Ross Mayfield's Weblog

I've Got Your Ownership Society Right Here

While travelling in NYC & to RIT to speak at their entrepreneurs conference last week, I collected some thoughts about our turbulent times.

We started Socialtext in 2002, during the last crash, a time when many said it was the worst time in history to start a company.  But history shows us that the best companies started in the worst times, such as Apple or Microsoft.  And all great companies lead their way out of recessions.

Equity is the Ownership Society

Silicon Valley runs on equity, not credit.  The source of funding isn't drying up.

How equity is allocated, or rather the terms and valuation, will be effected.  Too early to say how macro will effect it because all macro is currently just volatile uncertainty.  While the classical shift in recession for venture capital is either towards more stable late stage (safe bets) or advanced R&D early stage (long bets), the underlying costs of startups have changed and some contrarians will even out the stage distribution. 

How equity is reallocated will favor new money, but this is kept in check. Those who invested must be, those who vested must be incented and those that will work in the future must be offered upside. There will be greater requirements for startups to be more capital efficient, but at the same time investors will seek to further capitalize their companies to weather the downturn. There will be less leverage available for growth, so you will have to find more leverage within your business model on your own.

Scarcity and Abundance

Recent blog posts have some concerned that venture capital is drying up, but that is a perception problem.  VCs are rightly advising that companies conserve cash, but entrepreneurs already know that.  Dave McClure put it better -- its not about conserving cash (although Cash is King), but finding your frigging business model, fast.  Don't panic.  Scarcity causes, or at least favors, focus.

The scarcity we worrry about in Silicon Valley isn't our own.  We have an abundance of innovation that is hard to disrupt, in part because we are so connected, through equity, but also social capital.  All in a culture that rewards success and failure.  I've got your ownership society right here.

What we do worry about is our customers.  On the consumer side, even more people will spend time on line.  Not just in the way that unemployment gave a boost to blogging.  But a fundamental shift in how people spend their time has occured.  Unfortunately, they will spend money with their time, but the difference is literally marginal.  For our company customers, whole industries will dry up quickly, but our markets are more global now.  And what the Valley brings to these companies is competitive advantage needed in turbulent markets -- from cost savings to productivity to the ability to innovate your way out of recession.  If the Valley can create value while other sectors of the economy do not, we will keep and grow our customers.

Make Do With Less, Together

If you are one of our customers, just like us, you likely have to make do with less, in your personal or professional life.  Funny thing about productivity.  You can't drive more in a company by asking individual employees to work harder, the gain comes from how they work together.  As a consumer, yes you can personally spend less, but you can spend smarter and find ways to make more with others.

Collapse: How Startups Choose to Fail or Succeed

Jared Diamond's new book, Collapse: How Societies Choose to Fail or Succeed, provides a simple framework of five forces that lead to collapse: environmental damage and population growth, climate change, hostile neighbors, weakened trade partners and failure to solve societal problems.  I thought I would mash it up with the Techcrunch Deadpool:

The NY Times has a great piece on Dr. Diamond's theory and the academic debate amongst anthropologists.  The above mashup is based on their infographic about the model and collapsed civilizations like the Maya, and it serves as an excuse to discuss the risks facing startups.

• Market risk is the big one.  A little startup has very little control over market size and penetration.  One way of managing this risk is to go after bigger markets, in which gaining a sliver is still substantial.
• People risk is all about the founding, management and larger team.  Get this one right and not only can you execute, but have fun along the way.  Get it wrong and it may be painful.
• Technology risk is both managing technical complexity and innovation as well as product management.  Some say this risk can be managed with sufficient resources, but it is more about the timing and activity of resources against the pressure to go to market.
• Financial risk is the ability to fund the company to get to profitability.  This is both a function of capital formation and the ability to execute on revenue.  Many in the deadpool failed to do the former, but largely because of the latter.
• Disruption risk is a broader category for things like platform shifts, asymmetric competition, legal risk and other force majeure

I find that any substantial startup risk, and inherent reward, can fit into these five categories.  Marc Andressen has a larger post exploring edge cases in the context of when VCs say no.

I'm actually with the anthropologists in this debate, where such simple frameworks help you think about where to pay attention, but larger forces are beyond an entrepreneur's control and vary significantly.

That sucking sound

Mike Arrington: Times are good, money is flowing, and Silicon Valley sucks.

Hard to argue with it.  Except that a lot of us are still focused on technology, burgers and beer.  My read of Mike's post is not the insanity of valuations, marketing budgets and parties.  Maybe a bit of the pitchiness that bloggers and journalists deal with in frothy times.  But certainly the culture that existed here a short bit ago.  Back when I met Mike, actually, and a bit before.

Funny how I couldn't find an entrepreneur who blogged about this gut checking post, even when part of the point is the valley is flooded with itinerant entrepreneurs.  Except Eric Rice, who is from here, like me.  We're the idiots who didn't move out when it got too expensive, for some good reason we believe in.

Deep within me I fear that the region that learns too much about, instead of from its failures, becomes Detroit.

Startupping Launches

Serial entrepreneur Mark Fletcher just launched Startupping, a community resource for Internet entrepreneurs.  He kicks it off with a blog post on the best and worst decisions made by John Battelle, Dick Costolo, Paul Graham, Chris Pirillo and yours truly. Some gems:

• Dick's best decision is hiring, but not the tired A player ego stroke answer, his emphasis is on cultural fit
• John says either keep control or don't act like you have it
• Paul emphasizes being strong with investors
• Chris says to hire salespeople who understand the product and be cautious of handing over control of the business model

Startupping is a blog, wiki and forum on topic.  I've tried similar efforts in the past, notably the Startup Exchange, but got consumed with my passion that more directly pays.  Mark, all the content in the Startup Exchange wiki is CC-licensed, so please reuse.

Being consumed by the primary passion apparently isn't just my experience.  Brad Feld noted this when passing on the launch of Dick's new blog:

Relatively early on in our relationship, Dick stopped blogging.  He’s a classic always working entrepreneur and blogging quickly fell to the bottom of the pile as FeedBurner started its incredibly rapid growth curve.

Dick's new blog, Ask the Wizard, is an absolute must read for any entrepreneur.  Let's hope he doesn't stop.  When to raise money isn't an easy question, because it really varies, but the important point is isn't just when, but how much.  Pitching your company is a topic more of lore than matter, and my approach is to keep it simple, know many pitches and get into real conversation as soon as you can.  There is more on outside directors and non-founder equity so far.  The advice is practical, smart and fun, just like the author.

So Dick, let me ask you one question that I think you are in a great position to answer, at least to keep you going.  How does an Internet entrepreneur overcome not being in the Silicon Valley? I'll bet it is more than being on a plane all the time.  And I happen to wonder if not being based in the Valley explains why Feedburner was to be first to market without any competition for so long.

Entrepreneur Hindsight

I was asked by email to provide what was my best decision and worst mistake as an entrepreneur.

Best Decision -- To become an entrepreneur in the first place

I started my career in the non-profit sector, and then in the public sector, all in hopes of changing the world.  I quickly realized that I could both have an impact and make a living in the private sector.  And am lucky to now work on a company that produces social goods.  Further, as a startup founder I believe you can quickly have a significant impact, possibly more than any other job.  It is a roller coaster of risk.  One day you can be beaming with pride to have created jobs and a fun place to work, and another you stress about meeting payroll and having folks be overtly human with one another.  I may be a little lucky in finding my role (but not so lucky that I don't have to work for a living), but sincerely believe the world needs more entrepreneurs.

Answer #2, to more specifically tie this to a decision...

Best Decision -- Picking co-founders you trust

It is not an exaggerated saying, that you marry your business partners, especially co-founders in a startup.  Some look to partner with the Geek Girl for her technical whizbangery or Phone Guy for the sweet talk and access to capital.  While you want to work with people that are skilled, I'd say the primary qualifier is if you can trust your co-founder.  If you have any hesitation, either work it out or walk away, quickly.  I'm luck to work with great co-founders I can trust with my life.  Beyond trust, I would also put startup experience beyond specific skills.  Someone that has rode the roller coaster before is less likely to barf in your lap.

Biggest Mistake -- Not taking bigger risks earlier

Maybe because in hindsight all risks are clear, but I always find myself regretting not taking bigger risks earlier.  For example, open sourcing the Socialtext code was something we waited on until the company had strong footing.  Partially because we thought there would be cannibalization, partially because we were understaffed to really engage with the community.  But I believe if we bought this bullet earlier in the history of the company we would be reaping better rewards.  As a planning exercise, now I always try to ask two questions: "How could we take more risk?" and "What risk can we take that creates the greatest amount of options?"  I find there is always a way to do a little more, in particular by getting past instinct to control prevalent in so many entrepreneurs.

Pie eating

I'm not sure what movie I saw, or the analogy it applied to, but "It's like winning a pie eating contest, where the prize is a whole bunch of pies" really resonated with me as the saga of entrepreneurship.

Every win comes with opportunities, which creates new problems to solve, and so on and so forth.  The hard part is recognizing a win for yourself, for your team, and building upon it.

Analogies of hills (challenges) and rollercoasters (wild rides) of course apply.

The Wikinomics Playbook

UPDATE: An interesting related project by Penguin Books is A Million Penguins, letting anyone edit a book to be published.  The wiki is down at the moment, but PaidContent notes it began with “It had snowed, and was now raining. Gritty slush covered the pavement. Sharp crystals of snow decorated grass.”  Reuters notes the challenge is finding “believable fictional voice” within the mass collaboration.  This was a big challenge for group editing of the Wired Wiki story.

The last chapter of Don Tapscott's new book, Wikinomics, invites readers to write it: “Join us in peer producing the definitive guide to the twenty-first-century corporation on www.wikinomics.com.”  Today we launched a Socialtext wiki for the Wikinomics Playbook, where people can not only learn about the power of mass collaboration, but participate in it.  The book is already one of the fastest selling business titles and is an excellent primer on how models of collaboration are unfolding from open source to blogging to wikis in the enterprise to enable people to participate in the economy like never before.

The second to last chapter is about enterprise wikis.  Half of it discusses how Best Buy is using a wiki knowledge-base for the Geek Squad.  The other half is an interview with yours truly and shares some of Socialtext's success stories. The first chapter is available online as a pdf.

 

This is a great example of how a book can be augmented with a wiki, as most books are out of date by the time they are published, never quite finished and have the potential for participation. Last month we helped Larry Lessig share the entire Code 2.0 book in a wiki.  I expect that soon such commons-peer production, a wiki for every book, will be common.

10x 2.0

The traditional venture capital invests disruptive technologies that provide a 10 fold improvement and generate 10x return.  However, Web 2.0 consumer internet companies are not based upon disruptive technology, but potentially viral models of participation.  The consistent pattern is sharing control to create value.

Measuring the disruption in performance terms proves difficult and is an opportunity for research.  I have not found a way to measure the lower cost (zero marketing budget) of user acquisition and lower churn through virality and network effects.

But you can measure the impact of disruption.  Craigslist cannibalized the Bay Area classifieds market by $60 million by 2004, when they had $6 million in revenue.  This is asymmetric competition against models that provide less freedom to communities.  Consumer internet startups generally require 10x less capital to get off the ground (although not consumer, Socialtext was seeded with only $5k and six months of sweat, as an extreme example).  Realizing a 10x return with a developed community and functioning business model should be a layup.

But if this model requires 10x less investment, the lingering question is how $1B venture funds invest enough.  Or how much time even a small fund can spend with its portfolio.  The IPO window remains practically closed and burdened with $2M in new SarBox operating costs making it less attractive.  M&A is out of control and potentially furthered by the need for venture firms to exit earlier to make the model work.

We are in a bubble, that is representative of our times.  It began with Google's acquisition of Blogger, and it might have peaked with the rumored $2B valuation of Facebook (hinting at the cyclical tip from consumer to enterprise).  I'm not sure there is a lack of failure in this bubble, or if we just need to give it time.  There definitely are more plays in each category (e.g.  well over 200 in social networking or social bookmarking, possibly over 200 funded in video search).  I've said for a year that this bubble is build to flip.

The problem is there are too many companies being created that have no aspirations to be companies.  Most survey the feature portfolio of tier 1 and tier 2 acquirers and are precision guided towards flipping within 18 months.  Many make no attempt at generating revenue and most that do generate revenue from the advertising of other startups, let alone demonstrating a business model.

A dirty little secret for those actually building these things into businesses is that generating community value takes time.  Beyond the blog bump and 53,651, a community that stays with you and grows virally is tough to achieve.  Today's successful ventures are twice as old as the 18 month window.  They were born when it was a shitty time to create a company, were largely either hacks cast out openly to serve an immediate itch and community (e.g. Blogger, Six Apart, Technorati, Newsgator, del.icio.us) or almost accidental creations that caused a business model iteration (Flickr).

Today the problem is microventures optimized to flip are flopping, but they are too small to see.  It isn't just that VCs are taking the risk of the bubbles.  For every funded company, there are 10 with the sweat and tears of entrepreneurs that fade to black.

This is not all bad.  We are in the risk business.  There is creative destruction with tight iterations that provides a base of vibrant innovation for the economy.  But structurally, this bubble is attracting increasingly less experienced entrepreneurs (and investors) chasing the wrong incentives. 

Ethics Gone Wild

Paul Kedrosky takes a look at Girls Gone Wild.  Or rather, the actions of the entrepreneur behind it, and raises the question -- is there such a thing as entrepreneurship morality?

I tried to comment, but got an error, so posting it here (consider this a disclaimer for not writing more on what could be a very big subject).

Does business have a morality? No, but it has ethics.  Although you can get lost in definitions.

Social entrepreneurship is class of business with a fairly well defined set of ethics. It is also a investment thesis (pornotube.com is an ethical thesis to the contrary).

Enterpreneurship is like many professions without institutional barriers to entry (e.g. PR, and yes, Venture Capital, increasingly in the hedge fund age) -- ethics will be defined in industry groups, in some cases to gain advantage.  In most cases, explicit normative development only happens when egregious errors impact the community.  Then they act out of profit motive and perhaps before regulation is called for.

Innovation, Risk and the Intrapreneur

Scott Gatz picks up on the conversation he started on Intrapreneurship with a thoughtful summarizing post.  I had noted that Intrapreneurs take less personal risk than Entrepreneurs.  While I thought my point was largely true -- following strong opinions, weakly held as blogging practice -- I've second guessed myself firt, and with a mind open for others.

What also bothered me is that what I do for a living at Socialtext is help those in large organizations who take risk get promoted.  Some are Intrapreneurs who instigate a purchase and champion a tool, but many more simply stick their neck out by being transparent and on the side of a truth.

There is no question that Intrapreneurs take risk.  As Andrew Fife pointed out, your salary can fall to zero.  I disagree with him that being part of a large company opens more doors for you than a startup, just being there only counts for television, which further supports my original point that all companies should enable Intrapreneurial activity.  Intrapreneurship is a big hairy audacious mechanism to foster innovation.

Today I gave a talk before the executives of a prestigous R&D unit.  I was followed by none other than William Miller who has modelled The Valley better than anyone, gave me some key informal advice when starting Socialtext and helped me frame what we live and work in as a irreplacable marketing function.  But more than anything, to me, he was the one who realized that the Culture of Failure.

Based on the points in Bill's Habitat for Entrepreneurship, we were discussing what a large organization could do to model the engine of innovation we call The Valley. Quoting one point in full:

4. A business climate that rewards risk-taking and does not punish failure is a prerequisite for an entrepreneurial high tech community. Most high tech ventures fail, so a climate in which the stigma of failure hangs over the unsuccessful entrepreneur serves as a powerful deterrent. This is especially true if the rewards for risk-taking are not sufficiently high. In Silicon Valley, there are many examples of entrepreneurs who have failed and successfully started over. These entrepreneurs view failure as a learning experience.

On the failure side, bankruptcy laws that provide limited liability―that is, laws that limit liability to the invested capital and do not permit creditors to “reach beyond” the company―permit entrepreneurs to be more venturesome. Similarly, the availability of limited partnerships for venture capital firms encourages their formation, and in turn, their capacity to engage in the high-risk business of high tech ventures. Japan, Korea, and India are moving in this direction, or have already done so.

On the success side, security laws that bestow equity credit for ideas, organization, and hard work give larger rewards to the entrepreneur. By contrast, a security law environment that requires company founders to pay the same amount as investors for each share of stock does not result in a large enough payoff for the former. This situation often results in large initial dilution of the founders’ stock, making them reluctant to take further investment ― and dilution ―to grow the company quickly. In fast-growing markets and markets characterized by increasing returns to scale, rapid growth is essential to survival. Changes in these kind of securities laws are currently under consideration in Japan and India.

A culture of failure is a prerequisite for success, and is based upon both legal structure and business norms.  Liability must be limited and risk respectively distributed.  Corporate venturing and M&A are a proven models for a large company to couple itself with the risk taken and the innovations of entrepreneurs. 

Intrapreneurship, in my opinion, is less developed.  Primarily because organizational cultures do not reward failure.  I am interested to hear of a large companies that have structures and norms for personal risk taking by employees.  By personal risk, I mean organizational, social and financial capital where the more you risk, the greater the reward.  Liability is inherently limited within an organization, which is the conservative strong suit.  But the undiscovered incentive, which goes against the grain of most corporate culture, is the ability for an individual, or team, to play an internal market with their own risk and reward.  And when they fail, be rewarded as well, with the chance to succeed.