February 20, 2018

The Startup Playbook: Will Herman and Raj Bhargava

How many startups fail? Just take a guess. The answer is 90%. Having a better idea or a bigger market or just working harder isn’t enough. What every entrepreneur needs is a fast track to the wisdom and experience gained from building successful companies and that’s what today’s episode—with Will Herman and Raj Bhargava, coauthors of The Startup Playbook—is all about.

Will Herman is an angel investor with more than 60 investments in startup and a five-time founder. Raj Bhargava is the co-founder and CEO of JumpCloud, the first directory as a service. He’s also a 10-time entrepreneur with six exits including two IPO’s in four trade sales. In this episode, Will and Raj share their years of knowledge to help you keep your company out of the startup graveyard.

Will Herman: After a couple of years, I quit college to join a startup. I actually got hired over the summer after my sophomore year and decided to stay there because the startup environment was so cool and way better than college. My parents were frustrated, they were angry, but you know, I just had to do my thing.

Well, the culture was a complete meritocracy. I was probably the eighth or ninth employee. It was the wild west. The biggest gunslinger wrote the most code, got the most done, got the biggest reward, got the most visibility.

Where school was this incredibly long feedback loop, startups tend to be very short feedback loops—which is good and bad.

In this case, all I remember is the good part. Until it became all bad.

About 18 months in, the company slammed into a wall and failed. I had no idea why, even though I was one of eight or nine people, it wasn’t even clear that the founders of the company knew why it had crashed and burned.

We ran out of money, we didn’t have enough equipment, we couldn’t get customers, we didn’t have a unique enough idea, we weren’t differentiated enough, we didn’t have enough marketing spent…Still to this day, it’s unclear to me what happened.

But one day I had a fun, exciting job and the next day I didn’t. Lay off is a very nice term for what happened.

“They said, ‘Doors are closing at 1:00, get the crap out of your desk.'”

Basically all anyone understood was we didn’t have any more money and it was all over and that’s it. That happens to a lot of startups, exactly like that. They’re almost blindsided by their failure.

That started my learning process about what was important, what needs to be watched. I can’t say I learned a lot that first time, just that I learned that things going well is not a reason to believe they will continue to go well.

Of course, the worst part is I had to go back to my parents who said, “Yeah, we told you this was going to happen.”

Charlie Hoehn: It was a small scene, a startup, and you were doing startups way before they were a thing. Raj, did you go through something similar?

Raj Bhargava: Yeah, absolutely. I started my first company while I was still in school. Will and I met there actually, when he became one of the first investors. But all the issues that you can think of around building that first company, I experienced.

“What’s the right idea? How do you build the team? How do you build the founding team that’s functional?”

I’ve struggled with that a great deal. We tried to raise money a number of times. We almost got bought at one point and that failed. Then when we tried to raise money, we picked the wrong investors and that changed the dynamic of the whole company. Hired the wrong people, I mean, almost every mistake you could think of, I made.

As part of that, you quickly learn that you’ve got to go figure these things out before you make these mistakes because some can be company killers. Fortunately, they weren’t company killers, but that wasn’t necessarily because of skill on my part. It was because some other people came in and helped me out and helped the company out to help make sure it was successful.

Learning the Hard Way

Charlie Hoehn: Tell me, what was the most painful mistake that you remember making, tell me about that moment?

Raj Bhargava: I think the most painful mistake was picking the wrong investor. By this time, Will and a friend of ours, Brad Feld, had decided to invest just a little bit of money to get us going, and then a couple of rounds later, we were picking venture capitalists and choosing between a few different venture firms.

I didn’t understand the process or the game or the signals that they give you about what they’re going to do or what they want to do with the company once they invest.

I picked what I thought was the best firm because they were offering us the best financial deal. He careful of a great deal because there might be a lot of strings attached to it. In our case, there were. We just didn’t know what those were.

“Once we closed the financing with this firm, they decided to promptly change just about everything in the company, including asking for a new CEO to come in.”

We had a choice between them and a few other firms and one of the other firms that we were deciding on, and we had an incredible relationship with the person and they were not offering us the best financial deal. It’s one of those situations where you realize maybe the best financial deal isn’t the best outcome for the company. Sometimes it is, but in this case, having an investor who is more aligned with our philosophy of how to run the business would have been the better choice.

That was a very painful mistake for the entire company because it changed the trajectory of the company forever. There are things that you do that you can’t recover from or undo, and one of them is who you pick as a financing partner.

Charlie Hoehn: Both of you have earned your startup scars so to speak? The one thing that you really want listeners to take away from this conversation?

Will Herman: I think that there is a large set of misconceptions about what’s important in the startup process, and they’re driven a lot by the financial community. As Raj has pointed out, it’s not always clear if that’s the best place to get advice. Core among them is that ideas need to be outstanding and unique, and we don’t believe that’s the case.

“Steve Jobs didn’t create the mobile phone. Bill Gates didn’t create the operating system. Henry Ford didn’t create the car.”

There’s actually more opportunity in the great execution of a company—of converting a good idea into a solid company—than there is in actually having a unique idea.

We also believe the odds of you having a unique idea in general are exceedingly low. They’re basically zero. Raj and I both mentor and advise a bunch of companies, and we always advise them to just assume that somebody very close behind them is smarter, has a bigger team, and is better funded than they are, and is doing exactly the same thing.

Everything they do needs to be pretty optimized, and they need to move very fast.

Innovation Isn’t Always a New Product

Charlie Hoehn: Do you think it’s wise to pursue creating a new category or is it okay to go into an existing category that already has some top dogs in it?

Raj Bhargava: Uber and Lyft didn’t necessarily create a category. They were taxis and limousines. You could hail a cab in New York City, you can hail a cab almost anywhere in the world. They just created a different model to make that work.

They made it far more convenient, they made it cashless, they made it so that anybody who wanted to have a job could go drive a car, so they worked on both sides of the equation. And they brought tremendous innovations to that area. But I’m not sure that the category was necessarily new.

It was transportation. We’ve got transportation in many different forms today and before they started, they were all existing in that way, there were limousines, there were buses, carpools. People did all those things, they just happened to take, have this incredible take on it that was far more convenient, easier, safer, et cetera, et cetera.

The core of our point is that you don’t necessarily have to have this completely novel idea. You don’t have to have this new algorithm or this new box that you’re creating that nobody’s ever thought of in the world before.

“What you do need to have is a different take on the whole thing.”

Uber and Lyft are a great example of something that we like to think is a sleepy industry up until they showed up. Boy has it gotten really interesting and competitive.

What’s fascinating to me about that particular category is, they moved beyond replacing or being an alternative to limousines and taxis but they’ve now potentially become an alternative to a person buying a car.

They had this completely different, novel thought process or approach to something that had already existed that we used on a daily basis, but they completely turned it on its head. It’s been tremendous.

I think that’s sort of what we talk to people about. Don’t worry about if it’s a completely new category. If it is, great, wonderful. If you come up with something that’s so novel, that’s incredible. We don’t want to discourage that. But it doesn’t have to be that way to build an incredible business.

Charlie Hoehn: What are some other things that they run into that are keeping them from succeeding in their first startup?

Raj Bhargava: There’s so much blocking and tackling that needs to be done that you can make such a great business by just focusing on execution. Maybe you don’t have a completely novel idea, but you have sort of a very innovative approach to deliver that solution or product or you have a way to service the customer that’s better than somebody else.

Go all in on those things and really work hard at building an incredible business overall. That means the team, that means your pricing model, it means the way you attract customers, the way you service them, the way you work with them on an ongoing basis.

“All those things are opportunities for you to differentiate.”

It’s such an all-encompassing thing to create a great business that you can innovate in many of those areas, but you also don’t have to innovate in every one of those areas to be successful.

Pick the ones that really matter to you and then make those differentiators.

A Well-Rounded Startup Idea

Will Herman: Most of the entrepreneurs we talk to don’t understand that an idea needs to be a problem and a solution. It can’t be one or the other. It needs to be both, and there’s a path between taking that idea and making it into an actual product or service that gets delivered to a customer.

That path is where a lot of companies fail, and it has to do with the things that Raj was just talking about. You need to make sure that there’s a fit between the product and the market that you’re going after. That you can market to those customers, price to them correctly, and differentiate what you’re delivering from what everybody else is delivering.

“You don’t have to be the best product.”

You can have a better distribution channel, you can have better documentation, you can be easier to use, you can have better service.

When you start throwing all of these factors in and think about the permutations of a company that you can create out of that, it’s really not one idea to one product. It’s one idea to dozens of products that are a potential. That’s why nobody should be limited by the idea that they have. There’s just lots of ways to optimize to make a great product into a great market.

Charlie Hoehn: What other problems to startups run into?

Will Herman: FitBit’s actually a good example of the model that’s going on, where a fairly inexpensive piece of hardware is being sold but the differentiation doesn’t really completely come in the hardware. It’s their business model.

“We’re going to sell this product, we’re going to make a little money on the hardware part of the product and then we’re going to sell a bunch of services behind it,” and that’s really where the companies make their money.

Without that hardware lever, it’s difficult for them to actually make money just on the hardware, and that happens often with consumer products. Take a Nest thermostat for example. It’s a cool device, but you’ve got to sell a lot of Nests if that’s all you’re going to do. If you use it as a lever to create a larger business around the IOT devices and the home, you can then start charging a monthly fee. That’s a pretty good model.

The problem with it is that getting the hardware product to market for startup. It’s very difficult. It’s much more difficult than getting a software product to market. Companies have to understand the complexity of manufacturability, the error rates that they’re going to have.

“Generally speaking, if they build it themselves, it’s going to be costly, if they build it domestically, it’s probably going to be costly.”

If they go over to China to have it built, it’s going to be costly, mostly because of the distance and the failure rates and the problems that they’re going to have.

There’s expertise around about how to do those things, but often it’s not sought out. This is a key problem we address in the book. A startup, especially a startup that’s going after markets that they don’t already have a lot of wisdom about (which most don’t), needs to bring in that wisdom.

Otherwise, there’s a load of potholes. In hardware, there’s more than usual.

Take Your Time Before Launching

Will Herman: Often these companies go out and they get some funding, they get venture capitalists, angels, even accelerators very excited about what they are doing, and they tend to underestimate the difficulty in getting the product out. So they have to do new revs of the product one, two, three times—which consumes all of their capital.

Once they’ve got their product right or close enough, then they have to go to market, and they’re out of money and have no money for marketing and sales.

It’s almost always underestimated the amount of capital required to make it happen. The wall that they run into seems to be taller and they’ve got more momentum hitting that wall when they involve hardware.

That’s not to discourage anybody from doing a hardware startup. It’s just like everything else in the startup world.

“Once you have an idea, you need to understand all the parameters of what it’s going to take to turn that idea into a product or service.”

I advised several companies that no matter how much information is out there about this problem, they go along the same path. They think they are going to get it right the first time and so that’s how they budget, and they find that their first gen product doesn’t work or doesn’t work to what the customers expect, to the level that the customers expect and they have to turn it. It happens all of the time.

When you turn software, when you make a new rev software, it’s a couple of days and a few man hours of effort. When you turn a new hardware product you have to go through a whole new manufacturing process, and it’s timely and expensive.

I don’t think there are absolutes. As a fairly active angel investor myself, I’d say that you’re way under where you need to be, just use some pattern matching of companies that came before you.

“We call it the vetting process, and it’s a loop of points, where each point along the loop is a test of converting your idea.”

It’s a process and a test of converting your idea into your ultimate product.

See if there’s market demand, then check with people who are experts on manufacturability and talk with them. That is all very low cost. So you take your 250K and don’t pay yourself or your team a dime. Use that money to develop that first prototype of a product and get feedback from the market.

See if the market is interesting, and even go to a couple of VCs to say, “Hey, if we could do this, would you be interested in funding?” It’s not until you have tested all of those things that you leave that loop and move forward to build your product. None of that really costs much. And if you do that, you optimize your chances for success later on and minimize the amount of money you’re going to consume.

Raj Bhargava: And I think that the interesting point there is it’s almost like you’re going slow to go fast. We are not really saying go slow at the beginning, but you’re testing in small quantities or very specific ways to make sure that those all work before you really spend a tremendous amount of money and go with large scale.

Look for Market Pull

Charlie Hoehn: How often do you see entrepreneurs skipping steps that are not fun and sexy and trying to go straight into scale?

Raj Bhargava: I see that all the time. There’s so much incentive to try and skip that step. You’ve potentially already raised money, and you’ve got this idea because you’ve got experience in the space. You know exactly what needs to be done, and the investor says, “Just go fast.”

So you jump in and build the product and get it out there. You hire lots of salespeople, do tons of marketing, and then you find out the product wasn’t quite right. There were problems with maybe the fit of the customer relative to the product or maybe the product still had some issues. Maybe it is not complete.

We see that all the time.

“The amount of money that you spent and the amount of time that you burn through puts you at a huge disadvantage.”

Take a little bit more time upfront vetting and iterating and testing to make sure product market fit is there. Those companies end up having the ability to scale at a much, much greater level than if you haven’t really obtained that fit and if you’re trying to do it with many sales people, lots of marketing dollars spent, maybe too big of a staff.

Those all end up being a factor on whether a company runs out of money too fast.

Will Herman: We see companies that are sort of stuck. Of course, there is no completely quantitative way to determine when is the right time to exit that loop. but we suggest that primarily with good, really solid customer feedback. We are not talking about from one or two potential customers but from a fairly large group of customers.

Depending on your market, it might be 20 or 50 customers, that if you can sit down with them and test whether they’re really interested in buying what you’ve got, you’ve got the momentum to leave that loop.

As part of the loop, you have already determined you can build what you’ve promised to build and that you can afford to build what you’ve promised.

When you pass all of those gates, it’s reasonable to exit and move forward and complete your product. At that point, you have also created a lot of momentum for financing. Leaving that loop before you’ve even started to really build your final product, you are now in a place where you can raise more money to help you build that product and to accelerate your pace to get through the product creation and marketing and sales.

Raj Bhargava: We like to talk about it saying pull versus push. If you are really pushing your product or your service hard and there is not much pull from the customer, you probably aren’t ready.

“If you’ve got a lot of pull from the customer, they are saying, ‘Hey this really matches a problem I have.'”

Even though you’re not maybe quite there, you haven’t figured out all the challenges and problems and you don’t have all the features, they’re still saying, I still really need it and I’ll pay for it today, because I know ultimately you’ll get there.

It’s an unbelievable feeling. The challenge is that not everybody is going to hand you a check because not everybody has the problem that you’re solving. For the people that do have that problem that you have a solution to, they want to hand you a check.

So if you can frame it that way and understand that when you talk to a customer that fits your target and they want to hand you money, now you’ve really got something.

The business starts to scale very fast. It goes faster, you have many more pressures and demands, but they are all good pressures and demands because you can’t keep up with enough customer demand. Not every business, unfortunately, hits it, but the ones that do, it’s an incredible feeling.

More Than Feedback

Charlie Hoehn: You have to be able to get money from them basically, right?

Will Herman: Yes. I think Raj mentioned this earlier, that the entrepreneur wants to get positive feedback. We’re humans. We hear what we want to hear. All of these cognitive biases that we have will distort anything to be what we want. You have to ask the customer and then you have to close.

Granted, you won’t have anything early on to close with, but you can frame it. Raj and I like to say, “If we can deliver it tomorrow and in pink would you buy it for $15?” It is actually a gutsy and hard thing to do that we don’t try to minimize.

“It really is validating that your baby is cute enough to be kissed.”

Raj Bhargava: It’s tough for us to feel rejection, but in a lot of ways, you want to feel that rejection from people that aren’t in your target customer set.

So, it’s okay if somebody says “no” if they weren’t part of the target segment that you were going after anyway. If you are selling to men and a woman says, “Well I don’t really need that product because it’s only for men,” that’s okay.

It gets much deeper than that when you are selling to a very small segment but you really want to find that segment who that’s the target that you’re going after. If the person is not within that segment, it’s okay if they say that this isn’t the right product or service for them. That’s what you want. You want it to be focused at the beginning, where it’s one tight group of people or companies that say, “Yes. This is really, really interesting to me and I want to spend money on that.”

What Readers Learn

Charlie Hoehn: I know at the time of this recording your book isn’t out just yet, but is there one favorite success story that comes to mind of a startup, an individual, who incorporated the lessons in your book?

Will Herman: Yeah, I don’t think I want to take credit for any of that because in the end, Raj and I feel strongly that it’s about good execution. So you could take all the advice in the world, if you don’t execute fairly well on that advice then it’s going to be a tough road.

Not mentioning any particular companies, but I worked with a company a couple of years back now that was struggling. In fact, they have raised some initial seed funding and had come out of an accelerator where they got a little money. He actually raised money from some angels afterwards. He probably had about a million dollars in funding before he released a product. It was a software company, and it ran out of money, eventually, to make the long story short.

When I met him, he was very bright guy, a very natural engineer, not a very good sales person and really didn’t have a lot of empathy for his customers, to put it mildly. We worked through building a team around him to recognize all of the personality deficiencies he had, let’s put it that way.

He went out and brought three more founders in. So there’s a team of four, and once the team came together, they started to execute. They were able to get a little bit more money, they revved their product, they started working with their customers early on, talking with them about, “Is this right? Would you pay for this? Would you buy this? What can we make changes?”

They did a bunch of revs of their product and eventually had something that came to market and was quite successful.

“Within a year, they were acquired by a very large company for a reasonable outcome.”

In fact, since they had raised so little money, each of the founders including the first one who started with the idea came out very successful.

I think they would look back and they’d say that was financially successful and educationally very successful. All four of them have gone on to start subsequent companies.

The Startup Playbook Reader’s Challenge

Charlie Hoehn: Could you break down how to be an effective executor this week?

Raj Bhargava: One of the things that we advocate and talk about in the book is setting goals and milestones. We talk about how you set them from big picture all the way down to tiniest milestones that could be over the course of a week or a day. Ultimately, execution is that you figure out the right things to do and do them.

You have to think big picture. When you think about the big picture and break it down into the steps, you know that you’re going to get to the right outcome or you’re going to be on a trajectory to get to the right outcome.

“The best way to do that is to figure out what the larger goal is, break it down into as many small steps as you can, and then just start checking them off.”

It doesn’t sound complicated, and it really isn’t. It’s just hard to do because it takes so much energy and effort to check off all those little steps and not be distracted by all the other things that you can be distracted by.

This book is really founder to founder, because we’ve been founders. There’s so much noise out there for founders. There are investors, investment bankers, lawyers, CPAs, you know, everybody wants to be a part of this ecosystem and they want that founder’s time. They’re so incredibly important to the whole ecosystem.

It’s so easy to get distracted and defocused from your core mission because of all these demands on your time. That’s why we wrote the book. From a founder to founder perspective, let’s tell you what it’s really like and what are the things that you need to focus on. Not what the investors say that you might want to focus on. Not what the press or the analysts or whomever. It’s really what you need to focus on.