Digital Casserole

WHAT I BELIEVE: I believe in the power of a single idea. A single good idea, anyway. Frankly, there’s just not a lot of power in a single bad idea, like scheduling “Bat Day” when the Red Sox play at Yankee Stadium. I believe in long, slow downloads that last 3 days. I believe in the designated driver, the fungo bat, and keeping words like gazebo and zamboni around just because they’re fun to say. I believe in naps but not Napster.(more..)

Location: Strongsville, OH, United States

Sunday, April 14, 2013

The Dirtiest Word in Startups

Just as karaoke machines created a nation of wannabe singers, and WordPress created a nation of wannabe writers, so the imperfect storm of global connectivity, crowd-funding, and America’s protracted economic and employment malaise (aka Lagflation) have created a nation of wannabe entrepreneurs.  While there are many articles out there urging you to throw caution to the wind, chase your dreams, and “Go for it”…this is not one of them. Instead, this essay is like a Simon Cowell wake-up call for those considering becoming an entrepreneur and launching their own company. In a world of Facebook friends cooing, “Believe and you will achieve,” this is the counterbalance – an adult, “eyes-wide-open,” practicum which draws back the curtain and cuts through the hype by zeroing in on the most controversial, misunderstood, and unspoken word in startups.   

Confessions and Credentials 

I begin with some confessions and credentials.  I love startups.  I love building things from the ground up.  I love taking a blank sheet of paper and transforming fantasy into reality. But more than anything, I love the culture of the driven people comprising this community - that audacious brotherhood of courageous pragmatists - who combine an infectious, ambitious, and generous entrepreneurial spirit with a passion for progress.

After spending the first decade of my career marching through the corporate world, I’ve spent the past 13 years as an entrepreneur.  I’ve launched five companies, written scores of business plans, investor guides, and industry white papers, and know firsthand the exhilaration of a public company exit.  I’ve raised capital and spent capital. I’ve consulted to private equity. I’ve pitched at “Stake and Egg” breakfasts and VC dinners, as well as conducting countless presentations to investment groups sporting edgy ironic names like ARCH Angels, JumpStart, North Coast Angel Fund, and Idea Stream.  My exploits have included forays into risk management, consumer products, corporate social media, commodities, bioinformatics, and commercial property, and I am currently a stakeholder in 7 startup companies.  I’ve been interviewed on XM Radio, hung out with Robin Williams at CES, had products featured in GE’s booth at RSNA, been on the Video Game Awards show red carpet, schmoozed in Studio 54, was showcased by MTV and Spike TV, and even had CNN cover a launch at COMDEX featuring a Bill Gates look alike. And yes, I’ve experienced failure and financial setbacks, and carry the scars from former business partners whose lack of integrity scuttled entire companies. I guess you could say I’ve been around the block so many times I can’t remember my first rodeo.

The Dirtiest Word

It’s been my experience that every meeting with a serious investor has what I call “The Moment.” You’ve just presented your brilliant, bleeding edge, “The next Facebook/Starbucks” idea, while bolding proclaiming, “Nobody else is doing this,” and thereby positioning your firm with that critical, “First mover advantage.” You’ve documented your industry research and market trends, you’ve smugly smirked at your, “Lack of any real competitors,” and you’ve detailed your product/service strategy, intellectual property, and price points.  And if that wasn’t enough, you’ve fawned over the stunning credentials of your veteran, experienced, top-shelf, blue chip, management team, your launch plan rollout, and your estimated revenue, costs, and profit margins - complete with requisite hockey stick growth projections (which are – of course – “conservative”).

The meeting reaches an emotional crescendo as you confidently answer the tough questions regarding the amount of investment you are seeking, in exchange for the amount of their stake in the startup.  And then there is “The Moment” – the moment they finally turn to the Excel spreadsheet on the last page of your meticulously prepared Investor Guide…and their eyes slowly scan down your projected expenses and use of capital…and then they stop…they ALWAYS stop…at the dirtiest word in startups – SALARY.  You hope it will go unnoticed.  You pray for a matter-of-fact nod…but it rarely comes.  Instead, they lean back, and start asking a series of awkward, personal, and uncomfortable questions beginning with the word “So” (so as to appear disarming, benign, and spontaneous):

“So, how much have you already invested in this startup?” 

A good question, for which you’ve got a good answer, but before you can reply, comes the kicker - “…not including your TIME,” - at which point, no amount of explanation regarding “opportunity costs” or “sacrificing family time” or “working nights and weekends” will suffice. 

Knowing you’re on the ropes, the next question (a direct and deadly corollary to the first), is as predictable as it is paralyzing:

“So, how much of your OWN money have you put in?” 

At this point, the room starts feeling stuffy and uncomfortable, and you’re startled to hear your once confident bravado replaced by a nervous stammer, as your now suddenly dry mouth sheepishly attempts to choke out a cryptic tabulation of what ultimately turns out to be an embarrassingly small amount of actual cash out of pocket – particularly when compared to what you’ve just asked them to invest.

As the hushed meeting falls silent, you decide to uncork a last ditch “Hail Mary” to salvage your dignity, demonstrate your commitment, and prove your passion for this project, by explaining that these figures represent a huge sacrifice, as you and the entire management team would, “Only be working at half our current salary.”

The next few minutes are the ones that stay with you, as the relaxed congeniality and respectful man-to-man camaraderie which marked the first part of your meeting are replaced by a dismissive air of mild annoyance, as they launch into a belittling, cliché-riddled lecture on the merits of “hard work” and “sweaty equity” and putting “skin in the game” and “keeping you hungry,” because heaven forbid, “We don’t want you getting too comfortable.”

The dirtiest word in startups is “salary” because of its proclivity to upset, offend, and alienate your investor audience and because it exposes the great hypocrisy and the dirty little secret resident within this community, and it is for these reasons that the word is seldom discussed or even uttered in polite company.

Salary: The Elephant in the Punchbowl

The problem with salary, and the reason it’s so controversial, is because it does not accurately reflect reality – and in their heart of hearts, everyone in the industry knows this.  Here’s how the flawed circular logic plays out. 

First, the typical entrepreneur, by his or her very nature, is ambitious and driven - motivated not by a fear of failure, but rather by an overriding optimism regarding the potential of the business opportunity, combined with a steadfast confidence in their abilities and passion to succeed.

Second, it is acknowledged and understood within the industry that the most important component of a successful startup is the experience, quality, and expertise of the leadership team.  While “past performance does not guarantee future results,” it is still the best predictive measure for extrapolating outcomes, and it is for this reason that investors give preference to management teams comprised of accomplished professionals with demonstrated track records of career success.

And finally, the blindingly obvious.  If these professional have already been successful in their careers (which, again, is what investors prioritize and rank most highly on a startup management team), then they will usually enjoy the fruits of their labors, including a nice house with a mortgage, a contemporary car with a monthly payment, and other lifestyle indicators of affluence.

The Problem with Investors

My problem with most investors is that, for some reason, they seem to think that when a person starts a business, Maslow’s Hierarchy of Needs no longer applies to them. That suddenly, once a business plan is complete, the entrepreneur will no longer require food to eat, clothes to wear, or a place to sleep.  Hello?

As an investor and entrepreneur who has spent time on the both sides of the table, I completely understand the desire of funders for initial capital to be allocated with an emphasis on product completion.  However, by failing to provide a means of sustenance for the founders during this critical ramp-up time, they inadvertently increase the risk profile of the very startup they want to succeed. Remember, you’re investing in this business because of the novelty and promise of the idea and the accomplishments of the management team.  Since entrepreneurs are by their very nature highly motivated people, a failure to offer a salary to cover living expenses is not an “incentive” – it’s a distraction!  How can we expect people to make rational, strategic decisions on the future direction of the company when their hair is on fire trying to figure out how to pay the mortgage and put food on the table?

Why do you think so many of America’s greatest success stories involve companies started by a few guys in a college dormitory?  It’s because when they’re living on a campus, all of their lower level needs for food, clothing, heat, shelter, and safety are being met and paid for – providing them with the necessary time to invent, explore, and workshop ideas, and then nurture them into actual businesses.  Why do so many firms like Apple trace their humble beginnings to “Working out of Mom and Dad’s garage?”  It’s because, within this environment, all of their needs for immediate survival were being met, providing them with the necessary time required to focus on building something of lasting value.

Most Incubators Lay an Egg

The word “incubator” is plastered all over the startup community, but the concept usually falls frustratingly short in practice. Why?  Because while incubators often provide “nice to have” WANTS like tables, chairs, whiteboards, mentors, and Wi-Fi, they rarely provide aspiring entrepreneurs with a sufficient amount of cash to meet their lower level NEEDS – money necessary to buy precious innovation time, enabling them to survive during the critical phase when their idea goes through the process of gestation, development, and refinement. (Remember, if your 3rd grade incubator didn’t provide heat, food, and shelter, your tiny yellow chick would have never survived).

The impact of this overlooked or ignored disconnect within the entrepreneurial community is significant.   Not only do these challenging financial dynamics serve as a barrier to entry for millions of would-be entrepreneurs, but they can create a detrimental bifurcation in the demographics of the startup community, resulting in founders who are either YOUNG (just out of school and still living with their parents so their financial needs are minimal), or OLDER (over 40, who have been successful enough to “retire” with a nest egg providing sufficient residual income to get by).  If not reconciled, the net result produces a hollowing out of what I call the “sweet spot” – that huge swath of the most eager and available 20 - 40 year olds - who shun startups simply because they need a predictable salary to meet their commitments.  

CoolCleveland’s Thomas Mulready recently interviewed Blackstone LaunchPad’s Founding Director Mike Nock, who poignantly observed, “College kids and young people have a lot of time and a lot of ideas AND they don’t have a lot of obligations like mortgages, braces and babysitters.”  While his comments are on target, they still fail to paint a complete picture, as today’s four-year college students are graduating with nearly $27,000 in student loans (with monthly payments starting within 180 days of graduation), meaning that most are so indebted that they can’t even consider a job that doesn’t have a functional level of salary.  

A Compensation Compromise

While the challenge of salary can never be completely erased from the startup culture, I believe there is room for a pragmatic compromise to effectively split the difference.  Do I want to enable lavish lifestyles supported by my investment capital? No!  Do I want to discourage aspiring entrepreneurs by insisting that my capital goes towards building the product and not towards the income they need to survive? No! I believe there is a middle-ground whereby the NEEDS of startup entrepreneurs can be met, but not the WANTS.  The effective allocation of investment capital requires a very individualized and intimate discussion regarding the monthly bills of the principals and the amount required to keep them solvent. Will they earn enough to buy a new car, take expensive vacations, max out 401K contributions, and go out to eat regularly at pricey restaurants?  No!  The idea is to provide just enough cash flow to cover their monthly commitments - so that the entrepreneur knows their NEEDS are being taken care of - and thereby allowing them to focus on a successful launch.  By ensuring their survival needs are met, entrepreneurs will no longer need to waste energy grappling with the daily struggle for compromise – deciding between making the best strategic decisions for the long-term growth and viability of the company OR the short-term urgency to rush things, just to get some cash in the door.

Keeping Entrepreneurs Respectable

In addition to providing cash flow coverage, this investment approach also provides something far less obvious yet equally important to company founders – RESPECT.  By allocating a portion of capital investment for salary, investors show their respect for the entrepreneur by both honoring their track record and body of work to date, while also affirming their belief that their best work is yet to come.

One of my clients (Evolution Capital Partners) is a private equity firm which embodies this practice of respect in their investments in other companies (although their focus is on established Second Stage firms). While their model involves taking a controlling interest in their portfolio companies, they structure these deals so that they respect the success of the founding entrepreneur by providing a significant cash-in-hand payout at the close of the initial transaction, as well as a roadmap for an even more lucrative return at a larger exit down the road   Like signing a 4-year contract for a proven veteran NFL quarterback , this income commitment is a tangible recognition of their confidence in the idea and the individual, and clearly demonstrates they are “Putting their money where their mouth is” regarding their belief that the leadership team is the most important component of the startup.  For those who claim that human capital is the most important, yet fail to recognize and respect them with a modicum of salary, my inclination is to question the validity of their stated belief.  As the old saying goes, “The proof is in the pudding.”

Entrepreneur or Entremanure?

If approached in this respectful way, salary doesn’t have to be a dirty word – for investors OR entrepreneurs – and the reason it works is actually scientific.  The DNA of the entrepreneurs I’ve met shares a similar “motivation” gene.  These aren’t people satisfied to be coasting along with compensation that just gets them by month-to-month.  No way!  These are individuals who go above and beyond because they’re high achievers - that’s just how they’re wired.  The decision to provide sustenance-level salary to these ambitious individuals returns the dual benefit of providing entrepreneurs with the confidence that their NEEDS are being met, while providing investors with the confidence that their decision matrix is not being dominated by a tactical “tyranny of the urgent,” but rather informed by measured actions as part of a long term strategy.

My Solution

Over the next 18 months, my firm Briarcliff Capital is going to take this concept one step further by combining the best attributes of “Campus and Company” to design an entrepreneurial environment which truly covers all of the bases.  Our goal is to offer a self-contained entrepreneurial ecosystem which provides not only for the corporate and capital needs of our members, but the physical needs as well.  By providing office space, infrastructure, working capital, and mentoring, as well as efficient living quarters and attached community area, we’ll have the opportunity to maximize the impact of every dollar invested in our portfolio companies, as we seek to create an integrated entrepreneurial tribe of like-minded professionals committed to incubating the next generation of big ideas.

Conclusion and Caveats

I conclude with a few caveats.  As I mentioned in the opening paragraph, the purpose of this article is to serve as a counterbalance to the irrational exuberance which often surrounds the euphoria of wannabe entrepreneurs.  As such, the enclosed storyline represents a purposefully heavy-handed caricature of some of the salary discussions I’ve participated in over the years, with the goal of attempting to level-set this conversation by sharing this unflattering reality of working in and around startups. The truth is, while I actually HAVE received a respectful salary at some of my startups, it’s also true that on other occasions that has not been the case, and the discussions paralleled the awkward exchanges described earlier. 

My purpose for composing this piece is to educate would-be entrepreneurs of the fact that – within startups - the topic of salary is dicey, nuanced, and grey - and will hinge on a lengthy list of variables including your age, experience, credentials, idea construct, location, and regional customs (e.g. West Coast vs. Midwest), not to mention your context (incubator, accelerator), your stage of development (Seed, Angel, Series A, VC), and the specific investment terms.

Hopefully this article will better prepare you for the nuances of this potentially prickly salary conversation, and thereby increase the chance of achieving a balanced equilibrium in the risk/reward continuum, and a beneficial compromise between investors and entrepreneurs.  Remember, it’s always easier to “Pay it forward” when you know someone’s “Got your back.”


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10:14 AM  

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