Lean Startup: Business Planning for Startups Has Been Wrong

Entrepreneur, Stanford/Berkley/Columbia professor and startup expert Steve Blank in May, 2013 published an article in the Harvard Business Review titled “Why the Lean Startup Changes Everything.”  The article is available for free downloading at steveblank.com.  

Blank says “no business plan survives first contact with customers.”  By this he means we have startup business planning all wrong. Rather than assume the plan is correct, Blank urges us to realize the plan is based upon a series of assumptions, some of which are highly likely to be wrong.  This is because a startup, by its very nature, deals with uncertainty.  It’s trying to do something new and different.

That was certainly my case.  In one of Learned-Mahn’s (a computer software company I co-founded) blunders, we designed and programmed a very specialized accounting system for trusts and estates.  We wrote the system because my father, a retired accountant, was the trustee and executor for a large estate.  Once the program was complete, we learned no one else did trust and estate accounting the way my father did.

One accounting firm that tried the product, however, forced the system into something it wasn't meant to do—keep small company books. We then modified the program to allow accountants to use it to keep books for their small business clients.  Turned out that most accountants found that uninteresting as well.  Finally, almost in spite of ourselves, large companies found the system and began to use it.  By then several years and most of our capital was gone.  If only we had first gone to the market and then built the product rather than the other way around.

For the forty years or so we have been teaching entrepreneurship, the standard prescription for an entrepreneur intending to start a business has been to write a business plan.  Once written, the entrepreneur proceeds to execute the plan, building the product or service, and bringing it to the market.  Yet we know many, if not most business startups fail.  Rather than accepting this fact as immutable, Blank argues persuasively that what entrepreneurs have been doing frequently leads to failure because the startup business-planning model is wrong. 

Here’s the hallmark of Blank’s approach:  A startup is a temporary organization in search of a scalable, repeatable and profitable business model--how the business will create and capture value.  The founder’s vision initially is a series of unproven assumptions about the market. The job of the founder is to turn the assumptions into facts as quickly and inexpensively as possible—hence the phrase “Lean Startup.”

I've seen in my business counseling and angel investing career dozens of examples of the entrepreneur raising capital and beginning to execute to a series of assumptions that turn out to be wrong.  Most heartbreaking is when an entrepreneur invests his or her life savings, and perhaps that of family and friends into inventory of a physical product only to learn the design is wrong, or the price needed to produce a profit too high. 

So Blank prescribes a rigorous, formal process of testing assumptions as quickly and cheaply as possible in the search for the business model.  It involves consciously writing down the assumptions about the business model and then designing inexpensive tests of those assumptions.  Getting these assumptions right before a lot of time and money is invested is important to both entrepreneurs and those who finance them. 

Fellow Venture College directors Ed Zimmer and Mary Andrews, and I were privileged to sit at Blank’s feet in New York recently as we learned his methodology.  We have embraced the methodology at Venture College and our entrepreneurs are successfully implementing it. In coming articles I will write about how entrepreneurs can utilize Lean Startup techniques to search for a scalable, repeatable and profitably business model.

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Kevin Learned is former software executive, entrepreneurship professor and business counselor.  He is a board member of the Boise Angel Alliance and co-founder of its two related angel funds.  He is the director of Venture College at Boise State University, a program to help current college and graduate students start businesses while continuing their studies.  He can be reached at kevinlearned@boisestate.edu or 208-426-3573.  

This blog post was originally published by the Business Insider, a business magazine of the Idaho Statesman.

A Report Card on the Boise Angel Alliance

I have been arguing for some time in this column (these blog posts are originally published as a column in the Idaho Statesman's Business Insider magazine)  that an important component of the ecosystem for entrepreneurship is the availability of risk capital.  I have also argued that using best practices, angel investments can produce nice returns to the angels in addition to helping entrepreneurs.

Here’s a report card of sorts on some of the Treasure Valley angel activity.

The Boise Angel Alliance was formed about 2003.  Unfortunately, we didn't keep any investment records in the early days.  But for the first five years there was relatively little activity.  As a result, a group of us formed a “fund” to try to stimulate more investment.  A fund is a limited liability company.  The members of the fund agree to contribute cash capital to the fund as investments are made.

Our thought in forming the fund was that it would result in making investments since the cash would be in the bank waiting to be invested.  A fund has the added advantage of spreading risk since each investor has a small piece of a number of investments.

We formed our first fund in the spring of 2007.  Members agreed to contribute up to $50,000 each.  We received commitments for $1,350,000 and began to invest. It took us five years to fully invest the first fund.  Last year we formed the second fund.  Coincidentally, we also received commitments for $1,350,000, so between the two funds up to $2,700,000 will be available to local entrepreneurs.

So what’s happened? 

We have invested a modest amount of money outside the valley with partner angel groups around the northwest, but this article is about the local impact.

The two funds have invested to date a total of $1,535,000 into 14 Treasure Valley companies. Now that is not a large amount of money per company (our largest investment is $160,000 and our smallest is $25,000).  But the money was generally invested early in the companies’ lives and helped the entrepreneurs move their companies to the next level.  We haven't kept track of how much capital the companies have raised since we made our investments, but it is tens of millions of dollars more.

How have the companies done?  All 14 are in business and continuing to execute their business plans.  Some are growing rapidly; some are struggling to find the right path forward. But today all are still in business. 

Collectively their Treasure Valley employment as of June 30, 2013 has increased by 146 positions since we made our investments in each.  If the positions average  $40,000 a year in salary, then that’s an annual impact of nearly $6 million in salary alone in our valley.  

How have the investors done?  It’s too soon to know as angel investments take years to mature.  One of our local companies and one of our non-local companies have been acquired.  One non-local company went bankrupt and we lost our investment.  However, we are starting to get a picture.

Investors in the first fund have received back nearly all of their capital.  Of the $1,350,000 of committed capital, the fund has returned all but about $50,000.  And the fund still holds about  $1 million of stock in portfolio companies at cost.  Those companies will be sold over the next few years and the proceeds distributed to the investors.  At this time it looks like the investors in the first fund will likely be quite happy with their returns.

So, thus far the angel funds have been good for the Treasure Valley economy, good for the entrepreneurs, and good for the investors.

Invest in What You Know

We know from angel research that returns are positively correlated with experience.  That makes sense from two perspectives.  One, angels with experience in a field can better recognize a good value proposition.  Two, those angels can bring their expertise to new companies.

We know a lot about food in the Treasure Valley thanks to Albertsons, Simplot and Ore-Ida to name a few major producers and sellers.  The angels in the Boise Angel Alliance and its funds thus far have invested in three food companies. Each has taken advantage of the knowledge of food available in the Treasure Valley.

Nurture. (www.happyfamilybrands.com) Selling under the Happy Family brand, Nurture produces a line of organic, natural baby and toddler food.  This is an unusual company in that the CEO lives and works in New York and the COO, Jessica Rolph lives and works in Boise.  Both officers are mothers of toddlers with an interest in creating good-for-you food for children. 

Under Rolph’s direction the company sources its raw materials, directs the manufacture of its products and coordinates the delivery to more than 10,000 stores throughout the United States.  Nurture employs more than 25 people in the Treasure Valley, many of them with prior food experience with some of our biggest companies.

In June, 2013 Danone, the French yogurt maker purchased the company. The local angels received approximately eight times their investment, a superb return over four years.

Prosperity Organic Foods.  (www.meltbutteryspread.com) Prosperity produces a line of organic, natural butter substitutes under their “Melt” label.  Hailey resident, Cygnia Rapp created the product when dietary restrictions meant she couldn’t eat her favorite foods (like butter).  As the company grew, Cygnia and her board (I was a board member at the time) determined that her best role in the company was as the spokesperson and chief science officer.

Meg Carlson, who was an angel investor in the company and board member, became the CEO.  Meg had a very successful career as a vice president at Ore-Ida and brought to the company her in-depth experience in food development, manufacturing, marketing and distribution. Meg has attracted experienced food industry talent to the company, both as employees and directors.  The company is now beginning to scale with Melt available in about 3500 stores.

Fit Wrapz. (www.fitwrapz.com) Shige Toyoguchi was a personal trainer in Boise with an interest in healthy food.  He began creating foods for himself and his clients.  This led to a line of healthy frozen burritos available locally at coffee shops, athletic clubs and Albertsons.

Fit Wrapz is a seed stage company, now ready to expand beyond the Treasure Valley.  It recently concluded a seed stage round of financing led by the Boise Angel Alliance.  The capital will be used to fund the expansion as the company tests different channel strategies.

Shige attracted two very experienced directors to help guide his company at this critical time.  One is a former senior officer with Simplot; the other was a senior vice president in merchandising for Albertsons. 

Be Careful of Family and Friends as Board Members

My last post was on the importance of outside, knowledgeable board members and how some entrepreneurs unwisely try to control their boards.  I am expanding on that article with my experience with family and friends in management and on the board.

Gary Mahn and I cofounded Learned-Mahn in the early 1970’s.  When Gary and I joined together we were best friends. Bea Black had come to work for me right out of college. Later my wife Nancy Learned (now Briggs) joined us.

We were well educated, hard working, and totally dedicated to the success of the company.  But even with these attributes, I believe our personal relationships got in the way of our success.

When family and/or close friends run a company, management is often by consensus.  The problem with this is that options, which may be good for the organization but bad for an individual, are rarely discussed, much less implemented. Further, it is difficult for the leader to hold his or her friends and family members accountable. 

Our first board consisted of Gary (best friend), Bea (who I had mentored since she graduated from college), Nancy (my wife), my father (who had invested in the company) and me. For a while Bea’s father (who had also invested in the company) also served on the board. 

We thought at the time we were doing the right thing; but as I read this, it was ludicrous. I would never again invest in a company with this degree of family and friends in management and on the board. Boards need to inspire and to hold management accountable. But when management is the board, and half of it is family, there’s no real accountability. 

And if the company tries to change that structure, the results are predictable—everyone reverts to protecting their own interests rather than doing what is right for the company. Gary, Bea, Nancy and I all believed we should be on the board. After all, we were the founders and managers, we had capital invested and felt we should be on the board by virtue of our stock positions.

My father was a good businessman, but he knew little about the markets or the technology we were deploying.  We felt there were others who could bring more to the boardroom. When I tried to talk my father into resigning, he threatened a proxy fight.  This obviously impacted our relationship, but Dad and I were able to resolve our differences

Ultimately Gary, Bea and I left the company, Dad resigned from the board, and Nancy was made the president. The company made the transition from an inside board to an outside board. Ray Smelek, who was a senior vice president at Hewlett Packard, Chuck Jepson who left HP to run a technology company in California, and Gary Atkins who left HP to start Extended Systems joined the board. Their impact was huge. They demanded performance, constantly pushing Nancy and her team to move more quickly, to grow more rapidly.

I know the counsel of the board was often frustrating to management.  Its demands on management and the company were difficult.  But in hindsight, I believe the success the company ultimately achieved was due primarily to having a skilled president clearly in charge without any family or friends as employees, and to having an experienced, outside, demanding board. The company was sold to National Data Corporation of Atlanta in 1994 in a successful exit for the shareholders.  In 1999 National Data Corporation closed the Boise office.

Dr. Kevin Learned is the Director of the Venture College at Boise State and an experienced angel investor.  208-426-3875, kevinlearned@boisestate.edu

Don't Be Afraid of Outside Board Members

Its board of directors governs a corporation.  The owners or shareholders elect the board; the board delegates management of the company to management.  In my view the board has two principle tasks:  (1) to hire, evaluate, and when necessary dismiss the CEO and (2) to see that there is an effective strategy in place and being executed. 

In early stage companies, the founders generally form the board.  They are the shareholders, the board members and the officers. But when they begin to raise capital, the new shareholders will want to have something to say about who will serve on the board.  This frequently makes the founders nervous as they want to stay in control of their company’s and their own destiny.

Often we angels see boards made up of two founders and one outsider elected by the investors, or the CEO and his or her spouse, and one outsider.  I believe when the CEO does this, he or she is missing an opportunity to bring put in place a board that will not only bring expertise to the company, but will also hold management accountable and thereby accelerate the company’s progress.

When we had Learned-Mahn back in the 1980’s, we had an all inside board consisting of the four founding officers and my father.  It didn’t really work very well.  I was the CEO and the other officers worked for me.  But they were the directors, and I worked for them.  My father brought really interesting family dynamics into the boardroom where they didn’t belong.  And what good was a board meeting when all of the officers worked together all day long?  We didn’t get any outside perspective. 

After agonizing discussion, we decided to bring in outside board members to replace the three management directors that reported to me.  We didn’t replace my father, but family dynamics are the subject of another article at another time.  We were able to recruit experienced business people to the board who could bring their experience to our company.  They included Ray Smelek, who brought HP to Boise, John Dahl, who had just retired as the President of the Simplot Company, Gary Atkins, CEO and Founder of Extended Systems and Charles Jepson who was an early HP employee, and an experienced small company CEO.  

We got expert advice and counsel, and for the first time, I became accountable to people who weren’t my employees.  In hindsight, I think that was one of the best business decisions we ever made.  The outside board made us face our weaknesses and guided us to successful strategies. In fact, Smelek’s counsel convinced us to see ourselves as a financial software company rather than a company for banks.  But for him we might never had seen this blind spot because we were to close to the day-to-day operations.

Today I serve on the board of Medical Management, Inc. The company manages both physician-owned and hospital-owned medical clinics throughout the Pacific Northwest. Until a year ago the board members were all company employees who owned company stock.  A year ago the CEO, Jim Trounson took the difficult step of asking the internal board members to resign.  He replaced them with Dr. Ted Epperley, CEO of the Family Practice Residency program in Boise and Dr. Pat Hermanson, a retired hospital administrator and currently a professor of healthcare management at Idaho State, along with myself. 

We have served a year and were just re-elected by the shareholders, so apparently the shareholders are happy with the change.  The boardroom is a much different place that it was before we were elected.  We bring our diverse perspectives to the company and we hold company management accountable for performance.  The results after the first year have been terrific.

When small company management tries to hold onto control of the boardroom, I believe it is making a big mistake.  The team is giving up the information and counsel they could be receiving, and they are shying away from accountability.  Most entrepreneurs are so focused on execution, they lose sight of the big picture. An outside board will force you to confront your weaknesses and help you see opportunity where you may only see problems.

Dr. Kevin Learned is the Director of the Venture College at Boise State and an experienced angel investor.  208-426-3875, kevinlearned@boisestate.edu, http://kevinlearned.blogspot.com/

Market Feedback is Critical to Early-Stage Companies

The local Boise angels like to invest in “Seed-Stage” companies. A seed-stage company has a workable product or service in the market place and is beginning to generate some revenue. It needs to test the market and learn which customers will find the offering most attractive, how those customers can be reached and what product features are of most interest.

Often what happens is the entrepreneurs will learn that they need to make changes to the product and/or their original market is not the most interesting market.  Many years ago the company I co-founded, Learned-Mahn brought a computer-based accounting system to the market.  Our hypothesis was that most small businesses would find this attractive.  At the time most did their books by hand.

Our market tests helped us learn that our product cost too much for small businesses, and there was no efficient way to reach the target market.  But as we attempted to sell the system, we learned there was a niche with certain large companies that we could profitably reach and who needed what we had to offer. We went on to license the software to AT&T, Campbell Soup and the 1984 Olympics to name a few.

Good entrepreneurs know that almost never will the first version of a product be what the customer will pay for and that frequently the initial target market will not be most productive market.  The most important step for them to take is to bring something to the market as quickly and inexpensively as possible so that they can start to get feedback from real customers. 

We have learned that no matter how much you know about a market, you need to get out of the office and talk to that market.  And the best way to talk to a market is to ask it to actually purchase something. When you do, you get real information about real consumer behavior.

Steve Jobs knew this better than most.  His entire career he brought out less than fully featured products and got instant market-based feedback. Think of the changes that have been made to the iPhone since the first one was released, or the iPad.  Apple is superb at learning from the market place and then releasing a new version of a product that captures a much larger market.

An example of a local company who has brought an early service to the market and learned from its experience is Social Good Network.  Both the Statesman’s reporters and I have written about Social Good Network before.

The Boise Angel Alliance has invested in Social Good Network through its two angel funds. (Full disclosure, I am an investor in those funds.) The purpose of our funding was to enable the company to test its services in the market.

The company provides an on-line fund raising community for charities.  It offers several services:

•       Consumers can shop on line merchants through the community.  When they do, Social Good Network earns a commission. The consumer can then designate 50% of that commission to a charity of his or her choice.  
•        The consumer can make a direct donation to the charity through the on line community. 
•        Charities can install unique patent pending software directly on their web sites, which allows contributors to make donations without leaving the charities’ sites.

The November/December time frame was a perfect time to test these services, both shopping as well as contributions.  Their theory was that they were a consumer centric community focused primarily on shopping.  They learned that the charities were more excited about the donation services.

Armed with this information, the company now knows where to focus its valuable resources. It is changing its software road map and marketing to respond to the information it gained from taking the initial product to the market place.

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Kevin Learned is the Director of Venture College at Boise State University, and the co-founder of two angel funds which invest in early stage companies in the Boise, Idaho area.