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.