ADDRESS YOUR BIGGEST RISKS EARLY
Venture capitalists call it the Valley of Death, the period after a founder has begun to spend capital but has yet to find a steady stream of revenues. A large percentage of new business attempts never make it through this first phase, which is why startups are known to be hazardous and the word “entrepreneur” conjures an image of a daring, swashbuckling gambler. But, as Matthew J. Eyring and Clark G. Gilbert note in the May 2010 issue of Harvard Business Review, the stereotype of the risk-loving entrepreneur is a myth, at least among those who are highly successful. Effective entrepreneurs recognize that some level of risk comes with the new venture territory and is necessary to create value, but they are not the bold risk-takers that they are made out to be. They are, instead, in the authors’ words, “relentless managers of risk.” They understand that not all risks are created equal, so they identify and prioritize threats that pose the greatest danger to their venture. Gilbert and Eyring call these “dealkiller risks,” and wise founders find ways to creatively address these early in the startup process.
Gilbert and Eyring observe that “when risks are overlooked, fewer than 15 percent of firms are still in operation three years after initial funding.”4 An important strategy for lengthening your venture runway is to identify, very early in your planning process, deal-killer risks that might stop you in your tracks. These risks usually correspond to fundamental assumptions and uncertainties that must play out in your favor for your concept to succeed—an expectation of strong market demand, for example, or the availability of key expertise, favorable regulatory changes, or well-functioning technology. Once you have identified the handful of key uncertainties to be addressed, you can then work to reduce the likelihood of their occurring and build contingency plans to deal with them if and when they do occur.
Here are some examples of how successful entrepreneurs have addressed early-stage risks to clear their runway of potentially venture - killing obstacles.
■ Market Risk. For enthusiastic founders, the most fundamental assumption of all is that an abundance of paying customers will be waiting to buy your product or service as soon as it is released. These expectations are often too rosy, which means that the existence of adequate market demand is almost always a pivotal area of uncertainty for the new venture. You can mitigate this risk through piloting, prototyping, and related approaches, as outlined in Chapters Four and Six.
A powerful approach for radically reducing market risk is to sell your product before you build it. Starting with $1,000 in funds in 1984, Michael Dell, founder of Dell Computer,
Launched a build-to-order computer business from his University of Texas dorm room at age 19. To avoid the cost and risks associated with holding an inventory of components and finished products, Dell got his orders from customers up front, and then he secured necessary components to create each customized computer. This approach brought advantages from a cash flow perspective, but its most fundamental value was that it directly tied his incremental investment of resources to the presence of validated customer demand, effectively eliminating market risk from the startup equation.5
■ Relationship Risk. In 2006 and 2007, Mark Williams and his Modality co-founders were developing a technology for delivering content to the Apple iPod that they felt was compatible and secure within the iPod’s architecture. Overcoming this technical barrier required them to continue to iterate their software solution, called Modality Manager, but also required Mark to convince key technologists and senior leaders within Apple that Modality’s solution was safe and effective. As he wrote in a planning brief in January of 2007, “Currently, Apple developers are uncomfortable with the Modality Manager solution because of potential to cause problems for consumers as the iPod platform evolves.”
The stakes attached to gaining Apple’s approval could not have been higher. Modality’s offerings were exclusively developed for Apple’s vast customer base and designed to fit within Apple’s products. Mark’s goal was to earn Apple’s full support so that the powerful company would embrace and champion Modality and its innovative solutions. But in terms of scale and clout, Modality was the proverbial flea riding on the back of a bear. At a minimum, Mark needed Apple leadership to tolerate his early attempts to integrate his technology with theirs. Anything less would amount to a deathblow.
Mark focused a great deal of time and energy into strengthening his relationships with key Apple leaders, working to understand their objectives and concerns, and developing solutions that worked for both companies. The approach paid off, as he noted in an e-mail to advisers in late February 2007. “A key development occurred yesterday,” he wrote. “Following a meeting between the Worldwide Developers Group and iPod Marketing, it appears that Apple is comfortable enough with our current software solution to work directly with us on distribution in the Apple Retail Stores and in their online channels.”6 Mark’s partnership with Apple would continue to improve and mature. Modality developed a reputation within Apple as a talented, trustworthy partner, leading to a host of opportunities over the next few years. Increasingly, Apple championed Modality and its products, and recommended the Modality team to its institutional and educational partners.
■ Operational Risk. Every entrepreneur’s plan contains assumptions about how the product or service will be created and delivered to customers. In the passion and haste of a launch, these assumptions are often untested or unexamined, although they are usually fraught with uncertainty and, in some cases, pose tremendous risks to the venture. Gilbert and Eyring note that these operational risks can often be evaluated in surprisingly simple ways. They cite the example of Reed Hastings, founder of Netflix, the movie-by-mail business, who conducted a simple, early test of his concept’s logistical viability: He mailed himself a CD in an envelope. “By the time it arrived undamaged,” the authors write, “he had spent 24 hours and the cost of postage to test one of the venture’s key operational risks.”7
Operational risks can also involve reliance on key personnel. One of my startup clients began as a spinoff from an existing company, having negotiated a deal that allowed it to transport nine major client accounts into the new venture. But until the new company could develop its own technology platform to service the accounts, a task requiring at least six months to complete, the original company’s operations team
Would continue to service the accounts. In my first meeting with the founders of the spinoff, we acknowledged that the dependency on the original company’s operation represented a significant area of risk. What if key team members in the original company favored their own client accounts over those that had been transferred? Worse yet, what if one or more key members of the operations team, already stretched to capacity and openly unhappy about the spinoff decision, decided to call it quits? Revenue from the inherited accounts would be important to the new company’s startup runway, so any major disruptions to client service could pose serious problems.
The next day, the operations leader in the original company confirmed our fears and submitted her resignation. While not a deal-killing blow, this event required a lot of attention and problem solving from the new team and detracted from other priorities. Fortunately, the team had identified back-up plans for communicating with clients and serving their needs until an in-house platform was up and running.
These are just a few examples of areas of early-stage risk. Each venture will bring its own unique set of uncertainties that can lead to a fatal early blow. To address these, scrutinize and test key aspects of your concept sooner rather than later, even if your entrepreneurial passion and optimism tempt you to assume the best. Eyring and Gilbert note that many venture managers succumb to this temptation. “Instead of testing their assumptions,” they write, “they become more and more invested in confirming them. But successful entrepreneurs do the opposite: They devise low-cost experiments to disprove a concept before it’s too late.”8