A friend inquired last few days, what was a “lean startup”? At an accelerator event, I actually listened to a presentation from the author, Eric Ries, who supposedly coined the “lean startup” phrase. http://theleanstartup.com/principles. I concluded from the lecture that the lean startup principles are no different from the basic business concerns for any company, but distilled to the size and needs of a young, startup company. I responded to my acquaintance that I have actually developed my own set of principles that guide me to handling startups in an efficient, “lean”, and cost effective method. In fact, I practiced such “lean startup” ideals prior to hearing the Ries phrase — plus I added some more principles from my real life experiences. I actually named it the “snap count” system, rather than the “lean startup”, in deference to the American football terminology, when the ball is snapped to the QB and he must make a decision to move the ball in less than 2 seconds to move the ball forward. In an analogous sense, a startup company also has a short window of opportunity to develop and market a product efficiently.
I believe that the “lean startup” genesis comes from common sense. The principles are established with one objective in mind: developing a commercialized product that reaches out to the marketplace as quickly as possible to achieve the best ROI for investors – the mecca for any “for profit” startup. These are my “lean startup” principles:
1. Test a beta product quickly with consumers prior to final design. Any concept for a lean startup cannot ignore the ultimate goal – having the product validated by a consumer, either by purchasing or adoption. That is the first year business school definition of marketing. And that is the mantra for any sized company from startup to conglomerates. The major difference between that of the startup and the conglomerate is the lack of capital and what is at risk. A conglomerate can invest millions in product development, take years to finalize a product (look at Proctor & Gamble), and can yet shut down a non-profitable product without seriously harming its EBITDA.
Not so for a startup. Because of its smaller management team, a startup can execute faster product development. I myself have had the unusual experience of working with companies with thousands of employees, exceeding 70k, and holding a meeting took weeks of preparation and the participation of several departments – marketing (why the product), engineering (can it be built), legal ( IP, contracts), financial (can the product be financed, will it be profitable). On the average it took weeks and at least 7 to 10 personnel. I have samples of presentations for a major product to be deployed in Europe that would cost a telecommunications carrier to several million dollars to create and deploy.
Startups, on the other hand, might comprise of 7 people and hold any impromptu meeting without losing a step. However, it cannot afford to build a product that takes too long, has no attraction to consumers or will not work without the failure being fatal to the startup.
I have had 2 real life situations where the startup product had gone through the iteration to market validation.
In one company, I worked with an IT engineer with a unique hardware patent for data storage. The patent was originally designed to build petabyte storage systems. The problem is that this startup would have to prove that its unique technology would be able to attract customers while the overall product that could cost hundreds of millions of dollars in hardware and operations and time – over one year. My lean startup solution: use the same patent to build smaller terabyte systems, test out the product locally with universities and companies, which beta system could be built in less than 2-3 months. That achievement attracted series B financing – again the mecca for ay startup.
Recently, I have been handling a medical device that would require regulatory FDA approval through clinical trials and still operate as a lean startup. Clinical trials can cost millions of dollars and can even take years of testing. The setup must be approved by the FDA and would include an Independent Review Board to oversee the results from the trials. None of this would be inexpensive. I even noted that some clinical trials had used over 600 testers. Such a large population of testers would take years to complete and millions of dollars. Yet this startup product requires some product validation as expeditiously as possible to attract financing. My lean startup/snap count solution: develop a small “proof of concept” in-house clinical trial, which would validate the product, take a shorter time window, and should attract investors sufficiently to finance the FDA trials, operations, and product development.
Note that how similar are these shortcuts or “snap counts” to the definition of Mr. Ries’ applications to his lean startup principle. None of what I have described is theoretical but real life applications. But I believe that this is common sense for any startup to be successful with limited capital.
2. Every startup must use its capital efficiently. I have mentioned this principle in earlier blogs. Every startup dollar must be spent efficiently in 2 major areas: operations (staff salaries, rent, etc.) and product development (product design, marketing, testing). Every other expense should be avoided or minimized. One such unnecessary or costly expense I have described in earlier blogs is legal. Even though I am attorney, I have noted the need to parse out legal expenses frugally, maybe because of my business school training. How problematic can be legal expenses? I met a fellow law school alumnus who was appointed as CEO of a startup company. Between the patent and litigation costs, the company exhausted its financing to the point of bankruptcy. He returned to law practice. Had he invested the limited resources in product development rather than law firms, the company would still exist. ( I suspect another reason: if the in-house counsel makes sure that the outside counsels are well compensated, he/she could be hired as “of counsel” upon leaving the corporate employment, just as this CEO did.)
The average law partner’s hourly rate in Silicon Valley is $800 per hour. If the startup company decides or initiates litigation, the company will run up monthly legal costs to around $15k-$40k a month, or half a million a year. A simple litigation case can last several years. The startup company is then embroiled in a vicious circle of rising legal bills. Why? As an example, a simple billable matter would include the time and travel to a courthouse to argue a motion. All courts set up a calendar date and the specific matter is one of many other motions being heard for other cases on the court’s docket. The client will be paying for the attorney(s) (in case more than one lawyer appears for the client) to wait in the courtroom until the case is called up by the clerk. Without counting the time for preparing for the motion argument, the client will be charged for virtually all of the morning and/or afternoon while awaiting the motion to be heard – anywhere from 3-6 hours – for a legal argument not lasting an average than more than 10 minutes. Of course, the attorney must be compensated for his time allocated of the client. Meanwhile, a well-funded or experienced legal opponent knows about costs of the legal process. Since I worked with defense oriented law firms, these defense oriented law firms include as a major part of their legal strategy legal methods to prolong litigation by applying legal procedures or filing extensive legal documents to exhaust the financial resources of the opponent, among other tactics. One such strategy is to file motions to dismiss, or other procedural filings to make the legal opponent’s life miserable. The result: higher legal bills for the opponents. Ries never mentions this aspect of lean startups, but I do extensively. Virtually, a third of all presentations, events or meetups in Silicon Valey are sponsored by regional law firms: “use our services and your company will attract investors or protect your legal interests.” But since the bread and butter for law firms are billable hours, many firms will endeavor to find projects or legal issues marginally needed by any startup company just to generate additional fees. The best analogy is buy this car accessory for your new automobile and it will make it more valuable.
Mind you that established publicly traded companies don’t have such restrictions on legal expenses. Citibank spent over $2 billion dollars on legal fees in over quarter alone for compliance and litigation, enough to impact its EBITDA. One San Francisco startup admitted to me that his company has spent too much on legal fees just to setup a stock option program. Many firms charge over $10k for that alone. How many employees does his startup company have? 3. And I later discovered that even that legal paperwork was wanting.
So much on legal costs. How about marketing and using that capital efficiently? I recently raised the point to the senior management team to develop a logo for the startup company. I have observed that many startups in the medical field have invested considerable time and effort to create a logo for their companies. Since I believe that my company will compete for the same investors, I concluded that we should create a logo. However, the co-founder believes that we should hire a “logo” expert. I have had the direct experience in hiring a logo expert, and my past experience taught me that one could create a logo in-house with today’s technologies. When I, as the previous company’s CEO, employed an expert, I found myself bringing in the other CxOs, and spending an hour or so the options. The outside contractor returns, and then another meeting with the other CxOs. Then an internal meeting to agree on the final design. After $9k and several executive management hours, we selected a logo not even proposed by the contractor. So it takes time and capital – very limited resources for a startup. Fortunately, the Internet reduces the turnaround time and the costs. So that is how I approached this time my logo process. After 2 hours, one iPad, almost zero costs, I created a logo that when showed to a marketing executive, he thought that the logo was wonderful and on point. Again, the “snap count” decision – reduce costs and deliver results quickly for a lean startup company.
The next serious, marketing problem for a startup is customer acquisition. In today’s world, the cheapest and fastest customer acquisition is to adopt a twitter strategy, create buzz on the product, create an attractive, SEO website, and generate online sales. But will it be effective in relation to the product being marketed? In the case of a medical device being developed, no, since that on-line marketing gravitates to the 20 somethings, not 40 somethings. However, one continues to explore of ways to reaching the low hanging fruit targets with a marketing channel that is cost effective.
3. To attract financing efficiently and quickly, make sure that the company’s collaterals are well prepared and identified the potential investors. Every startup will require additional financing. I also refer to financing strategy in earlier blogs. There are 3 important elements to successful fund raising: a) the paperwork – business plan, red herring, private placement documents – is well drafted and prepared; b) essential company information is well highlighted for the pitchdecks and executive summaries; and c) only go to potential investors who are interested in your product – anyone else is a waste of time. And, yet, I meet many CEOs of startups of young companies who ignore these rules at their peril. One company in the hardware space with actual, growing revenues, related to me his uphill battle to bring in additional investors. I quickly noted that outside of a broad stroke powerpoint, he has no collateral expected by the investment community. He wastes his time in fruitless meetings. Another CEO indicated to me a similar frustration. The problem: my swift review of the spreadsheet indicated to me that it didn’t meet investment community standard. (I even have a PDF document describing the standard Excel format for investors and analysts.) Many of the assumptions had no basis, and as a consequence, hard to explain to investors who are numbers oriented how did this company did its financial analysis.
Finally, I will not mention as a principle but raise this important strategic point: avoid mistakes. Some colleagues encourage startups to make them as part of the learning process. I suggest to avoid them by advanced preparation. And, if the mistake is made, not to repeat them. I actually worked for a well-known NYC attorney who related to me that I can afford to make mistakes, but just one. His advice to me is also applicable for startups. Again, we return to the startup’s major weakness – limited capital. If the company makes a mistake, it has exhausted sorely needed capital funds and time — 2 extremely valuable commodities. In American football, the QB has only seconds to decide but cannot afford a mistake. Otherwise the game is lost. How do you avoid those mistakes? By diligent preparation. This principle should also apply to any young startup.