Figuring out how to make a great investment never seems to get easier. But deciding which opportunities should be declined is a good place to start. Short-term wonders are immediate candidates for rejection–hence our interest in listening intently to the words people use. Any suggestion of a quick flip or a quest for instant riches is not something that will ever grow into a great company. The better venture capitalists know that it takes considerable patience to organize, develop and build a substantial and lasting business; indeed, some will equal Warren Buffett in the length of time they are prepared to own shares in a company.
One test we often apply to a new business is the ease with which it can be explained. If someone is able to summarize his company’s plan on the back of a business card, it usually means that he will be able to describe its purpose to employees, customers and shareholders. A proposition that takes a paragraph to describe or 10 minutes to explain is dicier. One thing I remember from 1988, when we provided the start-up financing for Cisco Systems, is the stunning clarity with which the company’s founders, Sandy Lerner and Len Bozsack, were able to explain their business. The entire mission was summed up in three words: “Cisco networks networks.” While that might seem abstruse for the man in the street, it was a description that has stood the test of time.
The get-rich-quick artists–and there are a lot of them roaming Silicon Valley–don’t have the faintest clue how to describe a company, let alone build one. Some are arrivistes for whom forming a start-up is little more than a fashion statement. People who might have blindly joined an investment bank, consulting firm or law office a few years ago are now panting for some dot-com pixie dust. This isn’t a phenomenon limited to 26-year-olds dressed in black; it’s also a virus affecting CEOs of many large companies. These artful dodgers cruise around the Valley in their black limos, seeking a way to append the magical two syllables–“dot-com”–to their company in an effort to conceal poor performance in their main business. In this latter case we have detected two cautionary signs. Many of these CEOs don’t even have an e-mail address on their business cards. Others drone on for an hour, explaining how they seek to “unlock shareholder value” (code words for a fancy financial shuffle), without making a single mention of their customers or products.
Both these caricatures–Ms. Dressed-in-Black and Mr. Shareholder Value–lack the most important ingredient of a company founder: an unquenchable passion for an idea or a product. An entrepreneur without passion is an empty vessel. Anyone who starts a business–and wants it to last–needs this quality. It is a journey against all odds. Every business starts with one or two people, an idea and nothing else–no employees, no money, no product, no customers and no shareholders. It is an existence where sometimes everything that can go wrong, does. Force venture capitalists to choose between a well-heeled Ivy League student and a smart and impoverished immigrant, and we’ll pick the latter every time. The lily-livered need not apply for life at a start-up. Tenacity is a necessity.
Passion is one thing. Misguided or misdirected enthusiasm is another matter. The most propitious beginning for any company is the marriage of extraordinary passion with an enormous market. One of the cruel facts of life is that even the most talented people will fail to prosper if they start a company aimed at a small or slow-growing market. We venture capitalists sometimes say, in undiplomatic moments, that great people cannot overcome mediocre markets, but a company started by mediocre people can flourish in a great market. The best of all worlds is to pair talented, articulate people with a large market. This combination stands a good chance of becoming a leading company. One of the laws of venture capital is that the leading company in any market is eventually worth more than the sum of its competitors.
Companies often get started by people who develop a product for themselves or their close friends. It’s almost accidental that their product becomes something that millions of other people want. Almost all of our best investments have sprung from this personal impulse. Two unknowns named Jobs and Wozniak, developing a product as a hobby, turned their diversion into Apple Computer. Jerry Yang and David Filo started Yahoo as a way to keep track of their favorite Web sites. When Toby Lenk started eToys, he did so, in part, because he had a nephew and niece clamoring for birthday gifts; shopping for gifts at ordinary toy stores and then figuring out how to pack and mail them across the country was not something that Uncle Toby found enticing. Similarly, when Louis Borders began Webvan, a massively ambitious online retailer that delivers to businesses and homes, he did so because he thought there was a better way to sell the goods that people frequently need.
Technologists often fall into the trap of infatuation with their work or invention. This blinds them to the cruel realities of the marketplace. We sometimes ask people: “Who needs your product?” This might seem like a simple question, but it is surprising how often it serves to ferret out fuzzy thinking. If an entrepreneur cannot describe who really needs his product, it presages trouble. We far prefer to support an entrepreneur with a simple product and lots of prospective customers over a person with a patent-protected device and a very limited number of potential customers. Our business is to develop companies rather than invest in science projects.
The company founders most appealing to venture capitalists are those who understand what they do not know and that they need all sorts of companions if they are going to turn an idea into an enduring company. The DNA of a company usually gets established within the first 100 days of its existence, and is composed of three strands: the one brought by the founders, a strand brought by a venture-capital firm and a strand brought by the people whom the founders and investors recruit. It helps enormously if the agenda and sensibilities of all three groups are complementary. It saves time; it allows decisions to be made quickly; more important, it infuses a company with a particular feel.
Every company comes to echo the sensibility of the few people who were present at the creation. If arrogance was apparent at the dawn, it will inevitably permeate the company. If frugality, confidence, humility and a desire to develop a wonderful product or service were evident when an idea got started, then these will weave themselves into the corporate fabric. If modestly talented engineers were there at the beginning, the only people they will be able to hire will be the lame. If a CEO insists on obtaining the safety blanket of an employment agreement and a golden parachute, everyone of any consequence will demand one. (People often ask for the secret of Yahoo’s success. There isn’t one big answer; there are hundreds of little answers. But if somebody absolutely insists on getting a sound bite, my answer is simple: Yahoo CEO Tim Koogle does not have a complex employment agreement, and neither do the other 1,832 U.S. employees.)
My partners and I have invested in hundreds of companies, but we still make expensive mistakes. Occasionally we fall victim to the glibness or simplicity of an artfully designed slide presentation. Other times we fail to assess a market correctly or misjudge the time it will take to design a product. But what stumps us most frequently is people. We go to great lengths to try to assess people correctly, but we are perpetually surprised. We’ve been startled by the fatal coronary of a CEO just a few weeks after we invested in his company, and by people who go AWOL after they come to understand the demands of a start-up. There was even the CEO who kept a loaded gun in his desk drawer, and the company founder who drove his pickup truck through the ground-floor windows of an office building in an attempt to eliminate his cofounder.
Despite the topsy-turvy nature of our world, at the moment it is breathtakingly easy to obtain financial backing. Over the last two years, our partnership has invested in three companies that we first heard about via e-mails sent directly by entrepreneurs we had never met. Reams of financial projections appended to glossy business plans aren’t necessary to capture our imagination. Similarly, it should be reassuring to know that the boxes of chocolates, baseball bats, simulated treasure chests or $100 bills that sometimes accompany business plans usually have the opposite effect of what was intended. And there definitely is no requirement to do what one entrepreneur recently promised if we endorsed his idea: run naked across the parking lot. Casual dress is fine, but we have yet to finance anyone clad in his birthday suit.
