Perhaps this wasn't the most opportune moment to sneak out. I still had some time before my next meeting, and for all his bravado, this kid could really use a clue.
I took my coat off. “My friend out there,” I said, “he'd like a decaf.”
Chapter two
THE RULES
OF THE
GAME
LENNY, THOUGH SUBDUED for the moment, was likely to spring back to life and resume his story of those putrefying bacteria, probably in the middle of lunch. So, why was I still here?
A couple of reasons, I suppose.
My father's parents were Russian immigrants. My mother's family came off the boat from Germany. Both sets of grandparents left their homelands for a new and unknown world. It was a courageous bet on a vision, simple faith. I see a common gene among immigrants and entrepreneurs who strike out from the pack to pursue their dreams. I admire people who are willing to bet everything on a belief. Some of these risk takers, whether immigrants or entrepreneurs, have a profound impact on what happens in the world. They place bets on the future, often against fantastic odds. I see heroism in that.
The other reason is simpler still. On one or two occasions in my own history I've been helped by people who should have given me the boot for my naïve and disruptive zealotry. I have been sympathetic to the plight of true believers ever since.
I carried Lenny's coffee out to his curbside table. The center's shopkeepers were all arriving for their various businesses—a women's boutique, a video rental-cum-post office, a liquor store noted for its fine wines. Everyone stopped by the Konditorei for their morning java, exchanging pleasantries. No virtual mall could ever replace this small town feel. Technology does have its limitations.
Still preoccupied with his phone call, Lenny was surprised to see me and started to get up. “I'll get the presentation,” he said. “We can finish out here.”
“Sit down, Lenny. Let's just talk.”
“What will you tell Frank?” he asked as he sipped his coffee. Concern and frustration passed over his pallid face.
“I don't really know. If Frank called me right now, I'd have to say I don't completely understand Funerals.com—or you.”
Lenny leaned forward to protest, but I cut him off.
“Lenny, I've seen some great ideas—Palm Pilot, WebTV, Intuit. They all struggled in their early days but persevered in the face of many skeptics.”
“Struggled? I've got people interested,” he countered, obviously eager to reassure himself.
“Any term sheets?”
“Not yet.”
“What interest do you have, then?”
“Four or five VCs say it's a great idea. They want me to get back to them when I'm further along. If I can produce a credible lead investor, others will follow.”
Ah, it was what I thought. VCs have no percentage in telling you “no” outright. A “no” from a venture capitalist is as rare as the “no” of a Japanese salaryman. Unless you mug the receptionist on the way out or spray graffiti all over their German sedans, VCs seldom turn you down outright.
The other day, a prominent VC described how cutthroat his business had become. One-time friends are bludgeoning each other to win deals. My buddy had gotten cold feet on a deal just as another firm made a move on the founder. “I went crazy to close that financing before it walked out the door,” he said. “Wait a minute,” I protested. “It was a bad deal.” “Sure,” he said, “but I couldn't let somebody else steal it.”
So, I asked Lenny, why would they tell him “no”? He might improve the idea or his team, or some other investor might get excited and then those on the sidelines would swarm in and create a frenzy. Or, who knows, if not this time, his next idea could be a winner. Might as well keep the door open.
My news was a splash of cold water. Lenny leaned back in his chair. He pursed his lips and shook his head. He had probably suspected as much after all these months, but hadn't been able to admit it to himself or his partner.
“They were still interested,” he persisted. “I could tell.”
“Listen, why don't we look at Funerals.com the way a VC actually would,” I suggested. “A VC asks a set of threshold questions about every business proposal. Let's walk through those, and see where they come out.”
I took his silence for assent. I'm sure he would have preferred to finish his pitch, but I didn't give him a choice.
VCs, I explained, want to know three basic things: Is it a big market? Can your product or service win over and defend a large share of that market? Can your team do the job?
VCs like to target markets with big potential, especially tiny markets growing quickly into big markets, like the Internet. If it's a small market, the chance for a portfolio-levitating, reputation-making home run isn't there. A VC's portfolio return is an average of all its investments, so he'd rather have a huge winner and some no-ops than a bunch of minor successes. If you're off-target slightly in a big market, you might still make it, and, if you make it, it can still be big. Off-target in a small market means you're dead.
“So,” I asked, “how big is the market for all this funerary gear?”
According to Lenny's research, there are more than two million funerals every year in the U.S. The average funeral and burial costs close to $7,000. That makes a $14 billion market. About a third of that is for the items Funerals.com was slated to sell. That made Lenny's overall market $4 to $5 billion, a sizable target.
“How much of that will be sold on-line, do you suppose?”
“Maybe 25 percent in three years.”
“But isn't that a problem, Lenny? Your projected sales of $100 million in three years amount to what share of the Internet slice of that market?”
“Ten percent or so.”
“Do you expect a lot of competition?”
“Hell no. Maybe a couple, but we'll be the leader.”
“With 10 percent of the market? It doesn't foot.”
Perhaps a billion-and-a-quarter-dollar Internet market was too big a guess, but one hundred million in sales suggested he wasn't headed for market leadership. If that was true, it was a problem, because top VCs only want to invest in potential leaders. As most markets grow and eventually consolidate, only the leading one or two players are likely to make money and see their share prices rise. So plans ordinarily promise that the new company will “dominate” its market. If Lenny didn't think this way, VCs would conclude something was wrong with his projections or his ambition. On the other hand, his market share might be much greater than 10 percent, because the total on-line market for funeral gear might be smaller than he projected. Either way, he would have to sort it out.
Funerals.com would face the same issues other Internet retailers face: How much of the market for their goods will shift to the Internet? In the case of Funerals.com, would the business find a way to redirect sales from local funeral homes?
Lenny could only guess. Fundamental to his plan was the assumption that the children of baby boomers would be more willing than their parents to buy these goods electronically. So, following his reasoning, it was important to stake out the territory now and prepare for the growing numbers of baby boomers who will start swelling the funeral market in the next few decades.
Of course, it didn't help Lenny that virtually everyone he'd been talking to, including me, is a baby boomer. We would like to believe we make cool, rational decisions, but not many pitches force the pitchee to contemplate his own mortality.
“So you think it would interest Frank more if we decreased our estimate of the total share of business moving to the Net?” he asked.
“Not necessarily. That could result in too small a target market to be interesting. I assume you estimated your sales bottoms up and projected the market tops down. But either you've underestimated your sales or you've overestimated the potential market. If you don't see yourself as the leader, or you believe the on-line funeral business is pretty small, you won't get much interest.”
�
��But I figured we could show that, even conservatively, we can build a nice, profitable business.”
“Fine, but make that the ‘worst case’ in your plan. Maybe it reduces some risk, but those market share numbers won't inspire investors. Don't even try to do this if you aren't planning to take it all. Then allow for some competitors, but hold the leadership spot. Nothing else is worth investing in.”
“Good. That's good.” He scribbled notes.
I put my feet up on one of the white plastic garden chairs that serve as café furniture in Portola Valley. When he was done, I asked, “Lenny, why is this a big idea?”
“It's a big market, big dollars.”
“Will it change the way the world operates? Will it change people's lives in any meaningful way?”
“Change the world? We're saving some people from the sharks that prey on grief. The current system is awful.”
“But basically you're just changing the way the product is sold and bought, substituting yourself for some brick-and-mortar intermediaries.”
“What's wrong with that?”
“Nothing, it's probably a good business strategy. How do you see this business in five years, though?”
“$400 million? $500 million!? Who knows?”
“But it's the same thing, right? Same products sold the same way?”
“Yes,” he said hesitantly, as though he were missing something. “Is that a problem?” he asked.
“Not necessarily, at least for some VCs,” I said. “Let's go to the second question. What kind of competitive position will you have? What makes your products or services unique and compelling enough to ward off copycats? Can you stake out a significant chunk of your market and defend it? Or can someone reproduce what you're doing overnight?”
Lenny explained that federal regulations aimed specifically at the funeral business created an opportunity for his venture. Funeral homes must accept caskets provided by third parties without fee. The trouble is that the regulations extend that opportunity to everybody, not just Lenny. Like other Internet merchants, he would bank on the limited ability of brick-and-mortar merchants to cut prices. But with these margins, who knows? And what about Internet-based competition? Where were the barriers to entry?
His answers were not satisfactory. He was offering nothing that another competitor couldn't also develop. The key to his business was swift execution. There's nothing inherently wrong with that. But fundamentally, there was a risk that, after Funerals.com gentrified the neighborhood, some brick-and-mortar heavyweight would sweep into town, or some Internet speed freaks would catch Funerals.com from behind. There were no safe havens unless Lenny could achieve Silicon Valley's new mantra, “Build Brand.”
“How will people find you when they need you?” I asked. “How will Funerals.com establish a brand and presence? E-commerce is all about distribution, building awareness, being seen, and the Web gatekeepers take a hefty toll before granting you access to their traffic.”
His plan was to work with the existing non-virtual infrastructure—social service departments, hospitals, clergy, and hospices—the people who know when someone dies. They would serve as referral points. But would they tell people about Funerals.com? Would that word of mouth suffice in an age of Internet portals?
“Price, convenience, no pressure,” he said. “They'll refer people because it's a better way to shop.”
“You said a while ago when someone dies, no one wants to shop around,” I pointed out.
He made a note, probably a reminder to take that sentence out of his pitch.
“Some won't. Some will,” he said.
“Besides, nothing prevents someone else from making the same offer,” I challenged. “If that happens, where are you?”
“So far ahead, nobody can catch us,” he said.
First-mover status might confer some advantage, but how much wasn't clear. The need to move with ferocious speed is the Internet's legacy. If nothing else, e-commerce forces every business to accelerate to defend its turf or cede precious market share to the fleet-footed mammals of the Web.
“If we beef up that point in the plan, will it make a difference to Frank?”
“You need to address it. It's a threshold question.”
He made some more notes. My chai was getting cold. Maybe Connie would be so kind as to warm it up. I turned toward the window and waved to her inside. She ignored me, deliberately not looking my way. No respect.
“That takes us to the third question,” I said, turning back to Lenny. “You and your team. Your first-mover status relies on rapid execution. That means the composition of your team is even more crucial than usual, because you won't have time to learn on the job.”
“It'll be a good team.”
He reached into his case of files and handed me a copy of his business plan. “There's a summary of people in here,” he said.
So there was. Unfortunately, besides Lenny, there was only one other founder identified by name. She was a marketing manager for one of the biggest funeral home chains, so she would be the domain expert. He obviously didn't suspect I had overheard his earlier conversation regarding his teammate bailing.
I told Lenny I was troubled by his and his partner's lack of startup experience. It heightens the risk. Startups are unique animals. We take them pretty much for granted out here now, but they are still endeavors that require very different skills from the ones needed in established companies.
Like tourists on safari, senior executives from some of America's largest corporations come to the Valley to study the exotic ways of the natives. Arriving from Chicago or New York or Dallas, they think they need to be more like Silicon Valley startups, but they usually end up scratching their heads. I recently met with some senior managers from a world-class package goods company who had been up and down the Valley. “We thought we could take a crash course in the Valley way and apply the lessons to our business. But this place is extremely foreign to us. We'll have to partner with experienced startup talent and Valley VCs if we really want to try our hand at being entrepreneurial,” a senior manager confessed.
Even when large companies try to set up small, intrapreneurial units, they are hard-pressed to find people inside the company who will drive them with the same fervor and penny-pinching zeal that desperation demands of independent startups. The accoutrements of established businesses— the company cafeteria, the clerical support, the illusory job security, the pension plans, and everything else a large organization can provide—are inconsistent with Valley startup mentality.
“I'm not concerned about it,” Lenny shot back. “We have a good plan, and we know how to work a plan.”
I thumbed through the material. It was a fairly polished presentation: market description, customer need, product strategy, competitive positioning, launch schedule, sales projections, expense forecasts, IRR and other rates of return, investment required, discounted cash flow. All the numbers you'd want. Year one. Year two. Year three. Everything worked out with an inevitable logic. Lenny had outlined in some detail how he planned to run this business.
But how would he react when reality swept over his PowerPoint slides?
It was becoming clear that he believed his task was to raise money and then follow his plan. As far as he was concerned, the answers were all there. That's the drill in large companies: “work” the plan. Every week or month or quarter, the head of a new venture will meet with senior management and report progress against plan.
I once sat on the board of a startup that had raised an initial round of funding from a wealthy Hollywood financier. This was the kind of startup the Valley fondly refers to as “Brave New World.” (The other kind is more soberly called “Better-Faster-Cheaper.”) This particular startup envisioned a business based on a radically new product and service. Naturally the business plan laid out detailed projections, but everything was based on assumptions that could not be tested, short of actually starting the business. Of course, the business at that time was nowh
ere near the place specified in the plan. Crucial distribution partners were not moving as quickly as expected, and their involvement remained outside our control. The financier, who had made billions in oil and gas, was troubled and became progressively more upset when he learned the company was falling farther behind and away from the plan. He was a savvy investor, but he was not acquainted with technology startups and was increasingly rattled by the risk inherent in this venture.
Finally, after yet another hand-wringing board meeting, at which one of the financier's henchmen screamed, threatened to cut off funding, and jumped management through innumerable hoops, I took the fellow aside. I explained that in a Brave New World startup, where there's no existing market, no incumbent competitors, and no economic model, you're literally inventing the business as you go along. It was absurd, I told him, to hold the team to the original plan. Look at the progress they had made on everything within their control, such as the quality of the organization and the status of the product. It was necessary to be vigilant and flexible in order to learn as the business progressed. These were the right indicia of success at this point, not the plan. The management team was obviously working hard to close a deal with distribution partners and was pursuing alternative strategies. By any measure, except the original plan, this team was doing a great job. The principal use of the plan comes at the beginning, I explained, to show that the founders are intelligent, capable of structuring the business concept and expressing a vision of the future. Later the plan can help track problems that may reflect on the startup strategy itself. The financier's henchman calmed down, but his boss never really got the point; he dropped out before the company went on to be sold for more than half a billion dollars.
“Lenny,” I said, “I doubt your plan will take you all the way. There are too many unknowns. You'll need people capable of navigating without street signs. The composition and experience of the team are something VCs will look at hard.”
The Monk and the Riddle: The Art of Creating a Life While Making a Living Page 4