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Business for Geeks at OSCON 2005

by Daniel H. Steinberg
08/04/2005

Your team works on a new application late into each night and all weekend long for months on end. You think there might be money in this idea, so you put together a presentation to convince potential investors to back your product. What do you put in your PowerPoint presentation? Marc Hedlund, O'Reilly Media's entrepreneur-in-residence, says that if you are like most engineers, you will have twenty slides about the product and maybe one describing the team. Hedlund explains that this is not the way to raise money. There are many practical decisions you will need to make if you want to start up a business around a product or service. In the three-hour morning session, Hedlund identified the issues that geeks need to consider and explained the consequences of deciding one way or the other.

What You Are Pitching

In his sold-out opening day tutorial at O'Reilly's Open Source Conference (OSCON) 2005, Hedlund gave a crash course in seeing work from the business point of view. An engineer might think that all that is required is to combine a good idea with great people and go about your business building the product. To the surprise of most of the session attendees, the list of questions that a potential investor wants answered doesn't include "Is it a cool product?"

The business people focus instead on customers for the product. They want to determine if there are enough customers willing to pay and whether or not they are high-margin customers. An investor wants to know that customers care about the product. They worry about such things as sales channels and market conditions.

If you want to attract investors, you need to be able to figure out who your competition is. Hedlund said that most pitches present the extremes. Either a team says "we have no competitors" or they present 20 or more companies that are somewhat similar. Hedlund advocated that you find four competitors doing something similar to what you are doing and clearly show how you are different than the others.

Identifying your competitors also helps you make reasonable estimates that potential investors will find believable. You might look at a company you are similar to and guess that within the first year you will have one and a half times the sales that they do. Maybe you are right and maybe you are wrong, but now you have a reasonable foundation on which to build your estimates.

Researching the Market

Suppose you have a great idea for a product. What should you do? Many potential startups think they must enter a stealth mode where they don't tell anyone about their ideas until they have a product almost ready to ship. Hedlund advises that "you should worry far more about misunderstanding the market than you do about secrecy." He advocates picking up the phone and calling as many people as you can think of. For his current venture, he has already interviewed six hundred people and learned a lot about potential customers.

He demonstrated the technique with an audience member. In this example, Hedlund explored the market for a potential conference he might put together. In a quick and casual conversation, he found out a bit about the conference attendence habits of the person he was interviewing. Hedlund determined how many conferences his subject had attended this past year and how much he had paid. Hedlund then described the conference he was thinking about and asked whether or not the interviewee might attend and what he might be willing to pay. He took a minute at the end to find out what were potential obstacles to attending and what might be a factor that would encourage registering for the conference.

Hedlund's point was that although you might be worried about revealing your idea, you should pick up the phone and ask everyone what they think. It's as simple as saying, "I'm working on an idea and want to see if it would work for you." He finds that many people are willing to spend half an hour talking to you about your idea. Explore feature requests for similar products or ask people what their pain points are. Assume that everyone is fascinated with your idea. If someone tells you they aren't really interested in your idea, follow with a question that explores what it might take to get them interested.

Researching Yourself

You've taken the time to find a compelling product and to research the market; you should then spend some time thinking about yourself and about the team that you are launching this new venture with. You need to understand your motives and commitment. Are you willing to work on this idea for ten years or are you thinking you will work for a couple of years and then sell it for a lot of money? Are you thinking about your idea all the time? Once you've decided that you are in fact committed to the idea, you then need to make sure that you have the resources to survive lean times. Make sure you have a financial cushion on which you can live for half a year. If times get tough, Hedlund explained, you don't want to be in a financial position that makes it likely that you will take a bad deal. After outlining the potential risks, he smiled and said, "It's OK to be afraid. You just need to make sure that you are more excited than afraid."

As you search for the team you want to launch your new venture with, Hedlund cautioned that most cofounders wind up hating each other. This, he explained, is true whether your company fails or is wildly succcessful. This doesn't mean that you should choose someone whose friendship is expendible. It's just that you need to be aware of the risks at the beginning. He recommends two-member teams. You generally don't want to start a company yourself as you will often be under-resourced, and you need different skill sets as well as somebody else in the same boat with you. On the other hand, you don't want teams that are too large. In any case, at the beginning stages, you need to keep the number of employees small so that your burn rate remains manageable.

During the start up phase, you want to run lean. Choose people who can do lots of jobs and who have different skill sets. For example, a two-man team might consist of one person who writes code day and night while the other person is "the phone guy." While the skills of the team members should be disparate, they should agree on their goals and expectations. It would be awkward to have one person hoping to just have a product that generates enough money to comfortably live off of while the other team member wants to bring in venture capitalists and aggressively grow the company.

Rules for Fundraising

Before you decide to look for investors, consider whether or not you want outside money. Whether you take money from angel investors, bank loans, government grants, or venture capitalists, those giving you money will expect something in return. You need to decide whether or not their expectations match your goals for the company. After you accept money, it is not just your company any more. In fact, Hedlund explained, you should focus on the business first and not the fundraising. You don't want to go for funding too early when all you have is an idea. Get people involved in your business before it has money. Think of how much stronger your position is if you build the product, get users, and get to break even before you consider a growth plan. If, instead, you are running out of money when you start to look for financing, you are in a vulnerable position. Investors can wait until you are in a position where you will take almost anything they offer. In other words, like so much else in life, the best way to get venture capital is to not need it.

What can you get from a venture capitalist (VC) other than money? Sometimes a VC gives you the credibility you need. For some larger customers, the fact that you could attract an investment from a known VC is essential to making a sale. There are VCs who can actually introduce you to potential partners and clients, but more generally, they tend to be visible advocates for your company. Before facing the VCs, you will need to arm yourself with a 10-15 slide PowerPoint presentation and a 2-3 page executive summary. You will also need introduction to a VC.

Hedlund said that with VCs, "no means maybe and yes means maybe." If a VC has said no, it might just mean "not now" or "you're not ready yet." As long as you are making progress, it doesn't hurt to check back in with VCs and update them on what you've done. If this sounds like a lot of work, it should. Hedlund advised that funding is more than a full-time job. He ended the presentation by providing estimates of how much work it takes to get funding. It takes a lot to get a face-to-face pitch. On average, about ten pitches yields a term sheet and three term sheets leads to one financing. It takes around two months to get from the initial pitch to a term sheet, and this may involve ten or more "Oh, we need one more thing" type of meetings. The time between term sheet and the money is around a month. In addition, you have to account for the fact that VCs often take vacations in August and December, so there is a cycle to when they tend to do business.

Daniel H. Steinberg is the editor for the new series of Mac Developer titles for the Pragmatic Programmers. He writes feature articles for Apple's ADC web site and is a regular contributor to Mac Devcenter. He has presented at Apple's Worldwide Developer Conference, MacWorld, MacHack and other Mac developer conferences.


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