Altos Ventures Musings

Celebrity Investors, Board Members and Advisors

"The quality and quantity of the financial backing that HomeGrocer.com has received for this latest round of financing clearly indicates that we have a model that is both viable and sustainable." 

- Homegocer's CEO in 1999 Press Release announcing $100mm round 

Chris Dixon's blog post from today about how to select your angel investors talks about a common mistake entrepreneurs make - choosing an investor based on their "celebrity value (by "celebrity" I generally mean in the TechCrunch sense, not the People magazine sense)." 

The same is true for choosing VCs, board members and advisors. We've invested with plenty of famous VCs and board members who were extremely well connected to the CEOs and boards of companies such as Microsoft, Oracle, Cisco, Intel and many other Fortune 500 companies. 

In our experience, celebrity investors and board members do little to help entrepreneurs do what they need to get done. They offer little in the way of strategic or practical advice about hiring, firing, product development, closing deals and financing. Even worse, sometimes the advice can be out of touch with what is going on in the industry or company but due to their celebrity status, some off the cuff comments can carry too much weight. 

Perhaps the most value that celebrities bring to the table are connections (even Chris in his blog post applauded "connectors" who can "introduce you to key people when you need it"). In practice, however, most people with great connections guard their rolodexes. 

Even when an intro is made directly to the CEO of a BIG company, it will get passed down the organization (usually down several levels) to the real decision makers. If the company is well run, the CEO will let his/her people make the decisions. 

If you do choose to use high level connections to force a deal through you should be warned that such a deal can backfire. If you don't take the time to build real support with the right people in the organization, they can do many things on a day to day basis which can ultimately sabotage the deal down the road (and distract you from what you should have been doing in the first place). 

My advice to entrepreneurs is to build your own buzz, based on fundamentals (an excellent banker advised one of our companies to "build your own heat" - it was good advice). You have to deliver real value! 

Also, please, please, please focus on generating your own leads. No matter how big your board or how well connected your advisors are they will NEVER produce the quantity or quality of leads your own team (and sales/marketing engine) will produce for you if you are going to be successful building a real business. 

In my experience, the entrepreneurs who see the most value from celebrity investors/board members and "advisors" build nothing of real value themselves. On the flip side, the best entrepreneurs see little value from celebrities (in fact, they probably find them distracting, if not somewhat annoying). 

Ironically, celebrities begin to embrace entrepreneurs once they think they are going to be successful anyway - with or without them. As it turns out, most celebrities need you more than you need them.

As far as I'm concerned, the real stars are entrepreneurs who create something from nothing.

Disclosure: As Chris D. admitted, as a non-celebrity but hard working small investor, this post is almost entirely self serving.

Overcommitted

Hard working entrepreneurs and their companies often feel over-committed. There are always too many things to get done and not enough resources.

One of our companies that is growing at 200%+ this year was feeling that way and we had a serious discussion about various options. One was to do a better job of account management so that expectations of customers and partners do not get ahead of our ability to deliver. Another option was to raise more funding and hire more people. A third option was to make tough decisions about what to cut (this is not an exhaustive list but will give you a flavor for the discussion).

The third option is a hard one to swallow, especially when things are going well. We have customers lining up and a window of opportunity that may close if we don't go for it - NOW! An easy answer would be to raise more money and ride the momentum.

After much discussion/debate, we made a decision to cut. We did not cut people. In fact, we will continue to hire. But we cut some very promising initiatives and we will have to turn away customers that are ready to pay (or have already paid).

Cutting can be scary, but it can also be liberating. It is not 100% clear that we made the right decision but here are two interesting quotes to think about, if you ever find yourself in a similar discussion with your board/investors:

"The essence of commitment is making a decision. The Latin root for decision is to 'cut away from,' as in an incision. When you commit to something, you are cutting away all your other possibilities, all your other options."
    -The Lombardi Rules, Rule #6 - Be Totally Committed 

"A great company is more likely to die of indigestion (from too much opportunity) than starvation (from too little)."
    -David Packard ("Packard's Law")

Twitter Envy

After what seemed like the biggest PR week ever for a start-up, I did a Google News search this morning on "Twitter" and found 1,612 news articles. It was more than twice the Google News results for Facebook, Google, Microsoft, Amazon, eBay and Yahoo! COMBINED.

Last month, Seth Godin wrote a blog post talking about the difference between PR and publicity. If great PR is the strategic crafting of a compelling story...just what is the Twitter story? Can there be a credible story without customers (not users) and how they make money?

Before you get Twitter envy and start doing dumb things (like Facebook did changing its homepage) be sure you understand what your true mission is as an entrepreneur.

An entrepreneur's mission is not to get publicity or to become famous. It is to build a company. Without revenues and profits, you cannot have a viable company.

There is no doubt that Twitter has innovative product people and great engineers to be able to handle scalability issues. But let's just see if they will still be around when their venture funding runs out and the hype dies down.

In the meantime, don't learn the wrong lessons from Twitter. Don't rush out to hire a new PR agency. I've seen plenty of companies get hyped, raise huge amounts of funding, and land speaking gigs and magazine covers all around the world. It doesn't mean they will make it. In fact, it might decrease their chances (don't confuse cause/effect).

Yes, they might get lucky and flip the company for a princely sum (as Youtube did). But I doubt they will build a successful business or a lasting company.

What is your definition of success? PR or publicity? Build your company or your reputation? Build to last or build to flip?

Burn the Ships!

The past 6 months have been two of the toughest quarters in decades. Almost every company is struggling - but some are surviving and some are not. What separates them?

I want to share an observation. There seems to be one common theme across every Silicon Valley company that I've seen go out of business. For some reason, the management of companies that abruptly shut their doors thought that they would get more funding. It could have been VC funding, debt financing or some other source of outside capital. That was their back-up plan. They were counting on it.

If you are an entrepreneur, you should have the attitude that there will be no-one to save you. There will be no outside capital. You have to generate revenues, cut costs, make the business model work - or find some way to survive until you do.

This doesn't mean that entrepreneurs should not raise any debt or equity financing. It just means they should never, ever count on it.

In Silicon Valley, it almost seems as if entrepreneurs count on VC as a business model. They aspire to become adept at raising VC money and "exiting" in a few years. What ever happened to the idea of building a real business, funded by paying customers? How about building a company that can stand alone, built to last?

In a book called Predictable Irrational, I found a story that every entrepreneur should think about.

In 210 BC, a Chinese commander named Xiang Yu led his troops across the Yangtze River to attack the army of the Qin (Ch'in) dynasty. Pausing on the banks of the river for the night, his troops awakened in the morning to find, to their horror, that their ships were burning. They hurried to their feet to fight off the attackers, but soon discovered that it was Xiang Yu himself who had set their ships on fire... With their ships gone, the soldiers had no route of retreat. Winning was the only option. 

They won 9 battles in a row before defeating the mighty Qin forces.

If you are an entrepreneur and you think that you will need some more funding to survive - or thrive - I have one piece of advice for you. Burn the ships.

Fat and Happy

One of the biggest challenges that start-ups face is inertia. When you hear comments like “things are fine the way they are” or “there is no interest in making a change right now,” entrepreneurs, or any pioneer, will have a very difficult time making headway.

If you're an entrepreneur, I have good news for you. Fat and happy people are in short supply these days.

The world is ready for change. This means that you will be able to accomplish things that were simply not possible before. Isn’t this is one of the reasons that someone like Barack Obama got elected President of the United States?

Entrepreneurs are not only the agents of change, they are the beneficiaries (see creative destruction).

This is not a time to panic. This is the time to act and to take advantage of the great challenges and opportunities that lie ahead.

Over the past few months, I’ve sensed a subtle but real change in attitude. The ones who are not paralyzed seem more determined than ever. People seem more hungry, more creative, more open minded. They are also more realistic. They face problems with new resolve.

Of course, not all start-ups will do well during tumultuous economic times. But I also believe that it is during times like these, when everyone is NOT fat and happy, that the conditions are most ripe for great new companies – and perhaps great new industries - to come out of nowhere and help change the world.

The Death of Tech and Entrepreneurship?

I had an interesting chat the other day with a former venture capitalist who is now doing private equity (i.e. managing larger funds than ever before). He has given up on venture capital. Too difficult to make money, he said.

He observed that the technology industry has matured. Just look at a company like Oracle. Are they innovating or have they turned into another Computer Associates? Hard to believe that not long ago Larry Ellison used to make fun of CA for not innovating but growing by acquiring maintenance revenue streams. We also talked about the semiconductor and EDA industries. Very grim. Cadence is now trading at far below 1x revenues, yet the technical problems they have to solve are getting even harder as geometries continue to shrink.

One of the characteristics of mature industries is that it takes a lot of capital to start new businesses. For example, you cannot bootstrap a new auto company. It could take hundreds of millions, if not billions of dollars. In our own back yard, Tesla Motors is learning that lesson now (Tesla recently asked for $400 million from the government).

So, since the technology industry is maturing, his new investment thesis is that the only way to make the big bucks in high tech is to write big checks. That certainly fits well with his larger fund size that allows him to invest a lot in each company. It helps justify bigger management fees too.

That whole discussion reminded me of a quote from 1899 attributed to Charles Duell, the former commissioner of the U.S. patent office, who said "everything that can be invented has been invented" (actually, the quote is part of an urban myth. The story has been told so many times that even Ronald Reagan once used it in a speech).

I know that we are living through some difficult times, yet I remain optimistic about our future - the technology industry, entrepreneurship and venture capital. Before talking about the future, let's step back for a moment into the past.

Once upon a time, the railroad industry was thought to be "high tech." In the 1830's, rail road entrepreneurs in the U.K. were followed around by the media much as Larry and Sergey are followed around now (or Marc, Meg and Jeff during the Internet bubble).

Many decades later, the auto industry was thought to be "high tech"...and then there was the aerospace industry...the "electronics" industry...these thing called UNIVACs and Mainframes, etc.

Who would have thought that a college drop-out with no funding would hobble (if not topple) IBM, once the most admired company in America? IBM was so powerful that the U.S. government tried for years to break it up, just as it tried to do with Microsoft. It may try it with Google at some point too.

Sometimes, it doesn't even take a high tech wave to create enormous new companies. UPS and Wal-Mart are examples of companies that would require massive amounts of capital to compete against today (they are the two largest employers in America, not counting the government). They were both bootstrapped companies. Neither company raised any outside capital to get going and to reach profitability. They had modest beginnings...but kept growing for decades and rode various technology waves along the way.

The common theme is that entrepreneurs, over hundreds of years, have defined and re-defined what is - and what is not - the latest and greatest. "High tech" or not, entrepreneurs change the rules of the game. They help create waves (or just ride them) to help topple once dominant corporations.

It seems that great companies of every era get toppled by the next generation. Typically, the next gen seem to rise out of nowhere because they start very small, often without much fanfare. They are too small to notice - until it's too late for the incumbents. It takes less time for the average Fortune 500 company to drop off the list than it takes to grow big enough to make the list.

Destruction is all around us these days. Even companies well established for decades are dying right before our eyes, sometimes evaporating in a matter of days. We are also seeing once great, fast growing industries and once innovative, entrepreneurial companies stagnating, perhaps dying slowly. However, this doesn't mean that we're at the end.

Entrepreneurs, even those with venture funding, can't possibly match the resources of large corporations. Yet, entrepreneurs always seem to figure out ways to do the what conventional wisdom thought was impossible. I'm more optimistic about the future than ever because, as venture capitalists, we see exciting developments all around us. Let me provide a few examples.

I'm on the board of a company which saw an announcement that had strategic implications late last week. On a Friday night, the team got together and hashed out a strategy. They came up with new specs for a product. About 48 hours later, the CTO came up with a new product release (apparently, he doesn't sleep). Unbelievable. Such a thing would not be possible without the Internet infrastructure and the innovations that have come before us. A few years ago, even a team of engineers spending months may not have been able to do what a single engineer can do now in a matter of days.

Another example is a company which is using Amazon's cloud services. As they closed major deals, they were concerned about scalability. They had great software engineers who knew little about configuring routers or managing large farms of servers. Now, a software engineer can put out a new release without leaving his bedroom. The company has increased its ability to scale by 1,000x with less work than ever before. An added bonus was that this required no more up-front capital - which really helps in today's environment.

I have so many more examples. It is easier than ever to bootstrap companies. Salaries are coming down. It is easier to find people. Real-estate is getting cheaper by the week (we've seen office rental rates drop 30-50% in the past 2 months alone). In a meeting with Kanwal Rekhi this morning, he told me that the "fear of God is back. This will lead to better companies. More cost conscious. More disciplined."

I continue to be utterly amazed at what a few good engineers can produce these days. But there's more. It's not just about technology. We are seeing unexpected innovations in business models. New revenue and cost models are being created that were not possible even a few years ago (this should be a topic for a future blog post).

The bottom line is this. The pace of innovation is quickening, not slowing down. It's getting cheaper, not more expensive. Yes, if you want to start a new oil company, it will be expensive. A new auto company? Forget about it. A new ERP company? Workday is finding out that it's pretty expensive. Such ventures are not for us because we bet on entrepreneurs who bootstrap. By necessity, they don't go after opportunities that huge competitors with deep pockets go after.  

As long as I'm a venture capitalist, I will continue to bet on entrepreneurs who can do a lot with very little. They surprise us every day. They are our heroes.

The entrepreneurs we see all around us are very hungry. They will struggle - but they will not stop dreaming. They will not stop innovating. They believe. They will endure.

RIP Good Times? A Different Perspective

Rip Good Times A Different Perspective

View SlideShare presentation or Upload your own. (tags: venture capital)

I put this presentation together to encourage a group of entrepreneurs I was to speak to at a conference in Reno, NV last week.

It's funny how times change.

People who have been following our blogs over the past 2 years know that we've had a more pessimistic, contrarian view of the venture business, even as the number of VC investments, fund sizes, deal sizes and valuations had been going up.

Now, of course, the world is totally different. Whether or not you believed that we were in a Web 2.0 technology bubble, Sequoia declared that the good times were over and it's now time to hunker down and fight for survival. In their widely publicized "RIP Good Times" meeting, they extolled the virtues of cash conservation to all of their CEOs and told them that they had to change in order to survive.

Now, we are contrarians again.

Our companies did not need Sequoia to tell them cash is king. They had been operating that way for years. In fact, more than a third of all of our companies are on track to be profitable this quarter. Many have been maintaining profitability while growing for many years.

The reason that we feel like we are contrarians again is that we have not seen such a good environment for building companies in years. Entrepreneurs are more focused on getting to profitability and building companies based on solid fundamentals. Before, we felt like lonely voices in the VC world, which seems to be filled with people working toward billion dollar exits for money losing companies.

Over this entire year, we've noticed a trend. Some of our companies started seeing a steady flow of high quality resumes from competitors. I think it's now about to turn into a flood! It will be much easier to hire great people who are more hungry and realistic about compensation and how long it will take to build shareholder value.  

For entrepreneurs in it for the long haul, this downturn just bought them more time. Impatient VCs won't be hounding them to take more risk, to grow faster, to get more aggressive. Remember, as an entrepreneur, you have one company. You don't have a portfolio of companies. You can't afford to play venture lotto.

Remember what we said back in 2006 about Foxes and Hedgehogs in Silicon Valley?

"Foxes are great at raising capital - they thrive in bubble markets. Hedgehogs would rather bootstrap - they do far better during the inevitable crashes."

For all you hedgehogs out there, this is your time to shine!

Financial Weapons of Mass Destruction

The events of this past week made me scrap the article I was working on to write about the crisis in financial markets.

Warren Buffet first wrote about "Financial Weapons of Mass Destruction" in Berkshire Hathaway's 2002 annual report. When it was published in March of 2003, there was quite a bit of press coverage, as there is every year after he publishes his annual letter to shareholders.

In an article written by the BBC, Buffet warned of "time bombs." It seems like the first of many bombs went off a couple of years ago, with the decline of the housing market (and housing stocks), leading up to many more bombs in the past few weeks.

If you read his words, Buffet is quite vivid. His warning was not about the housing bubble or sub-prime loans or even the trillion dollars in CMOs (Collateralized Mortgage Obligations), the pass-thru assets which helped create the mess in the banking industry. Buffet was criticizing ALL derivatives.

Warren Buffet thought some derivatives contracts must have been devised by "madmen." Charlie Munger would say it was sheer lunacy. Buffet talked about "mass destruction" and "spirals that can lead to corporate meltdowns" such as the one which took down LTCM in 1998. Buffet warned of "huge scale fraud" and compared the ENTIRE derivatives business to "hell...easy to enter but almost impossible to exit."

Despite the simplicity and clarity of Buffet's words, few people listened. Even now, people don't seem to understand the magnitude of the potential problems that lay ahead in the global financial system. The derivatives market has grown exponentially since 1998, the year LTCM blew up. The global derivatives market is now more than $500 TRILLION, up more than 10x since Buffet's initial warnings.

So my question is this: how is a $700B or even a $1 Trillion bailout by the US Government in the mortgage market going to make a dent in the overall $500 TRILLION dollar market of even more complex, esoteric derivatives contracts???

How depressing. This is why, as a VC, I don't usually think about or comment on macroeconomic issues. Entrepreneurs and VCs build one tiny little business at a time...and once in a while some of those turn out to be winners that impact the lives of millions of people.

Believe it or not, I'm still quite optimistic about our future. We will get through this. This is nothing like disease, famine or war (at least, there is no war on our soil). There are many companies that are still growing and generating profits and cashflow here in Silicon Valley and around the world.

Most start-ups have no exposure to derivativew contracts and little exposure to the overall financial markets. Yes, the IPO market is closed (for now) but if you have a company which generates cash, you will be fine.

For example, one of our companies - one which has been private for more than 10 years - recently issued a cash dividend which paid out more than our entire investment, just as they did last year. They generate multiples of that dividend in free cashflow every year. Every acquisition they've ever made was paid in cash so I'd suspect that they can continue to fuel organic growth as well as future acquisitions. If they continue to generate cash and pay out more than invested capital every year, it would not be so bad, would it?

If you are counting on bubbles or "madmen" to pay crazy prices for your company when you raise capital or when you try to "exit" you will be sorely disappointed in the coming years. You might even wind up in unemployed lines along with those well educated investment bankers. But if you have a real business, one which delivers value to customers who will keep coming back over and over again, I suspect that you will do just fine. Just keep focused on what you are doing and don't get distracted by the macro issues that seem to swing paper valuations wildly day to day.

The macroeconomic problems we face today are issues that even Warren Buffet can't figure out. That hasn't stopped him from going about his business every day. Those hedgehogs just keep moving forward one step at a time. Since that BBC article in 2003, Buffet has increased his net worth by more than 50% to overtake Bill Gates as the wealthiest person in the world.

Ousting the Founder

I was shocked to learn this week that Diane Greene, the co-founder and CEO of VMWare was ousted. I was not alone. Except for senior management (who found out very late, the night before) the employees of VMWare read about it, just like I did on Tuesday morning.

I guess $1.3B in revenues, $14B market cap, 50% growth rate and market dominance was not good enough for the board/EMC. One slight miss in one quarter and BANG! You're out. Perhaps the board believed industry pundits and worried about competition from Microsoft. So they brought in a "heavy hitter"...former Microsoft exec Paul Maritz as CEO.

I'd guess that the more likely reason was that Diane Green was a difficult person to deal with. There is no doubt that she was a controversial CEO. It was her way or the highway and she churned through senior execs (especially in sales and marketing). She never gave much respect to the folks at EMC either (who owned the vast majority of the stock - and controlled the board).

Some other hard-headed, "controversial" founder/CEOs that come to mind are Bill Gates, Larry Ellison, and Steve Jobs. These founders may be difficult to deal with but I'd rather go with them than take my chances with a new hired gun CEO.

Over the years, we've observed that it's difficult, if not impossible, to match the passion and commitment that founders bring to their companies. It's not just a job for them. It's deeply personal. The difference in commitment is akin to the differences you might observe between missionaries and mercenaries (or hedgehogs versus foxes).

Look, I have nothing against Paul. I'm sure he's a very smart, capable and hard working guy. But this whole situation reminded me of the time Steve Jobs was ousted from Apple more than 20 years ago.

As co-founder and CEO, Diane Green built one of the all time great successes in Silicon Valley. Very, very few companies ever reach $1B in revenues. Even fewer in the technology industry. Even fewer in the software industry. And even fewer ever exceed $10B in market cap.

Why the hell would you fire her?? No, don't tell me...I've heard all the reasons. VCs oust founders all the time. I've been in plenty of board level discussions around this topic!

It's almost a rite of passage in Silicon Valley. As a founder, you start a company, get VCs to fund you, recruit a "world class" management team...and eventually, find your replacement (or get ousted).

What people seem to miss, however, is that just about every great company ever created - in technology as well as low-tech, was built by a founder (or a CEO who happened to join the company very early in its growth phase) and a team of dedicated people who grew with their companies.

I don't believe in "world class" management in the generic sense. "World class" in what??

What I believe in is people who learn on the job and become - over time - the best at what they do. Along the way, they make plenty of mistakes. But that's part of the learning (and perhaps the luck of it - because the mistakes happen to be not fatal for the survivors).

Think about it. Some examples of great companies led by founders for decades are GE, UPS, FedEx, Wal-Mart, Southwest Airlines, HP, Intel, SAP, SAS, Apple, Oracle, Microsoft, Adobe, Sun, Dell, Qualcomm, Broadcom, Nvidia, Dolby, Amazon.com, Salesforce.com, etc.

There are some great companies where the original founder(s) did not grow the company but the CEO who grew the business to $1B+ in revenues joined very early on in the life of the company (typically below $10mm in sales): IBM, McDonald's, Starbucks, Veritas, Cisco and Google are examples.

It'll be interesting to see what happens. Even a founder hanging on to the bitter end won't save some companies (i.e. Wang, DEC). But I'd rather take my chances with the founder who built a $1B business from scratch than go with someone new.

The average tenure of the CEOs in our three largest companies is 9 years. They learned on the job. None of them had been CEO before we started working with them. None had much experience in their industry - the market did not exist, and the technology and business models had not yet been invented. But they are guys who took us this far (average sales of nearly $90mm this year) and we will gladly stick with them as long as they still want the job.

I'd rather take my chances with the people who built the business and grew their companies than the "professionals" - the hired guns - the mercenaries - coming in, after the fact, to "fix" things or to "take it to the next level."

We tell all of our companies this - if you want to build the leader in your industry, you have to have the world's leading experts in your field working for you. But do NOT expect to find them outside of your company. Someone senior from the outside won't come in to show you the way. They won't save you.

Think about it. If you can go outside and hire a CEO or other very senior executives to come in to YOUR company and tell you what to do and how to do it - better than you - then you've created nothing special. There is no secret sauce and you have NO CHANCE of building a truly great company.

We like to tell all of our companies this - the world's leading experts in your business will be the people you develop. The young people you hire today will be your future leaders. Five to ten years from now, they will BE the world's leading experts in your business. You will have to figure it out - together - along the way.

Don't count on those mythical "world class" managers to come in to save the day. Not only are there no guarantees, I believe they will end up hurting your chances of building a special, lasting company. If you do try to hire them anyway...good luck. What I will guarantee is this - they will negotiate HARD for a nice severance package.

Failing Fast

Lately, I’ve been telling all our companies to fail.  Fast.

It’s not that I’ve decided to throw in the towel. Quite the contrary. After doing startups for a dozen years, I’ve come to believe that the best way to maximize the chance of a big success is to fail often and fail fast.

Thomas Edison was one of history’s most successful failures. He failed more than a thousand times before inventing the incandescent light bulb. When Edison finally figured it out, he famously said: “I didn’t fail a thousand times. The light bulb was an invention with a thousand steps.”

The idea of taking a thousand steps is core to our investment philosophy here at Altos.  We’ve come to understand that every company goes through a series learning processes – about new markets, products, distribution strategies, etc. My partner Brendon wrote a great post on the fact that there is just no substitute for time when going through these learning cycles. Sometimes, the outcome of learning means tweaking the product to meet unforeseen customer needs; other times it means completely scrapping the business model and starting fresh. In fact some of our most successful companies started with one business and ended up with something entirely different. Put a smart, tenacious team against a big market opportunity with enough operating runway, and you have a decent formula for success.

Failing fast is even more imperative in the world of Web-based software and services. Back when I was a rookie product manager, I’d spend months perfecting product requirements documents (PRDs) that would disappear into an engineering organization only to emerge months or years later as a finished software product. Nowadays, that one-shot, monolithic approach is just not a competitive option.

Failing fast requires companies to think about perfecting their products differently. To quote LinkedIn founder Reid Hoffman, “If you are not embarrassed by the first version of your product, you’ve probably launched too late.” Perfecting a product the first time out is impossible, but getting it out and iterating a thousand times just might get you close.

Some of our best development teams cull user feedback into new priorities to build/test/release on a weekly cycle. It doesn’t really matter whether they are using newer lightweight tools like Ruby on Rails and Adobe Flex or “heavier” Microsoft-centric stacks. The key is to obsessively listen to and incorporate feedback from Web users who aren’t afraid to tell you if their release sucks (or not). Keep what sticks, toss what stinks.

Of course, just failing a lot is no guarantee for success. There are plenty of teams that just fail all the way to a big fat zero. These teams either spend too much time and money failing or don’t fail in the right ways. Let me elaborate:

One corollary to failing fast is failing cheaper. Josh Kopelman has a good post (and investment model) on this, so I’ll let that him tell you all about it.

A second corollary to failing fast is failing well. Systems that fail well compartmentalize and minimize a failure so that it does not impact the whole system – for instance, a sealed chamber in the hold of a cargo ship that allows a single area to absorb damage without flooding the entire hold. Failing well is a lesson most of us learned in high school chemistry lab: isolating experimental variables by using a scientific control. Similarly, start-up teams that fail well run multiple experiments to get small, controlled failures. These teams understand that failure is a desirable and necessary byproduct of the learning process. They are humble, smart and fast.

So don’t be afraid to fail. Don’t even be afraid to be embarrassed. It’s all just part of being successful.

No Substitute for Time

Like many things in life, there is no substitute for time. A solid enduring company takes time to build for a number of reasons.

Markets take time to develop. How many times have you encountered venture-backed companies that reminds you of startups that failed years ago? These companies were too early to market. The infrastructure wasn’t there the first time around. The experience wasn’t right the first time around. The customers weren’t ready the first time around. Startups, by their nature, are early to the market and they have to wait for the market to catch up. Many startups try to push markets to develop faster with evangelical selling and marketing, essentially substituting time for money. But, success is rare and certainly expensive. More often than not, they pave the road to riches for companies that follow them.

Companies take time to develop. Look at the history of “overnight successes” and you’ll find that they actually took many years. That’s certainly true of many of the larger and enduring companies in Silicon Valley. On average, venture-backed startups take seven to eight years before an exit of any kind. Looking at IPO’s over the past several years (post-bubble), companies take an average of eight to nine years to exit. Products take more time to perfect, business models require more experimentation and sales take more time to ramp than expected. Some of the best companies we have backed have taken several years and several course corrections before finding success.

Managers take time to develop. Nothing beats learning from experience, but this takes time. You can try to learn from others, but nothing leaves as strong an impression as personal experience. Over the years and over the dozens of companies we have backed, we’ve come to recognize that certain pitfalls develop time and time again. We’ve found that no amount of cajoling or arguing can keep management from avoiding certain types of mistakes and that in some cases we shouldn’t try.

There’s no better teacher than reality. We try to minimize the impact of mistakes and help avoid repeating them. Many companies seek to circumvent the need for time by throwing out the founders or current management and parachuting in "proven" people with built-in experience who have “done it before.” Unfortunately, they’ve done it before elsewhere. Each company, especially at startup, is unique and offers different lessons to learn. And by jettisoning existing management, the company can lose valuable experience and learning that has already been acquired.

That solid businesses take time to build seems obvious. Yet again and again, we see entrepreneurs who present business plans that show growth from zero to $100 million in five years or less. Again and again, we see investors who want or expect such growth and dismiss companies with smaller numbers as unsexy, unambitious, niche opportunities.

All of this is not to say that a startup need not move fast or that we'll wait around forever for people to learn from mistakes. Let’s not confuse the fact that some things take time with a low sense of urgency, moving slowly, or tolerating inept management. A startup should always move as quickly as it is able. It is the ability to move quickly and nimbly that gives a small company an advantage. But if a startup is moving so quickly that it is years ahead of the market, or never has a chance to develop a sustainable business, or allow its people to develop the skills to run the business, it will not develop into a solid enduring company.

All of this is to say that entrepreneurs and their businesses should be pragmatic even as they keep pushing harder and harder, trying to do what may seem impossible to those with less faith. Decisions should be made understanding that some things just take time. A startup should be capital-efficient. The cash burn should be low so that you can wait out immature markets, so that you can experiment with the business model, so that you can change course when necessary, so that you can learn from experience, so that missteps are less costly. Managers should question the rate of growth, especially in the early years. How ready is the market in reality? Do plans account for the time necessary to tinker with the business, the fact that people need time to learn, the reality that many of the new hires won’t work out?

As they say, you can’t put nine women in a room and deliver a baby in a month. The process can’t be rushed. The same is true of a truly good company. We back entrepreneurs who appreciate this and plan for it.

The Ramp Phase, Jack Welch and a Coin Flip

The "ramp phase" is a period that my partners and I define as a hyper-growth phase somewhere between $10mm and $100mm in sales. It is perhaps the most exciting period in a young company's development. After years of hard work and tinkering, getting the product, packaging, pricing and positioning right (or at least good enough), you think that your company is finally ready to scale. By the time you reach this phase, you have a business model that is starting to work and lots of raving customers. Most companies don't even make it this far, so you are feeling great about things...

At this phase, most VCs are ready to invest big dollars and encourage entrepreneurs to be aggressive. They say, it's time to break through or get left in the dust. VCs don't invest in lifestyle businesses, you have to go for it!  Don't sand bag. Shoot for the moon! Those projections are not exciting enough...it's not BIG enough...the stakes are getting bigger...yada, yada, yada.

Let's get real.

Something that we see all the time when we drill down into sales projections of start-ups is a failure to take into account hiring mistakes that inevitably occur as companies ramp a sales-force.

Sales is typically the department which has the highest turnover in companies going through the ramp phase. Over the years, we've seen hundreds of sales reps get hired (last year alone, our companies hired 200+ sales reps) only to see most of them struggle, get fired or quit at some point along the way.

Based on our experience, less than one out of two new sales reps end up working out. Whether you have voluntary or involuntary turnover, the end result is the same - you end up with fewer sales reps than planned.

Given the time spent on each hire (plus recruiting fees) a lot of precious start-up resources are wasted. Some of this waste is unavoidable. It's just the cost of doing business. However, we believe that most of the waste can be avoided if companies apply some realism.

For example, when it comes to making sales rep or any other types of hires, the sobering reality is that many mistakes will be made. In fact, it's a virtual coin flip according to Jack Welch (who recently discussed this issue with one of our CEOs).

What exactly did he mean by this?

Basically, Welch thought that he was no better than 50/50 early in his career. Half of the hires he made were good and half were mistakes (which he tried to correct as quickly as possible).

Think about it. If Jack Welch (one of the most respected and talented businessmen of his generation) thought that his hiring decisions were no better than a coin flip, what are your odds?

Over the course of his career, Jack, of course, did get better (he was a learning machine and tried to mold GE into a learning organization). How much better?  Well...after 40+ years of hiring and firing people, Jack thought that he got to 70/30 for really important hiring decisions - such as a CEO hire.

In other words, even at the end of his career, he was very aware of the fact that he can (and would) make hiring mistakes a large percentage (at least 30%) of the time - no matter how hard he tried to avoid them.

The bottom line is this - making good hiring decisions is extraordinarily difficult to do. It's a super high risk activity. The risk level is higher, of course, when you're looking to fill critical positions (like CEOs) but even for lower rank, more "cookie cutter" hires (like sales reps) the risk is high (at least much higher than most people perceive).

So, as a CEO or VP Sales of a start-up projecting that "shoot for the moon" sales ramp, you have to ask yourself this question....are you going to be much better than Jack Welch at sizing people up?

If not, you had better plan for at least one in three new hires NOT working out. If you want to be realistic, plan on every other sales rep not producing for you (and try to correct your mistakes ASAP). If you actually planned for this, how would you modify spending in the rest of the company? How would you change your plans on ramping marketing, customer support, R&D, etc?

If you are indeed a superstar (or just super lucky) and you end up making better hiring decisions than Jack Welch...good for you. Use the extra cash-flow generated by your sales-force to reinvest for even faster growth.

But for planning purposes...I would not count on being much better (or luckier) than Jack.

Fear of The Living Dead in Venture Capital

It was not until I got into the VC business that I found out about the terrible, dreadful "living dead" - a term used to describe companies that merely survive, without future prospects. Normally fearless VCs fear the living dead. So do our LPs (the people who invest in VCs) who worry that we might waste our time (and their money) on a bunch of little companies that go nowhere.

Venture Capital is a "shoot for the moon" - go for the homeruns - business (for more on this topic see Swinging For the Fences). Most deals won't work out but great VCs bounce back quickly and easily. They focus on the winners and waste as little time as possible on the losers. When you think about it, the living dead might be far worse than the total losers because they continue to go on and on...potentially sucking up valuable time, energy and resources...indefinitely. Yikes! No wonder VCs fear the living dead!

The bigger you are (whether in size of wallet or ego) the more you will think that wasting time and money on little ideas and small deals is not worthwhile. For example, Larry Ellison believes that there will be only a handful of survivors in the software business - Oracle, Microsoft, SAP and IBM. To Larry, all others in the software business are as good as dead (or the living dead).

BUT, if you're really dead, then you have no chance.

In the VC business, all of our companies, even the very best, follow a rather bumpy and windy road. In the beginning, every company looks like a struggling little company with uncertain prospects.

The best approach to take in venture capital is to relish in uncertainty and to have a little humility.

There is no way to control outcomes in the start-up game. What you can control is whether or not you do your best and make sound decisions (like spending your time and money wisely) and just deal with problems (and take advantage of opportunities) as they come. If you stay hungry and learn along the way - and just manage to somehow survive - you give yourself a chance to make course corrections, take advantage of changes (often unexpected) in market conditions, or just get plain lucky once in a while.

So let's get back to basics...if you really want to have a chance at a homerun, you have to, first and foremost, make sure that your company survives.

Surprisingly, this is not obvious to some people.

One prominent LP once told me that he would rather have us return NOTHING than to play it safe. He was serious - dead serious. He wanted "volatility" because that's what is expected from the so called VC "asset class."

When I first heard this advice I was a bit shocked!

At Altos, rather than worrying about the dead, the living dead or the homeruns, we focus our early stage companies on getting to 1st base - typically around $10mm in revenues - without burning through a lot of capital.

If we can get to 1st base, then we might start to believe that there could be an interesting business forming. In our experience, most companies don't even make it that far, especially if people get obsessed with creating the next BIG whatever.

After reaching 1st base, some companies might go out of business (the equivalent of getting tagged out at 1st), or get bought out, or start slowing down. Only a minority of the companies that make it to $10mm, make it to 2nd base, or $40mm in revenues. At that level, we start to be fairly certain that we will have a winner...but we still don't know whether or not we have a homerun.

At this stage, some more companies might get acquired and others will start flattening out in growth (start-ups rarely go out of business at this stage but, as in baseball, you CAN get tagged out from 2nd base). Again, only a minority of companies break through to the next level...this time to 3rd base, or $100mm in revenues.

Once 3rd base is reached, VCs will typically get a 10x return on investment (sometimes 100x-1,000x, depending on market froth/timing). By that time, we also know that management is competent, scrappy and adaptable, through multiple iterations of products, strategies, business models.

By the time a company gets to 3rd base, at least 5 years (sometimes 10+ years) have passed. In the technology industry, that's an awfully long time! Whether or not a $100mm company can become a much larger company depends on countless factors that are largely unknowable at the time of investment.

We will submit that there is no way to know - a priori - which company will turn out to be a homerun at the time a company starts out (or when VCs invest).

Here is a thought experiment.

If you were really great at predicting the homeruns (and the losers), what would happen if you abandoned the VC business and started a hedge fund? If you can predict the winners and losers when companies have insignificant revenue streams, then you should be even better at predicting when companies reach $100mm (around the time of an IPO). Hedge fund managers can invest tens or even hundreds of millions of dollars at a time - buying or shorting public companies.

If you had invested in companies such as Oracle, Microsoft, SAP, Dell, Cisco and dozens of other companies shortly after their stocks were publicly available, you could have made 100x or more on each deal. So why waste time investing single digit millions in puny little companies?

As VCs, we love investing in tiny little companies started by passionate founders in interesting, dynamic markets. They always start as small, obscure, insignificant little companies that struggle along the way. The path is NEVER smooth!

It is a fact that most VC backed companies won't even make it to 1st base let alone home plate. But if we build solid businesses, based on sound fundamentals, we've seen that some do break through...to 1st, then 2nd, then 3rd, before reaching for home. We just don't know which ones will break through, often for many years after we invest.

We have ten year funds because it takes time as well as a great deal of hard work and suffering, enduring the ups and downs that come along for each and every company as they grow.

But hey, I'm not complaining about all that suffering (didn't Buddha say that "life is suffering"?). We actually love the bumps and bruises we get along the way. Some might say it builds character. But that's not the real truth. To actually LOVE IT, I'd say that great entrepreneurs, as well as VCs, are a bit quirky (some might even say that they are mentally imbalanced).

Rational or not, it has taken me a while to get over my fears...I fear not, the living dead.

The Peter Principle

The Peter Principle is often cited as a cynical view on management. Basically, it says that people are promoted until they reach a level of incompetence after which further advancement is not possible. Taken to the logical extreme, at some point everyone will be incompetent - it will only be a matter of time!

The funny thing is, I actually view the Peter Principle as an optimistic view on  management. Reality is worse (which is why Scott Adams came up with the Dilbert Principle, but I digress).

I would love to see the Peter Principle at work. In the old days, you had to work your way up from the bottom. For example, at UPS, you might start at the loading docks and if you were successful, you would become a truck driver. Eventually, you might get promoted to management - at first, managing a single warehouse, then a district, then a region, etc. The CEO and senior management have decades of experience from the bottom up.

Successful entrepreneurs (the ones who actually build their companies long after the start-up phase) are the ultimate bottom up guys. I've seen entrepreneurs goto Fry's Electronics to buy parts, crawl under desks to install wires, move furniture, clean up conference rooms,...heck, they might even scrub toilets. They do whatever it takes. 

A good friend of mine (and experienced serial entrepreneur) once remarked that "80% of the work at a startup is mundane & inglorious, and exactly the type of work that most people will put off for months in their daily lives (the equivalent of balancing the check book)."

Perhaps making progress one step at a time is not so glorious. These days, young people are in such a hurry to take short cuts that it's hard to find people who actually did demonstrate competence before they were given a chance to take the next step.

How many times have you met a manager who had no clue what their employees did? If companies followed the Peter Principle, at least a former programmer would manage programmers so that they would understand technology and be able to mentor young programmers. If companies followed the Peter Principle, at least a guy managing sales reps would have carried a bag before and would know what it felt like to handle rejection after rejection.

Unfortunately, as we enter yet another bubble (at least in certain sectors of the venture economy), we're seeing people with scopes of responsibilities far beyond even their Peter Principle level of incompetence.

But the problem isn't just caused by MBAs and young whipper snappers looking to skip a few rungs of the ladder as they climb to the top. It's also caused by investors, boards and corporations looking for quick fixes.

In corporate America high profile mercenaries are hired into businesses with obscene compensation (and severance) packages. It seems that even if they destroy value, they can walk away with millions of dollars (hundreds of millions in the case of Bob Nardelli and Home Depot).

The same goes for investors. How many VCs and other money managers are handling large sums of money far beyond what they are capable of managing? It seems that every Joe who has a decent track record with a small pile of money tries to raise much larger funds.

The world might be a better place if the Peter Principle were really true.

At our best companies, we avoid mercenaries who enter from the top. We try to hire smart, young people, challenge them, nurture them, and develop them over many years. It takes great patience, dedication, and commitment (on both sides) but it's well worth it. These people will become the future leaders of our companies.

Even if every hire doesn't work out or even if many of them eventually reach their levels of incompetence, to me, the Peter Principle doesn't seem all that bad. We're never at that theoretical "end point." We're always in transition, striving toward the next goal. If people are actually competent and have the patience to demonstrate competence at every step along the way, we might be much better off.

Cashing Out

At a board meeting after a recent financing, one of the VCs picked up a stock certificate (delivered to investors during that meeting) and said that he hoped that this piece of paper will be worth something someday.

I responded by saying that the stock is worth something now. Our firm would be happy to buy all of the shares represented by that piece of paper. In fact, we had already bought some shares from existing investors.

When we made our decision to invest, we believed in the management and the direction of the company. Our desire was to take a significant ownership in the company. We got to our minimum % ownership...but we would have wanted to buy more if people were willing to sell.

The UPS Story

One of the stories I like to tell is that of UPS, which is celebrating its 100th anniversary this year. Founded in 1907, they did not go public until 1999 (it was the biggest U.S. IPO ever - $5.47 Billion worth at $50/share). For 92 years, as a private company, there was always plenty of liquidity for shareholders because the company was growing and profitable.

UPS is a remarkable company. Even while helping to spread Unions, providing healthcare benefits for part-time workers, paying for lifelong continuing education programs, and promoting employee stock ownership and sharing the wealth, they grew revenues and profits almost every year and never had layoffs - even during the Great Depression. With millions...and eventually billions in revenues and profits, they had no trouble finding buyers and sellers of their stock, even as a private company.

Over the decades, UPS has probably created more millionaires than Microsoft and Google combined (many UPS truck drivers became your typical "millionaire next door"). Unlike private companies such as Cargill or Bechtel, UPS ownership did not remain in the hands of a very small number of family shareholders. The shares belonged to tens of thousands of employees (now hundreds of thousands, as the third largest employer in the U.S.).

In the case of UPS, the founder, Jim Casey's various foundations are now worth billions of dollars supporting causes such as underprivileged children's education (Jim Casey had to work to support his family rather than attend high school).

What we like to tell entrepreneurs is this - if you build a company that generates cash, your stock certificates be worth something. If the company is growing, then it will most likely be worth more the next year, and the year after that...

There are always buyers of stock in companies that are growing and making money. The higher the growth, profits, and competitive advantages, the greater the intrinsic value. It's as simple as that. It doesn't matter if the company is public or private.

When UPS was still private, the board determined the price of stock every quarter. They followed a rational process and valued their stock according to the same principles that we follow. These days, due to 409a regulations, we even bring in third parties to validate our logic in setting a fair stock price.

Rather than obsessing over cashing out and the "liquidity event" entrepreneurs would be better off if they focused on building value. The liquidity is secondary. There will always be buyers of stock in companies that are doing well. Sophisticated investors don't care if your company is public or private.

For example, Warren Buffet doesn't care if an investment is in a public company like Coca Cola or a private company such as See's Candies. He'll buy if he believes that 1) the business is great, 2) the price is fair, and 3) management is trustworthy, competent and passionate. He's not necessarily looking for bargain basement prices. (Buffet likes to say that it is far better to buy a wonderful company at a fair price than a fair company at a wonderful price).

As VCs, we look to be co-owners of wonderful businesses with tremendous long term growth potential. Such businesses are rare - really rare. An opportunity to buy a significant stake in such a business is rare enough that there will always be plenty of buyers if some (or all) shareholders desire to cash out along the way.

Another example I like to tell people about is Vesta, one of our private companies that has grown to over a thousand employees in a decade (much of it during the post bubble crash). We've had more than 24 consecutive quarters of earnings growth and paid out tens of millions of dollars in dividends with excess cash, even after making significant investments to fuel continued growth (including several acquisitions - all for cash). The company has also bought back stock - just as public companies initiate stock buy back programs to reduce share count and increase per share earnings.

At another private portfolio company, one of our executives recently sold shares to buy a bigger house (his growing family needed it). The company is doing well (the common stock price has tripled in the past year) and there were plenty of buyers. In fact, some potential investors were almost begging to get in (at the price those shares traded, none of the other executives wanted to sell).

I can recite many more examples. We've bought and sold plenty of private as well as public company shares (common as well as preferred shares). Such transactions happen all the time.

The bottom line is this - build a great company and your shares will be worth something - a lot more than it is today. Don't worry about liquidity. The key is building sustainable, long term value.

Cargo Cult Capital

During a Caltech commencement address one of my childhood heroes, Richard Feynman, introduced a tribe of people who practice a peculiar form of science. Here  is an excerpt:

"In the South Seas there is a cargo cult of people. During the war they saw airplanes with lots of good materials, and they want the same thing to happen now. So they've arranged to make things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head to headphones and bars of bamboo sticking out like antennas -- he's the controller -- and they wait for the airplanes to land. They're doing everything right. The form is perfect. It looks exactly the way it looked before. But it doesn't work. No airplanes land. So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they're missing something essential, because the planes don't land."

In past articles, we've described VC investments as "controlled experiments." We don't build new businesses through random trial and error; we develop them through a process of deductive tinkering. We try things out and perform tests against market realities, the way that scientists set up experiments to test hypotheses - and iterate and adapt along the way.

Unfortunately, almost three hundred years into the scientific revolution most people still don't get it. Perhaps this should not be a surprise. From a genetic perspective, humans beings are still pretty much identical to neanderthals who honed their instincts roaming the Earth for more than two million years.

Using Feynman's analogy, many people practice a form of business which I call "cargo cult capitalism." Delusions in the business world have been covered in books such as "Fooled by Randomness," "Hard Facts" and "The Halo Effect" so I'll focus on a special form of cargo cult capitalism practiced right here in Silicon Valley.

In our neck of the woods, the planes revolve around "top tier" venture capitalists who have become mini celebrities...sort of like in college sports, where coaches tend to be the stars (in the big leagues players are the stars). If entrepreneurs are fortunate enough to get funding from a Silicon Valley celebrity, their company might gain instant credibility and become branded as the next hot thing.

There are service providers who market the fact that they have "access" to the top VCs. There are later stage funds who raise money based on claims that they can access deals of the top firms. There are also angels and "feeder funds" who hope to co-invest with top VCs by courting them from the other side. They cultivate relationships with powerful deal makers and give them first looks at deals so that they might invest once key "milestones" are met.

The cargo cult capital wheel keeps spinning around and around...as the crowds scramble to "get in" to what is hot (or what they speculate might get hot). Once funded, some entrepreneurs might feel like they are playing with the big boys. They retain the top law firms, the best PR agencies, and the most exclusive recruiters.

Armed with prestigious backing and exclusive relationships of kingmakers, the hottest companies hire the best talent that money can buy. The hired guns then create more frenzy...attracting even more capital to support ballooning headcounts and lofty salaries.

There are definite patterns followed by the cargo cult crowd. The form is perfect - the top deal makers, "world class" talent, a hot sector and business model du jour. Yet, ironically, I'd bet the next Bill Gates, Michael Dell, Phil Knight, Chuck Schwab, and Sam Walton are quietly going about doing their own thing...building companies based on business fundamentals.

Real entrepreneurs cut through the hype - they know what is essential. Their sense of pride doesn't come from who they know or what others think - it comes from making a contribution and creating value. They will do it their own way - which won't include wads of cash from outsiders. They figure out how to do more with less by using their brains, guts, and sweat.

Disruptive new entrants that topple giants belong to determined, frugal and independent minded entrepreneurs - and in their minds, the true stars are the customers they serve and their tireless co-workers who help turn dreams into realities.

Focus on the controllables

I came across this great quote by a guy whose father ran a jewelery store during the Great Depression. He carried on to build Helzberg Diamonds into a big enough (and wonderful enough) business that Warren Buffet eventually wanted to buy it:

"When growing up, I was intrigued that my father only concerned himself with those business elements that were controllable. He refused to acknowledge the Depression and did quite well during that period. He was unwilling to talk about recessions or 20-inch snowfalls. He only thought about and talked about those conditions within his control. I saw this daily in Dad’s actions. I never knew when the country was in a recession because Dad wouldn’t talk about it. People would suggest we close the store on Labor Day because everyone would be out of town. He’d say, “How many will be gone?” Of course, we’d stay open and do just fine. He taught us to concern ourselves only with those things over which we have control. I thought he was unique in this until I realized this is one of the key common traits of highly successful people. Those folks are never victims; they take what comes and handle the situation. The rest is a waste of time."

        - Barnett C. Helzberg (from "What I learned Before I Sold to Warren Buffet")

This quote hit me like a ton of bricks. Barnett Helzberg, in describing about his father, simply and concretely described a prototypical "hedgehog entrepreneur" in a way that I could not. (See Foxes and Hedgehogs).

Hedgehogs don't concern themselves with a lot of nonsense. They know what matters. They ignore the rest.

There are some clever foxes who see themselves as intellects who have a mission in life to combat oversimplification. They like to say, "well, actually it's a bit more complicated than that." True. Unfortunately, in the process they may obfuscate the issues.

Albert Einstein once said, "any intelligent fool can make things bigger, more complex and more violent. It takes a touch of genius - and a lot of courage - to move in the opposite direction." Most people understand that it takes intelligence and deep knowledge to simplify (if you can't explain something simply, then you really don't understand it). But why does it take "a lot of courage"?

Reducing complexity involves making decisions. If you choose to march down a certain path, it means you are cutting off your other options. In business and life, we always have to make decisions in environments of uncertainty. The need to choose can create fear, anxiety and paralysis. The choices can be tough.

By choosing, you are rejecting other options. You live with the consequences. Sometimes, it can be a matter of choosing between the lesser of evils. It's never black or white. We live in a Machiavellian world - full of greys (whatever his faults may have been, Machiavelli was a realist. He tried to see the world for what it was, not what he wished it to be).

Some people will find Heltzberg's advice not useful at all. They will ask, well, just what is controllable? What is not? What is knowable? What is not? What is important? What is not? The answers depend on the situation. There are no easy answers, no one size fits all formulas.

To quote Einstein again, "make everything as simple as possible, but not simpler." There are no pat answers. Think for yourself. Each situation is different. The only universal truth is that there is never a clear roadmap, no pre-defined plan (experienced venture capitalists know that business plans always change). Just be mentally prepared to "take what comes and handle the situation."

Great entrepreneurs thrive in environments with high degrees of uncertainty (like the Depression). They tinker, experiment and figure things out along the way. They stay vigilant because they know that change is constant and the world is full of risks and uncertainties. Robert Ruben, the former co-head of Goldman Sachs and Secretary of the Treasury had this to say:

"some people I've encountered in life seem more certain about everything than I am about anything. That kind of certainty isn't just a personality trait that I lack. It's an attitude that seems to me to misunderstand the very nature of reality - its complexity and ambiguity - and thereby provide a rather poor basis for working through decisions in a way that is likely to lead to the best results."

The best entrepreneurs know how to simplify. It doesn't mean that things are so easy. It's never easy. There will always be randomness (if you don't understand what is going on things will appear random). Clever foxes sometimes try to anticipate those twists and turns in life. They seek certainty and control, put together fancy models and perform calculations to Nth degrees of precision. Those poor foxes often have a tougher time of it than hedgehogs who honestly don't think that they know as much (perhaps this makes them more immune to illusions of control).

Hedgehogs keep their noses to the ground. They stay in tune with reality because it's a matter of survival. They do learn along the way. They do adapt - but they don't dart around (like those quick and clever foxes). Hedgehogs know what they know (which is not a lot) and they know what they don't know. They know that there are always things are beyond their knowledge and control - like luck - yet they keep moving forward.

Everyone will have their share of luck - both good and bad. Some people will be prepared when opportunities pass by. Others will be asleep...or perhaps darting the other way (in the wrong place at the right time...or at the right place at the wrong time).

Hedgehogs are not simpletons who over-simplify. They get it. Which is why they are so effective. They don't waste time or effort. They make decisions and move forward. They get shit done.

Swinging for the Fences

I recently sat on a panel with Howard Hartenbaum, the founding investor of Skype, which yielded a 1,400x return in 36 months. Howard humbly noted that he was fortunate to have had such a deal so early in his VC career. In his words, "Skype was not the deal of a lifetime, it was the deal of three lifetimes!"

Venture capital is a hits driven business. Over time, it's likely that only 20% of the deals will generate 80% of the profits. (The 80/20 rule originated from Vilfredo Pareto's observation that 80% of his peas were produced by 20% of the pods. He also noted that 20% of the people owned 80% of the land in Italy).

Apply the 80/20 rule to the top 20% and the Pareto principle says that 4% of the deals will produce 64% of the returns. Apply it again and less than 1% of the deals will produce more than half the returns. You get the picture? It’s all about the homeruns.

Given the concentration of returns, LPs are lining up to invest in the "top funds" who have hit the biggest homeruns. Top venture funds are over-subscribed because it is believed that those who produced great returns in the past will continue to do so in the future.

As time passes, the gap between the winners and losers often gets wider. For example, about half of all returns in the VC industry have been generated in public markets due to post IPO (or acquisition) run-ups prior to distributions. If lock-ups and holding periods were longer, the gap would get even wider.

However, in the frenzy to "get in" to top funds, people seem to have doffed their thinking caps at the door. Even as the most sophisticated LPs are cutting back from many so called "top firms," new LPs to the asset class are not only taking their place but piling on.

Impact of consolidation

Over time, consolidation happens in just about every industry and venture capital has been no exception. A small number of firms have been growing to control a large percentage of the capital. Even firms with mediocre track records have been expanding in both scope and scale (because they are still considered to be "brand name" firms).

It's hard to turn down all that money flowing in, especially once people get used to a fancy lifestyle, nice offices, support staffs, and lofty salaries. Assets under management has become the proxy for success and VCs are becoming accustomed to making more money from management fees than carried interest.

With growth, the mentality of VC investment professionals has changed. When people get paid for activity (putting money to work) rather than results (which may take years to sort out) you will get more activity. Compounding the problem, there are pressures mounting to hit even bigger homeruns.

VCs are making bigger bets than ever (which are needed to move the needle on larger funds). Unfortunately, this is leading to value destruction of unprecedented proportions. Between 1990-2001, 63% of invested capital resulted in almost total loss (the median deal lost money). In contrast, between 1969-1985, partial or total losses occurred in only a third of the deals.

Predicting the future

A VC's job is to pick winners that emerge out of a confluence of technologies and markets. Some people seem to think that they can keep doing it even with bigger piles of money. Let's get real.

Obsessed with the future, all types of investors attempt to predict the future (usually by looking in the rear view mirror rather than out the window) - like the direction of interest rates, inflation, deficits, markets, etc. Unfortunately, predicting the future is hard to do.

Alan Greenspan once said "It's very rare that you can be as unqualifiedly bullish as you can now." That statement was published in the New York Times on January 7, 1973, right before the two worst years for economic growth and the stock markets since the Great Depression (yes, even back then he was considered to be one of the nation's top economic forecasters).

Ever the contrarian, as Fed Chairman, Alan Greenspan warned us about "irrational exuberance" before the last bubble crashed. Unfortunately, he said it in 1996. If you had listened to him, you would have missed out on the greatest bull market in history (when most of the venture returns were made).

Creating homeruns?

Alan Kay once said that "the best way to predict the future is to invent it" so perhaps the VC's job is not to pick the winners but to create them. Go visit any VC website and you will see a lot of chest thumping about how great they are at doing this.

Perhaps past successes have gotten into people's heads (see Leggo My Ego). VCs have started to think that they can not only see the next homerun coming, but actually create it (I'd bet that more than 75% of VCs think that they belong in the top quartile).

As a fan of baseball, I've observed that good coaches can help manufacture runs, but they can't do much to create the homeruns. If homeruns in baseball are the outcomes of duels between batters and pitchers, homeruns in the VC industry are the outcomes of battles between entrepreneurs and markets.

In the quest for homeruns, VCs invest tens of millions of dollars, "add value," and put together "world class" management teams to build companies. The funny thing is that it takes less capital to start companies these days. You don't need to pour money behind the homeruns because they don't need it. The best companies generate cash, even as they fuel growth.

Some of the biggest homeruns were not even venture backed - they didn't need the money. Even for those which were venture backed, many were already profitable at the time of funding and, with few exceptions, ALL of them required very little capital to become huge.

Let's get real. VCs don't create the homeruns. The great VCs do help their companies...but there is a fundamental difference in mindset. It's all about the entrepreneurs. The big VC firms may try to inspire confidence (or strike fear), but the best entrepreneurs do their own thing with or without the VCs.

Deductive tinkering

The hands-on, "get big fast" approach is the most common practice among VCs. The opposite approach is a hands-off approach where lots of bets are placed across companies. There's a method to the madness and some unconventional investors have done quite well letting natural selection take its course. People have called this "spray and pray" or the portfolio of options approach.   

Unfortunately, a blind, random process (like evolution) can take a long time to play out. It is also risky particularly as bet sizes get bigger. To our knowledge, not a single significant company has ever been attributed to a spray and pray VC.

There are huge multiplier effects that stem from early decisions and we believe that it is critical to be hands-on. We believe there is a third approach. Venture capital should really be a process of deductive tinkering.

The best entrepreneurs are all classic tinkerers. They experience failures along the way (if you are not failing, you are not really experimenting), but they don't make foolish bets. They give themselves a chance to succeed (or get lucky) by making sure that they survive and stay in the game.

Thomas Edison failed in his first 100 attempts at making the light bulb...but he learned every time about what didn't work. We don't mind the failures. The key is to make the cost of experiments as low as possible. It's like flipping a coin where heads you win and tails you don't lose much. Flip enough times and the odds are that you'll come out ahead.

Some might argue that VCs invest big dollars AFTER the tinkering (to scale or "get big fast"). However, in our experience, the tinkering never stops. While we try to take out the greatest amount of risk with the least amount of dollars, companies take on new experiments at every level.

The idea that there is less risk at later stages is a fallacy. Competition to get into good later stage deals is far more intense (at later stages money is more of a commodity). Not only are valuations higher but a lot more capital is put at risk.

As our companies grow, we create new experiments within companies (it's like creating portfolios within portfolios). For example, several of our companies completed acquisitions or started new divisions over the past year. Our portfolio of experiments would grow even if we did no new deals as long as our companies grow in a capital efficient manner (where we reinvest retained earnings rather than other people's money).

Risk and uncertainty

Conventional wisdom says that in order to shoot for higher returns you have to take on greater levels of risk. We choose to follow a different path.

We look to invest in highly uncertain situations. We call such deals "experiments with unknown upside potential," where the range of possible outcomes is very large (on the upside) but require little capital. This is better than gambling or lotto which have defined, bounded upside. We'd rather take unknown/unbounded upside and known/limited downside.

One of the ways we like to limit downside risk is to invest in bootstrapped companies. In our most recent fund, more than half of our Series A investments have been made in companies that have been in business for several years. Such companies seem to learn more than companies that burn through millions of dollars. People with less money learn to use their brains more.

In other cases, we might even invest in companies that are already profitable but might need a little extra capital (and some assistance) to accelerate growth. Many VCs as well as "growth equity funds" who target bootstrapped, profitable companies have minimum investment sizes of $20 million or more. We look to invest less than a quarter of that.

A third type of investment is starting companies from scratch...but following a deductive tinkering process, rather than a conventional one (see Venture Lotto). The beautiful thing about our business is that we don't need to predict the future. We just keep our eyes open and learn along the way.

Learning requires an active, hands-on approach (so there is a cost) but it leads to value, often realized in totally unexpected ways. Some of our most successful investments are directly linked to a past a disappointment or failure.

We don't feel the need to take on big risks. One of the great advantages of venture capital  is that even multiple failures can't "blow-up" a fund (see articles on LTCM for how billions of dollars can be lost in a matter of days. Hedge fund and other types of blow-ups are discussed at length by Nassim Taleb in "Fooled by Randomness" and the "Black Swan"). There is a huge difference between high risk and high uncertainty. We prefer the latter.

The conventional VC strategy of investing tens of millions of dollars is a risky proposition. There are thousands of venture backed companies that burn through millions of dollars only to get to a point where they seek even more funding to grow. We have some (rather painful) personal experience with this. Some of our companies have gone through Series A, B, C, D...and then after running through most of the alphabet started over with Series 1 or A1.

After making more than our fair share of mistakes, we've realized that such impatient consumption of capital creates fundamentally weak companies. Compared to our bootstrapped companies, they seem to have a much lower chance of becoming a homerun, unless another bubble bails them out (depending on the greater fool is an awfully risky way to try to make money).

VCs cannot manufacture the homeruns by pouring tens or even hundreds of millions of dollars behind companies. It's like pushing on a rope. Such a strategy requires not only a lot of capital but a lot of confidence, ignorance or arrogance. Perhaps VCs should remember the words of the great hall of famer Satchel Paige: "It's not what you don't know that hurts you, it's what you know that just ain't so."

Expecting the unexpected

New technologies can lead to waves of creative destruction. Even in low tech industries, companies come and go. The vast majority of Fortune 500 companies drop off the list much faster than it took to get there - creative destruction is everywhere.

Small innocuous events can set off avalanches of changes which are inherently impossible to predict. Such unexpected changes are extremely dangerous for the giants (who have everything to lose and not a lot to gain). At the same time, they can be hugely advantageous for the hungry new entrants who have everything to gain and little to lose. The beauty of venture capital is that we can bet small but win BIG!

Experimentation and failures go hand in hand - so it's critical to limit the dollars. Lots of money is not required to get value out of experiments - it takes a little patience, an open and prepared mind (willing to observe, learn and adapt), and the right attitude toward risk and return.

Venture capital should not be about putting money to work. Over the years, we've learned that if we focus on the fundamentals and keep doing intelligent things, we can make money even if a company is sold for less than $50mm (the typical value of M&A exits in the VC industry). Rather than trying to predict or create the homeruns, the focus should be on the productivity of capital.

If we build good companies, we've also discovered that some of our companies will just keep growing and growing. We just have no clue which ones will take off (and keep going) and which ones won't at the time of investment. However, we have faith that some of our companies will become the dominant new market leaders (we have several promising ones so far). Creative destruction favors the new entrants. 

The key to great returns

One of the legends of the VC industry recently told me that to be a great VC "you must have the courage to walk away." Maybe it takes courage because mainstream VC investments are becoming so big that they seem too big to fail?

We have a different view. If you invest very small amounts and the experiments fail, it doesn't take much courage to walk away. Our "losers" seem to do a fine job of dying without much help from us - they don't need to be killed.

The key to great venture returns is not the courage to walk away but deep conviction and passion for the big winners (see our Raising Sheep article on the issue of conviction vs. convention).

To paraphrase another great VC...the key is to have a little teflon coating so that you don't get jaded...you have to have the ability to fall in love - with technologies, entrepreneurs and companies - even after you've had your heart broken. Great VCs are just as passionate as the entrepreneurs. It's personal, not just business.

However, perhaps paradoxically, it's also critical to be rational. The homeruns are rare - really rare. If you think that everything can be a homerun, you probably won't even recognize one when it stares at you in the face.

Over the course of decades (if we are lucky enough to be around that long), a very small number of our deals will yield more profits than all of our other deals combined. It's just the way the math works. We can only lose 1x, so if we have a 100x or a 1,400x along with a bunch of 3-5x winners, the overall numbers will be skewed toward the few big homeruns.

So in between the homeruns, the key will be to keep losses to a minimum, learning to a maximum, and generate decent enough returns to stay in the game. Such an approach might not sound terribly sexy or exciting, but we believe that the key to achieving great results is to stick to a rational strategy (rather than gambling money away).

The great investors and businessmen we know are all pragmatic practitioners. They first think about (and protect) the downside, before going for the upside. Following such a strategy takes a lot more faith and courage than you might think. It forces clear headed thinking and hard, disciplined decisions rather than sloppy, wishful thinking and shoot-from-the-hip betting.

Ultimately, it's not about how much we invest but what we own of great companies. We feel - in our bones - that only a few companies will really matter in our lifetimes (and they will NOT require a lot of capital). So, like every other VC we're swinging for the fences too...but we're not going to leave smoking craters in the field if we don't clear the fences.

Monkey See Monkey Do

A few weeks ago, a fascinating New York Times article described observations of morality in the behavior of apes. For example, Chimpanzees, who cannot swim, have drowned in zoo moats trying to save others. Given the chance to get food by pulling a chain that would deliver electric shocks to a companion, rhesus monkeys will starve themselves for days.

Apes are social creatures. So for the good of the species, evolution has wired them to act in unselfish ways which can be interpreted as moral or ethical. Since we are also social creatures, it might be nice to think that perhaps humans have also developed "good" DNA like those apes.

With the invention of language, logic and technologies (such as the printing press, invented almost six hundred years ago), human societies and cultures have been evolving at rates far faster than evolutionary pace. Even though culture is a human creation rather than a biological one, culture now has a powerful influence over us.

For example, economists demonstrated the influence of culture by studying data from New York City on parking tickets issued to U.N. diplomats. From an economic point of view, diplomats should not care how many tickets they get (due to diplomatic immunity). However, according to the data analyzed between 1997 to 2002, certain diplomats committed hundreds of violations while "not a single parking violation by a Swedish diplomat was recorded...Nor were there any by diplomats from Denmark, Japan, Israel, Norway or Canada."

The reason for such wide variations is that we are not merely products of DNA or economics. Human beings are shaped by cultural and moral norms. According to the article, "if you're Swedish and you have a chance to pull up in front of a fire hydrant, you still don't do it. You're Swedish."

I'm no expert on Swedish culture, but I'd guess that there is a sense of honor and values which influence behavior more so than rules and regulations. In fact, Sweden perennially ranks among the least corrupt in Transparency International's Corruption Perceptions Index.

In modern society, I believe there is a third powerful influence - it is the culture of our workplace. The corporate entity is a relatively new invention dating back to the mid 19th century. Before then, liability was not limited to a corporate entity so owners and managers often risked all of their personal reputation and assets. (What would happen to the venture capital industry if we had to risk far more than invested capital?).

An example of a company with a powerful culture is Toyota (now worth more than GM, Ford, and Chrysler combined). According to Michael Cusumano, a professor of management at MIT, “the founders and the managers created and refined Toyota company culture, which is far more powerful than Japanese culture. It does build on many things that are Japanese — precision, quality, loyalty. But the Toyota culture dominates.”

With corporate scandals over the past few years our confidence in corporations has been shaken. Isn't it ironic to think that apes may have a sense of right from wrong, but humans need more and more laws and regulations? It seems a whole new profession is thriving these days - that of corporate ethics and compliance officers.

Unfortunately, I think we are barking up the wrong tree. New ethics and compliance officers won't shape human behavior any more than new regulations, motivational posters or "core values" statements on plaques. Anyone who has worked for different companies knows that companies have very different and distinct cultures. Whether good or bad, corporate cultures influence behavior.

In the "HP Way", David Packard did not talk about ethics and morality (and certainly not about compliance). He did talk about values - integrity was presumed. Packard promoted mavericks - people willing to buck the system and go against the rules (in order to create a great product and rise above bureaucracy). But when it came to ethical issues, everyone knew Packard had a "zero tolerance policy."

Both Hewlett and Packard set the tone for decades. HP was a highly ethical company long before there was a "Chief Ethics and Compliance Officer" (a new position created by Mark Hurd, after the recent board scandal). So where did they go wrong? As a society, where did we all go wrong? Answering such questions probably requires a book rather than this short blog post.

As VCs, we work with entrepreneurs and managers who shape the culture of companies from day one (whether they intend to or not). For example, I recently noticed that one of our companies has a peculiar culture - most employees get to work by 7:30am. That's unheard of in Silicon Valley, especially for engineers. Well, it turns out that the founder is an early riser and often gets to work by 4am. That company had only one employee last year. Now that it has a few more people, we can start to see the culture forming. (It'll be interesting to see how it evolves).

Over the years, we've observed that the behavior of management has a huge influence on the values and cultures of companies (what they DO, not what they say). If we want more honorable behavior by corporations, we don't need more regulations (and we don't need more compliance officers). What we need is better leadership. Character, integrity and leadership should go hand in hand. Being ethical is also more profitable in the long run. (Even merchants and traders from centuries ago figured out that a great reputation was the only way to build a great business).

Entrepreneurs have always had huge influence over the rate of innovation and the growth of world economies. I believe they can have even a more profound impact. Just as DNA can impact entire species starting from a single cell, start-ups can be the beginning of new corporate entities which can change our lives. It is much easier to get it right from the beginning than it is to change a fully grown entity. Entrepreneurs are the future. They can set the tone with the example they set in the companies they build.

Raising Sheep

"We're raising sheep in our educational system, not independent thinkers and doers."
      - Paul Orfalea, Founder, Kinkos

Have you ever wondered why so many successful entrepreneurs didn't get the best grades in school?  Even in the technology industry, where education is paramount, many of the best known entrepreneurs were college drop-outs (i.e. Bill Gates, Steve Jobs, Larry Ellison and Michael Dell). Maybe there's some truth to the saying - the A students work for the B students, the C students run the companies, and the D students (or dropouts) dedicate the buildings.

I don't want to diss the best students because we need them. They become our engineers, doctors or lawyers (OK, maybe we don't need any more of that last category). Overall, the conventionally successful will do quite well. Last year, I heard Eric Schmidt talk about "the premium for competence" as he described how Google was able to access top talent they could not attract when they were small. He explained that some people are so competent that they don't have to settle. They can wait to see the data (look for the sure thing) rather join a risky start-up. Good for them.

On the business track, the most popular (and highest paying) jobs graduates of top MBA programs pursue are in management consulting (McKinsey, Bain, and BCG are the most prestigious), investment banking (Goldman Sachs and Morgan Stanley are tops), private equity (just about any firm), and, these days, the most coveted jobs are at giant hedge funds (how depressing).

In school, there are discrete tests with answers that determine the grades. The real world is more complicated. Fundamental tenants such as "be honest" or "work hard" are too simple (and overlooked) to be useful. Good advice can even sound contradictory like "get the facts, do the analysis" versus "trust your gut." The real world is full of apparent paradoxes. There are no black and white answers, just shades of grey, and even being right may not be good enough.

In the business world, the cold reality is that being good - or even great - may not be good enough. The key to winning is differentiation. Great entrepreneurs have an edge  - but it doesn't come from higher IQs or greater imagination. The best entrepreneurs might even be considered simple minded (see the post on Foxes and Hedgehogs.) However, they do possess special qualities. They think and act differently. They don't go along with the crowd. Peer pressure is not their thing. Not only are they are willing to be different, they ARE different.

Nature versus nurture?

In some cases, there could be biological differences. For example, dyslexia, a neurological condition which causes difficulty reading and writing, is a learning disability which afflicted entrepreneurs such as Paul Orfalea (Kinkos), Richard Branson (Virgin), Ingvar Kamprad (IKEA), Craig McCaw (McCaw Cellular) and Charles Schwab. Perhaps, as a side-effect of their condition, they were forced to work harder, see things differently, and do things in unorthodox ways.

Whatever the cause, most of the time, there is no scientific proof of biological differences - but let me try to characterize these very special people who turn out to be extraordinary entrepreneurs.

This great country was founded by people who possess characteristics inherent in great entrepreneurs. Such people are rebels at heart. They are willing to fight for what they believe in.  They have the courage to stand up and say that the emperor has no clothes. They never use the excuse "everybody else is doing it." Throw out convention! They can be brash and stubborn. They don't pine to be popular. One might say that they just don't give a damn what others think.

They are skeptics at heart. They won't take your word for it - they always ask probing questions. They are incessantly curious. They look beyond the surface. They dig deeper. They don't fear the truth or the unknown. They don't fear change, they crave it. They strive forward, relentlessly, toward an expansive future, not with uncertainty and doubt but with faith and optimism. In fact, one of their most special qualities is that rare combination of forward looking idealism with a skeptic's realism.

However, contrary to what you might think, they are not driven by the desire to stand out or the courage to be different. They're driven by the courage to be true to themselves - it takes self-awareness and integrity. They are 100% genuine - the real thing - authentic, original, and refreshingly unique.

The willingness to go down an unconventional path requires CONVICTION. As investors, something we have in common with entrepreneurs is this - to win BIG you must have conviction (great fortunes are made through concentrated portfolios, while a diversified portfolio makes it easier to keep). Of course, in the investing world, it takes judgment to decide when a deal makes real sense. (Confused people tend to rely on stock charts or "comps" rather than fundamentals and valuations).

My wife likes to say that I have "an incredibly high tolerance for risk" (she prefers a much bigger safety net). But what I consider to be extremely conservative might appear risky to people who don't see what I see. That's exactly how entrepreneurs feel! They don't feel that they're taking incredible risk. When Bill Gates dropped out of college, he did not see himself as taking tremendous risk (although his "parents were very concerned"). If entrepreneurs don't believe in what they're doing, they shouldn't be doing it in the first place.

It's fascinating to observe people who possess that rare combination of conviction and open-mindedness. Conviction keeps them charging ahead while their questioning nature allows them to constantly learn and adapt. Balancing these paradoxical qualities is one of the keys to entrepreneurial success. 

Qualities such as intelligence or the ability to "think out of the box" are over-rated. You don't need to be smarter or more creative, but you must have your own point of view. This is NOT the same as being contrarian, which can be just as mindless as being conventional (just the mindless opposite).

The crowd is not always wrong. In fact, under the right circumstances, the crowd can be more wise than even the smartest individuals. According to "The Wisdom of Crowds," three conditions must be met for crowds to be smart - 1) diversity of opinions, 2) independent thinkers, and 3) decentralization. Ironically, Surowiecki's book contains many examples of the stupidity of crowds (when such conditions are not met). More examples can be found in "Extraordinary Popular Delusions and Madness of Crowds."

Herd mentality?

Sand Hill Road is full of people who got the best grades from the best schools (VC and private equity shops are full of Harvard and Stanford MBAs). It's a small, tight knit community (the "old boys club" as some might say). They graze the same grounds and talk about the same stuff - big markets, passionate entrepreneurs, connections, relationships, proprietary deal flow, experience, adding value, home-runs, and being part of the "top quartile" (the last point is important because average VC returns have been less than impressive).

The VC industry is full of rules of thumbs and conventional wisdom. The industry moves in herds. Variations of the theme epitomized by the classic (outdated) phrase "you don't get fired for buying IBM" seem to be the mottos most people live by. These days, the most popular deals involve social networking, user generated content, wireless, China and India. Look, I'd never short a tidal wave (like China or the Internet) but the herd mentality (and the lack of originality and depth) is real.

As Yogi Berra says, it feels like deja vu all over again. The conferences and cocktail parties are buzzing from Shanghai to Silicon Valley (see comments from last month's post). Just don't expect to meet the best entrepreneurs at such events. They are too busy to attend. The real entrepreneurs are out there doing their own thing.

At first, what great entrepreneurs do might appear uninteresting, mundane, strange, unimportant or too early (or too late). In the beginning, companies like Southwest Airlines, eBay and Craigslist seemed strange. HP, Wal-Mart and Intuit probably seemed unimportant. RIMM, Qualcomm, and Pixar looked too early. Cisco, Dell and Google were thought to be too late.

In Silicon Valley, the heroes are the technologists ("the suits" are thought of as necessary evils). Unfortunately, in the real world, entrepreneurs must have a nose for business. The great ones always figure out how to make money (even as teenagers, they often have track records - from running newspaper routes, writing code, buying stocks or selling stuff).

Entrepreneurs like Sam Walton, Bill Hewlett, David Packard, and Herb Kelleher didn't care about what investors wanted (or about changing the world or their industries). In the case of Kelleher, a middle-aged lawyer who sketched out his plan on a cocktail napkin, Southwest Airlines operated in the fringes, in small, under-served markets. No one took them seriously for years. They just kept plugging along, posting 34 consecutive years of profitability in a volatile, cyclical industry marred by enormous losses and bankruptcies. (Southwest also outperformed ALL public companies in stock market performance over the 30 year period starting in 1972).

One of the paradoxical qualities of great entrepreneurs is that they are actually conservative at heart. They say "show me the money" - in some ways, they might have more in common with those frugal, skeptical farmers from Missouri than most entrepreneurs and VCs running around Sand Hill Road. Our Venture Lotto article contained this characterization of entrepreneurs:

"The best ones we know are much more risk-averse than conventional wisdom might suggest. They don't take foolish chances. They spend money as if it were their own. They observe, listen and adapt; but fundamentally, they strive to control their own destinies, which is best done by generating profits. They do need a little capital, but they want help and advice even more. Being an entrepreneur is, at times, a very lonely endeavor."

However, this talk about profits should not take away from the most special quality of great entrepreneurs - they inspire others. Don't think of them as shrewd opportunists who read the fine print on every contract, looking to take advantage of every deal. Such people might do well (for themselves), but they won't build wonderful and enduring companies. Great entrepreneurs bring others along. They grow the pie, rather fight for a bigger piece (or the crumbs).

To go back to the example of the founding of this country, problems (like taxation without representation) may stir the pot (like inciting riots or unrest) but revolutions are ultimately inspired by values and ideals (like life, liberty and the pursuit of happiness). In the business world, a problem may lead to an invention or a new company...but exceptional companies are built on a foundation of core values and dreams of entrepreneurs.

If you want to be an entrepreneur, just remember this - follow a different path - your own path. The most successful entrepreneurs win with or without VC funding - they go out and just do it. Forget about the cocktail parties, the hot sectors, hot deals, or what's popular with investors or anyone else - think for yourself. If you do, you just might come up with something that you will pursue with all your heart and soul. Conviction, rather than convention, is the key.