joining a big company out of college and following the typical path of advancement.  As an example, a Software Engineer (SWE) hired right out of school at Google would be an L3.  Assuming about 3 years for each promotion, it’s 15 years until Director, L8.  If you’ve proven yourself and established solid startup experience, five years later you might be L6 material (your mileage might vary).

The Best Reason

I believe the best reason for doing a startup in the burning need to build something you are passionate about, and an organization like an established company or non-profit isn’t the best way to create it.  Maybe your passion is a product or maybe it’s a culture, but it keeps you up at night and every time you return to the idea you become more passionate about making it real.  It’s an idea you think it would be so meaningful that you would find the journey of pursuing it to be hugely rewarding.  You’re not thinking about the exit, you’re thinking about the satisfaction that comes from building the thing that drives your passion.

Do it.  Build it.  Make it happen.

 

Feedback, complaints or suggestions?  Please leave a comment!