Five Years Too Late

January 30, 2009

Smaller is Better

Filed under: Startups — Tags: , , , , , — fiveyearstoolate @ 2:43 pm

Today we’re happy to have a guest post from our partner Will Porteous on the benefits of small, entrepreneurial teams. – EDW

will

Will D. Porteous

Over the years we’ve come to believe that small teams can be stunningly effective at the early stages of a company, often much more effective than larger teams. We have also found that, when they are good, such teams typically only need a modest amount of capital. This may sound overly simplistic. After all, some endeavors are just more complex and require a wider array of skills. But in our experience good entrepreneurs understand that resource constraints can make it easier to focus on what’s really important in a new company. What follows are some observations on this idea:

Product development is a fundamentally creative endeavor that requires incredibly tight coordination among the participants. Three great developers are usually better than thirty average developers, particularly if they have worked together before and if there are one or two strong leaders among them. Over and over we see core innovations that become great products coming from small teams (often just three to five people). In our current portfolio this has been particularly true at companies like Drop.io, Payfone, and Kashless. And this phenomenon isn’t just limited to software companies. At hardware companies like Data Robotics and Peek (both current RRE portfolio companies) we’ve seen the innovations of two or three founders get to market as products with fewer than fifteen people in either company. This is not to say that there aren’t some tasks that large teams, or even large communities do well (e.g. look at the strength of many open source products that were refined by hundreds of thousands of person hours from their communities). But in pursuing a new opportunity, at the early stages smaller highly focused teams tend to do better.

And it’s not just creating great products that small teams do well. Small founding teams should also be able to prove real customer demand. Good founders tend to know the problem they are solving intimately well. And they tend to know more than a few prospective customers. If they don’t, they know how to reach them without the formality and expense of a big marketing effort.

When I first joined the venture business in 2000, at the start of the last downturn (was there an upturn in between?), we were receiving a lot of inquiries from systems companies making gear for the telecom equipment market. Their target customers were both the established carriers and the emerging CLECs (Competitive Local Exchange Carriers). Most of these new systems companies had already raised heaps of money. There was a lot of capital available for these new equipment companies after the multi-billion dollar exits of companies like Chromatis and Cerent. It was as if the race was on to build the next “God Box” and get bought for a ten figure number. I remember walking into one such systems company that had raised a lot of money. They were raising a Series D. There were thirty hardware engineers, thirty software engineers, ten people in QA and documentation, ten in marketing, plus a whole complement of senior management including VPs for every area. And they were all good people working very hard. And they had never shipped a product.

Not only had this company never shipped a product or booked a dollar of revenue, it couldn’t definitively tell you when it would. The glut of resources early in the company’s life had contributed to an undisciplined culture. Product plans were not clear and too many people had their “hands in the code.”

What was worse, the established carriers weren’t buying and the CLECs were going out of business. The management team had never anticipated that there might not be demand for their products and they couldn’t conceive of a way to build the company that didn’t entail burning $2.5 Million per month. While they were growing the organization they had lost sight of what was changing in the markets they hoped to serve. They had raised too much money and made too many promises to their existing investors to stand up and say “this isn’t working; we need to make something else that somebody actually wants to buy.” Instead, they kept running the company like nothing had changed hoping to persuade a new group of investors to underwrite their outdated view of the world. You can imagine what ultimately happened.

Companies that have raised too much money in pursuit of the wrong idea are scary places. They are like a parallel universe where everything appears normal, but it really isn’t (movie buffs, think of “The Truman Show” or “Stepford Wives“). Getting back to reality is always painful and usually includes a major reorganization and often a recapitalization. The motivational challenges that come with downsizing or restarting on a new idea with a smaller team can be withering. And the odds of long term success in a restart are never as good as in a new company. More on that another time.

The point of this story is that it is better to stay small and wait until you know you’ve got something great before you raise a lot of money. Good entrepreneurial teams can achieve a remarkable amount on just a few million dollars. They can usually build at least a Beta version of their product. They can put that product in front of some potential customers and learn a LOT. They can iterate until they have something that prospective customers REALLY like. Along the way, they can learn a lot about how to sell the product and what customers are willing to pay. And, by keeping their team small and their burn rate low, they can preserve their option to change direction if they need to.

So, why is it that small teams are often so effective? There must be many reasons for this. Certainly, good entrepreneurs tend to hire strong and surround themselves with broad gauged, talented people who can lead, manage, and also be major individual contributors. Such agile teams know how to both live in the details of making the product and to focus on the larger questions of building a business. They bring together many different skill sets in a small number of people. There’s often a high degree of trust in such teams, especially if team members have worked together before. In addition, the sense of having been chosen to be a part of something new and special is often very inspiring and motivating. The work at the early stages of a company is massive in its apparent importance – and there is a lot of both work and responsibility to go around. Good teams must have a tremendous work ethic and reject any team member who doesn’t measure up. And perhaps most simply, communication is easier in a small team with a shared sense of mission.

Small teams are also hard emotionally. They often feel very anonymous to people coming from large, well known organizations. They demand tremendous amounts of vision and faith. They tend to be fairly democratic, which can be good in the early days, but doesn’t work for too long. They are stark, demanding environments. They can also be a lot of fun. They are the true crucible of company formation and long term value creation. So, if you want to get big for the right reasons, it helps to start small.

November 17, 2008

Kashless

Filed under: venture capital — Tags: , — fiveyearstoolate @ 7:19 pm
Stuart Ellman

Stuart Ellman

We recently made a decision to invest in the Series A round of a new company called Kashless. This investment is one we’re very excited about, and reflects a lot of our investment philosophy here at RRE. The company is still essentially in stealth mode, although certain details leaked out via SEC filings we did around the financing. Rather than go into a lot of detail about what Martin Tobias, the CEO of Kashless, is planning on doing with the company, we’ll talk a little bit here about our process and thinking that led to this investment.

As we’ve mentioned in this space before, at a highly abstract level, we (and most investors) look for excellence in three key areas: people, markets and technology (the order depends on which of us you ask). In certain sectors, technology will be the key differentiator (materials science-based cleantech or semiconductors), in others it will be the vision and execution capabilities of the management team that will primarily distinguish the big successes. In all cases you need a market that’s capable of supporting interestingly large businesses.

Two major positives intersected to make us very excited about the opportunity here. The first was the opportunity to back Martin Tobias again. As the writers of this blog discussed offline the other day, Martin is a winner. We don’t just know him in a business relationship, we know him as a friend as well. Stuart stays with Martin when he travels to Seattle. They ride the 200 mile Seattle to Portland bike ride each year. Stuart and Martin have spend a great deal of time trying to figure out what business to start. Kashless is the culmination of this strategizing, much of it done during bike rides. Martin has demonstrated a great nose for the very beginning of trends, and that’s a terrific quality in an entrepreneur. He’s also extremely good at building organizations and getting them to scale. We know Martin’s strengths and weaknesses. We know that we can work with Martin and we know that there is mutual respect. We also know that he has lived through bubbles and busts before and we have a shared history on the appropriate ways to react to new market information.

The second is that (true to form for Martin), we think Kashless is poised to catch a big wave. Often times when we evaluate companies that seem good, but don’t quite feel right, one question we ask internally is, “what wave is this company riding?”, which helps focus the conversation around large, meta-trends that can propel a company and its target market into a high growth trajectory. Kashless is riding a big wave – call it “green”, “sustainability” or what you like, but economic, cultural and social forces are all moving us toward a world where issues of sustainability are more important than ever. Kashless looks to enable people to live more efficient, sustainable lives, and that’s an objective of which we are both supportive and optimistic. Also very important for RRE, as we mentioned in previous posts, Kashless can achieve these objectives in a capital efficient manner.

Stay tuned for more from Kashless, but we think big things are coming.

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