Blog & News

The Valley (or peak?)

21 August 2012 | Blog

The other day a very smart, very young, very inexperienced young man walked into our office pitching a business that has gained quite a bit of press recently. The business model is very cool. The technology interface is well thought out. Beyond that, the business is in its infancy and the path to success is as unclear as looking at a 4-month-old baby and predicting with any level of certainty that he’ll play professional football. The business, like many tech start-ups coming out of fashionable silicon valley incubators, is valued at nearly $10 million. Not bad for an idea with no customers. The problem with the venture ecosystem in Silicon Valley is not that it propagates absurd valuations. The problem is that the ecosystem actually causes harm by inflating the self worth of businesses before it’s earned. With so many “super angels” and early stage tech funds chasing any company that gains even a modicum of traction, founders end up with the delusion that their business is actually at a secure state and just in need of a little growth capital to take off.

For the vast majority of businesses in the world (like 99.99999999%) this couldn’t be further from the truth. Most business models in their infancy are actually quite flawed. For example, Groupon was born out of a company called thepoint.com, which was attempting to use the power of collective action to attract users that would eventually attract advertisers. The failure of that site to gain meaningful traction led to the development of Groupon (we wanted to prove that campaigns could gain momentum on the Internet and through the power of collective action amazing results could be achieved, i.e. 50% of local goods and services). In other words, Groupon was a pivot.

We have for many years promoted the concept of fast failure as a means to building innovative business models. The concept is simple. Often you have to iterate your way into a business model that actually works to the extent it’s disruptive, so every early iteration is in fact destined to be a failure. As a result, you might as well fail fast.

Now I’m not suggesting you behave recklessly, but I am suggesting you move quickly, take risks, and be bold. To transform a market, you have to be willing to go against the grain and take chances that are just as likely to result in failure, as they are success. This is the same process an artist goes through when they’re breaking new ground and trying to produce a new work of art. Sometimes the result is a masterpiece, and sometimes the result is junk. But if the artist isn’t willing to produce something that may very well end up in the garbage, the work will never push the artist’s own limitations, and therefore can never truly achieve greatness. Just look at the great breakthrough moments in art over the last 50 years and all were born out of great risk — from Jackson Pollack abandoning the paint brush to Andy Warhol’s use of consumerism to create pop art.

So how does this tie back to venture capital?

There are two kinds of money in early stage technology ventures – money that should be used to find a business and money that should be used to grow a business. Knowing the difference is critical. And having partners that work with you to iterate the permutations of an early stage venture until you find the right model is just as critical. Too often, young entrepreneurs think they’ve found the right model when they haven’t yet and they start throwing tons of money at a company, before its warranted. While you might think this would lead to fast failure, it actually has the opposite effect. The more time and money you invest in a broken model, the more committed you become to it.

This is precisely why raising less money (as opposed to more money) is actually a good thing. People come in our office every day and say “I’m looking for three million dollars to launch the business” and I wonder if they’re building an Internet business or a manufacturing plant. The only purpose of your first round of financing is to build a product and prove that it has value. Your goal, accordingly, should be to build things quick and seek to prove, or disprove, that your ideas are resonating out in the real world. The faster you do this, the more likely you are to stumble into a winning formula.

Most businesses fail for either a lack of capital or a lack of direction. Yet the two are almost always intertwined. Money without direction is useless, and direction without enough money to bring a product to life is equally constraining. But not only are they intertwined, they actually need to co-exist in equilibrium. In other words, throwing too much money at an idea that is not fully baked leads to ruin, as does throwing too little.

So when you’re looking for investors early on, don’t just seek the highest valuation from people who have thrown tons of money at tons of ideas (a few of which have been home runs). Look for partners that understand the innerworkings of your business and can help you iterate your way to the right model. Without it, you’ll just have lots of working capital, without anything working…

-Eric Lefkofsky

“I have had the good fortune during my career to work with many business visionaries, and Eric Lefkofsky stands apart for his grasp of technology-enabled innovation and his insights into industry dynamics -- all of which are captured in Accelerated Disruption. This is essential reading for anyone looking to energize, and ultimately to transform, their business.”

John R. Walter, Retired Chairman, President and CEO, RR Donnelley & Sons Company; Retired President and Chief Operating Officer, AT&T