Product / Market fit can be loosely defined as the point in time when your product has evolved to the point that a market segment finds it attractive so that you can grow your product / company scalably. In many ways, finding Product Market fit quickly allows you to focus on company growth rather than spending a lot of time and money on iterating your product to find that fit. Many companies linger in that limbo for quite some time unfortunately. Without this product market fit, it’s hard to inject nitroglycerin to generate the desired growth rate that all investors want when they invest.

Having spent time with several companies that have gone through the process of finding product market fit, I have observed that many get hung up on iterating only the ‘product’ part of product / market fit, rather than thinking of ‘product’ in a larger context. Speficially, the three things I notice are being omitted by several companies that have been religiously using the “Lean Methodology” product dev model alone to achieve PM fit, but failing to find it are:

1) A definition of a Minimum Viable (customer) Segment – As originally defined by Michael J. Skok
2) The testing of a well thought out positioning strategy alongside the testing of an MVP
3) The testing of a complimentary go to market / marketing strategy that tests your product vis-a-vis the chosen positioning strategy above

If you think of the three above as a bullet, visualise them as the lead pellet (product), the shell (positioning), and the gunpowder (go to market) that makes a bullet work. They only work when tested all-together, not separately. Testing only the lead pellet, doesn’t get your bullet very far.

In order to fit these three points into a more familiar framework, I have borrowed the Lean Methodology’s Build-Measure-Learn loop and expanded on it to create a larger loop designed specifically to help guide you achieve a series of test loops to achieve product/market fit. This isn’t perfect (and would appreciate any feedback on how to improve it) but I figure it’ll help provide a framework by which to test all in conjunction.

Here is the Product/Market Fit Cycle Model I propose (see attachment for illustration at bottom of post):

Start with a Product Hypothesis / Idea

This is effectively the way YOU think of your product the day you conceived it.
This should also have the rudimentary aspects of a defined value proposition for a set of customers.

Identify a Minimum Viable Segment (Customer Base)

The concept of an MVS comes from Michael J Skok’s observation of one of the flaws of the standard Lean Model. You can see his work on this here: http://www.mjskok.com/resource/gtm-segmentation. In summary, a Minimum Viable Segment allows you to test your product on a focused segment rather than leaving it too open ended across several segments, each giving your potentially different outcomes. The benefit of identifying a minimum viable segment is it allows for better differentiation of your product within your market segment, thus, you get easier referrals from this group as well as more efficient use of capital to acquire them.

Questions to ask yourself as you define your MVS:

*Who are my potential customers?
*How do I find them? (which blogs, which media, which social networks, which retail locations, which distributors, etc)
*What will they be willing to pay? (you may not know this off the start, but you’ll be able to determine this as you test it in the next step)

Build a Minimum Viable Business Model

The Business Model Canvas helps a lot in identifying a lot of the components needed for a fully operational Death Star, but what we are trying to test here is more ‘does it work’, rather than filling in all the components of the Business Model Canvas too early, and which you may not know at a start.

The three parts to the Minimum Viable Business Model include: A positioning strategy, an MVP, and a Go 2 Market Strategy.

*Build a Positioning strategy

As you create your positioning strategy, make sure it will resonate with your MVS and product hypothesis, or otherwise iterate these so that they are harmonious with each other. No point in having your positioning not be something that your MVS values, for example.
If you are not familiar with what a positioning strategy is, read the following book, it is the gold standard: Positioning by Jack Trout & Al Ries

*Build an Minimum Viable Product that fits the above positioning strategy

Most tech founders generally rock at this bit, so nothing I can really add here. However, take a look at my previous post on growth hacking summarising Traity’s experience in optimising their product to yield better conversions if you want to optimise your product for growth and reduce the potential of your product getting in the way of conversions: http://thedrawingboard.me/2013/04/15/on-growth-virality-loops-and-customer-acquisition/

*Build a Go 2 market strategy

A Go 2 Market Strategy is, simply put, a strategy that attempts to cost-effectively deliver the value proposition to the selected target segment(s). It is a strategy to help get the product or service out in the marketplace and includes pricing strategies, sales strategies, and marketing methods (internet marketing, direct marketing, PR, etc). It can include things like identifying key distribution channels and key partnerships required to get your product to the identified minimum viable segment. Clearly this will be different for B2B companies than B2C companies. The aim is to build a Go 2Market strategy that targets you MVS with your selected positioning strategy for best effect.

Once having completed and packaged the above three in a minimum viable form, assign a “cost” (what money you are going to spend on validating it) to the combination and set some expectations around target figures upon which to analyse your resulting metrics. How many users are you expecting, what constitutes an ‘active’ user? A churned user? A conversion? etc. Effectively, you want to have ‘targets’ for what you experiment will yield.

Test & Measure

As you know, a key part of understanding forensically whats happened after a test, you will need to have set up good tests to start with and also adequate data. A good book on this is: http://leananalyticsbook.com/  I’m in the middle of reading it, but so far it seems in line with what I’ve seen several startups doing.

Tests will include quantitative (Kissmetrics & http://newrelic.com/) and/or qualitative tests about how the product is perceived based on people that didn’t activate. Using the output from your tests find out how your users are behaving to gain intelligence.

However, keep in mind that testing will be different between the different phases of startups in how you can test. In the words of Andreas Klinger (co-founder of Lookk):

 I personally see product dev as a spiral. The further you go outside (mature) the more quantitative your approaches can be, the further you are yet on the inside the more qualitative. You repeat the same phases (build,measure,learn etc) but you use different tools.

 Most startups are in that inner core of that spiral but play games of outer ends. We can call this premature scaling or just inefficient behaviour (e.g. using metrics when there is no clear data). Many product hypotheses/ideas and especially customer segments can already be eliminated very cheaply before MVPs – eg by qualitative approaches (eg customer interviews).

Metrics are for me personally a bit further down the spiral.

Once you go down the path of metrics, use the Pirate Metrics framework (summarized below) to forensically analyse why (http://500hats.typepad.com/500blogs/2007/09/startup-metrics.html)  -

* Arrivals & Acquisition – How many people landed on your website coming from a marketing campaign that you are tracking and then you acquire the user. For a SaaS product, this usually means a sign up.
* Activation – The user uses your product.
* Retention – What is your churn? How many of the users you have in your userbase are active? How many stopped being active and why?
* Referral -How many of the users that are using your product are willing to refer to others?
* Revenue -How many users are willing to pay you of the ones that are using the service?

Learn/Debug your Minimum Viable Business Model (MVB – yeah ok, too many MV* acronyms, but too long to spell out)

Questions to ask yourself as you are reviewing the metrics:

Are you having high arrivals but poor Acquisition/Conversion? – Perhaps your Positioning is working, but your product isn’t living up to expectations. Think about this as you talked about a great party but when people showed up they thought the party (product) was lame.

Are you having high acquisition/conversions but poor arrivals? – Perhaps your positioning/marketing strategy is not working, and for those few people that are in your MVS that land on your site by luck, convert because they find the product useful. Perhaps you didn’t allocate enough cash to your Go 2 Market, or rather the cost of acquisition of the chosen MVS is higher than expected so you are just aren’t getting enough eyeballs on the site, but when they do they convert.

Are you having so-so arrivals, and acquisition at your target figure? – Perhaps your Go 2 Market strategy is not cost effective, or you didnt find the most efficient channels. Perhaps you didn’t allocate enough money to the Go 2 Market strategy.

Are you having high Arrivals, high Acquisition & Activation, but poor Retention? Then likely your product is failing in delivering ongoing value. There is something wrong with it. Use product analytics to find key churn out points and qualitative studies to find out what is pissing people off.

Are you having a hard time monetizing? – Perhaps there isn’t enough value in the product hypothesis for the MVS if you can’t get anyone to pay even if they are engaged (not enough of a pain).

No referrals? Well, likely a function of the above as well. Perhaps you haven’t build enough virality into your product (see Juan Cartagena’s work on this).

Decision point & New Ideas

Now that you have the output and a series of metrics and potential red flags as to where things went wrong.. you can consider various options before you go through the loop again:

Do I iterate on one of the factors of the Minimum Viable Payload? (try a different positioning strategy, go 2 market strategy, or product revision?)
Do I pivot to a different product hypothesis?
Do I pivot to a different minimum viable segment?

In conclusion, I hope you find this framework useful in helping you diagnose what you should try out. Let me know what you think and if you’d add/subtract anything to it.

Click here to see the full diagram of the Product / Market Fit Cycle.

Here is the slide share of a recent presentation I gave on the subject:

Everyone loves a personality test. Whether for fun, or to better asses our skills as part of choosing a career, we all love hearing about how others perceive us, how we function, and how we are likely to react in situations. We are all naturally narcissistic (up to a point) and it is at this point that Traity, a Seedcamp company that specialises in helping its users figure out how they rank in a variety of psychometric test (think of them as a more thoroughly complete Myers-Briggs test), helps users identify their core attributes as ranked by people in their social graph.

For the purpose of simplicity when speaking of Traity’s technology, I’ll use the term ‘personality test’ loosely, however, what was confusing for the founders was that while ‘personality tests’ are generally well received and actually fun for many (as in magazines or online for example), Traity struggled quite a bit, in their early days, in converting people to use their service because their personality test, while far more accurate and useful than those you take online where you assess yourself, requires you to have had your friend assess you as part of their process.

Traity was having a classical conversion/acquisition problem. Traity’s CEO, Juan Cartagena, could funnel people to his website, but couldn’t get them to go through the sign up process and then get others to sign up (which he needs as part of his product). So he went on a mission to find out how to optimise this. Here the video of Juan sharing his story of discovery (it is embedded at the bottom of this post for your convenience).

After this video came out, I recently had the chance to catch up with Juan and ask him if he could help me summarise how he worked his way through to where he is now. Firstly, he told me it all started with a chat with social games guru Blake Commagere (http://www.crunchbase.com/person/blake-commagere), who pointed him in the right direction…

Next, he identified the key metric he wanted to optimise around. In his words: “There is generally one key metric for every business that matters- optimise around that metric.”

He then decided to experiment with design as a key growth driver vs. the traditional MBA-type solutions which, until then, had not been working for him. For the record, Juan has an MBA from the Chicago Booth School of Management. One of the top MBA programs in the world, so for him to make a jump like this, really does mean a lot in terms of not adhering to ‘traditional-type’ thinking.

He then further committed to this path of experimentation by reading two books which greatly influenced his thinking on how to further evolve his customer acquisition process:

• Influence 
  
• Design for Hackers 
  

After having read both books, he went through each one of the key influence factors outlined in the book and scoured through his product to see how we could apply the concepts. Once identified, he then went about applying the appropriate design principles to yield the ultimate effect on the influence factors.

For your reference, the key influence factors highlighted in Caldini’s book on Influence include:

• Reciprocation
• Social Proof
• Commitment & Consistency
• Liking
• Authority
• Scarcity

Before proceeding any further, I should state that in order to better apply these concepts, that you understand what your Minimum Viable Segment (MVS) is. Without understanding your MVS, any optimization of design or messaging will likely not be targeted enough to yield directionally measurable results. For a primer on an MVS, go to Northbridge Partner, Michael Skok‘s site here: http://www.mjskok.com/resource/gtm-segmentation

The design process Juan subsequently followed, included not just the obvious making of buttons, bigger, correctly placed, or prettier or red (one of the points he mentioned about colors and engagement) or choosing a different logo, but more importantly in coming up with the correct messaging to convey the influence factors he was trying to exploit. This is crucial. The messaging is just as important, if not more, than the more traditionally-experimented visual elements of design. Although not from the books that Juan mentioned, two good books to get you thinking about how messaging matters for positioning and differentiation are:

• Positioning
• Differentiate or Die

As far as Juan’s design focus, think about it this way, he moved away from just building a more explosive gunpowder to thinking more about how to package and propel it forward (otherwise all you have is explosive gunpowder that will explode in your face).

Although it seems obvious when you read this, Juan discovered that a key aspect of using both influence and design as part of evolving his process, was understanding that his costs of user acquisition would go down the more his viral acquisition would go up, and in order to scale this virality he would need to leverage the emotions of users to have a stronger reaction. However, I’d venture to say that many don’t consider this as part of their design process, Juan admits he didn’t at first.

Specifically, Juan saw how, via design, narcissism and voyeurism was used by sites like Facebook & LinkedIn to yield frequent use, fear of missing out by sites like Instagram, Twitter, and Groupon, and Inspiration by brands like Coca-Cola. He set out to understand how he could leverage these feelings as part of creating better copy on his site’s messaging to both yield better conversion but also more virality.

He then took things one step further by truly delving deeply into what virality is… and then nesting virality loops within his product that amplified his ‘K’ value  (For a primer on Viral Marketing, check this Slideshare presentation from David Skok: http://www.slideshare.net/DavidSkok/the-science-behind-viral-marketing ) oh, and yes.. he’s Michael J Skok’s brother. Also from David Skok, an excel model you can use that might help you plan and predict this to investors: http://www.forentrepreneurs.com/lessons-learnt-viral-marketing/

Lastly, because without metrics you are just flying blind, Juan used Kissmetrics to analyse his efforts and truly understand whether his changes across the board were yielding his desired results. Build, Measure, Learn… Build, Measure, Learn.

In summary, if you have identified a real need within a market and built something awesome (gunpowder) but you just can’t seem to reach your customers, perhaps go through the journey Juan went through and assess whether perhaps the issue isn’t what your product does, but rather how you are presenting it to your users.

Additional Resources:

For a curated list of talks on what will get you on the right track in Customer Development - http://www.hackertalks.io/index/2
For a curated list of talks on UX - http://www.hackertalks.io/index/3
Growth Hackers Conference Lessons Learned - https://www.blossom.io/blog/2012/11/01/growth-hackers-conference-lessons-learned.html
Growth Engineering - https://www.blossom.io/growth-engineering
For a list of Growth Hackers - http://www.aginnt.com/the-growth-hacker-mafia#.UWvHXSv70qv

Juan’s original video -

Juan Cartagena: Getting What you Want from Interaction Design Association on Vimeo.

Related articles

• Are Viral Loops Or Viral ‘Oops’ Driving Your App’s Growth?
• The Ultimate Litmus Test: Personality
• Playing to your Strengths?
• The Myers-Briggs Personality Test Is Pretty Much Meaningless

Originally published on Venturebeat on April 3, 2013 3:44 PM 

Investments, like the ocean, can come in waves, but that doesn’t mean they should.

A “tranched investment” is an investment that is split into one or more parts. In order for the company to receive the latter parts of a tranched investment, it usually has to achieve goals or objectives set as part of the conditions of investment. A typical example of a tranche is: the investors give you half the investment amount right now, and half the investment when your revenues reach ‘x’.

Generally speaking, the current thinking around tranches by most investors is that they are a good tool to motivate founders to reach a milestone or alternatively to reduce their exposure to risk. However, tranches are more damaging to the long term success of a company than investors may typically consider, particularly if milestones are not met or the company comes dangerously close to just meeting them.

Specifically, I think tranches can:

• de-motivate founders and potentially reduce a founder’s drive (according to Daniel H. Pink’s view of extrinsic motivation, see below for more on this)
• reduce a founding team’s creativity on how to grow the business in a way that might be long-term better, but short-term fails to achieve the next pre-determined milestone. Think of a company sticking to a product rather than pivoting in hopes to hit a deadline, but then ultimately sticking with a product that long term will not yield the maximum returns.
• potentially reduce good-behavior (read: cheating to hit numbers). If someone is really really needing the cash, temptation to do something to cut corners is there.
• promotes “sandbagging” by the investor rather than full commitment
• creates a self-fulfilling prophecy. In the words of the CEO of Zemanta, Bostjan Spetic, “the cash you are raising is usually what you need to get to a significant milestone, like break-even. Tying that budget to sub-milestones implicitly reduces the chances to actually hitting the big milestone, because it increases the risk of running out of cash prematurely. I firmly believe that.”
• create an accelerated cash burn to achieve the goal, and then if missed by a little, leaves the company in a vulnerable position for subsequent fundraising.
• makes the company toxic for an external investor that would be interested in investing, if the company doesn’t receive the tranche from its existing investors.

So, if you’re a founder, what do you say to an investor who’s hell-bent on implementing tranches in your term sheet? And, if you’re an investor, how do you reduce the risk of your investment so that you aren’t over allocated prior to the key inflection milestone being achieved?

My recommendation for both these questions is to get a dialog going to agree on one of the following three potential alternatives:

1. Reduce the amount of money and target a closer-term milestone for the startup to achieve. Yes, this implies that if the startups hits its milestone, it may command a higher valuation and the investor will not have been able to secure the economics of a tranched investment, but in exchange, the investor is getting a higher probability of overall success for their investment. Note: This should not constitute an opportunity for predatory investors to under-fund a company by picking too-early a milestone for founders to accomplish, as this not only hurts the company’s likelihood of achieving it, but also the likelihood of the company being able to secure follow-on capital.

2. If an investor really needs to have tranches, implement “binary” milestones that are simple and clear. What you want to avoid are tranches that have partial or subjective achievement, such as when a company comes pretty close to hitting its revenue figure or number of users. An example of an ideal binary milestone would be: You will get a sum of money unlocked equaling the salary of a new CFO when you hire that CFO. The target is clear (hire CFO), it is not ambiguous or ‘close enough’; you either hired the CFO or you didn’t, and then the amount of money is tied to that achievement.

3. If you can’t agree on either of the above, that implies either the company is overvalued for where it is, or the investor may be overly cautious; if the latter, then the founder might want to reconsider taking them on as investor (assuming he/she has a choice).

One more thought on why the carrot/stick theory behind tranches doesn’t work: In his book Drive, author Daniel H. Pink walks through classical motivation models and compares them to his observations on actual motivation. He makes a very compelling case for companies, managers, parents, and just about anyone to rethink their preconceived notions on motivation, particularly around old carrot vs. stick methods.

He says the old form of motivation fails because for three reasons. One, It doesn’t mesh with the way many new business models are organizing what we do — because we’re intrinsically motivated purpose maximizers. Secondly, It doesn’t comport with the way that 21st century economics thinks about what we do — because economists are finally realizing that we’re full-fledged human beings, not single-minded economic robots. Finally, it’s hard to reconcile with much of what we actually do at work — because for growing numbers of people, work is often creative, interesting, and self-directed rather than unrelentingly routine, boring, and other-directed.

This topic may yield contrasting views on the efficacy of tranches by investors, but I sit squarely on the side that tranches, as they are generally used, are more value dilutive than value accretive for all parties involved.

Read more & Comment at:
http://venturebeat.com/2013/04/03/7-reasons-for-entrepreneurs-to-avoid-tranched-investments/

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Finding an investor for your startup is hard, and as I partly covered in my last post: What Tier is your Investor (or what to look for in an investor)? It involves taking a lot of meetings and dealing with a lot of rejections while at the same time ascertaining how much value-add the investor you are speaking with will provide, above and beyond their investment.

Last month, I had the pleasure of judging my local VCIC event at the London Business School and it reminded me of the importance of the symbiotic relationship between investors and founders. The Venture Capital Investment Competition (VCIC) is a competition for MBA students aspiring to become VC’s after graduation or trying to better understand the investment process for when they start their own companies. The competition is about how well they analyse a business opportunity and then recommend and close an investment with the founder of that opportunity. It’s a great experience. Probably one of the best experiences to get a business student a feeling for how the entire academic body of knowledge comes together into evaluating and investing in a company. If you are currently doing your MBA, you HAVE to do this if you really want to exercise what you’re learning across all of your classes.

More than 8 years have passed since my personal VCIC experience as a participant, but I still remember it vividly to this day. Since then, I’ve had the pleasure of judging it every year thereafter and seeing many MBA teams go through the process and trying any number of things, ranging from the silly, to the creative in their attempts to out-do their competing ‘VC Firms’ to secure an investment-agreement with one of the presenting founders (which, btw, are always real-live companies). Every time I judge this event, I’m reminded of how important it is for founders to not only find the right investors, but also for investors courting a founder to demonstrate their value (their ‘tier’ so to speak).

During my judging of these events over the years, I’ve noticed there are six key areas that differentiate the best VCIC  teams (read: VC firms) from the worst (both from the point of view of the founder and the judging VCs). These are:

* The best VCIC teams build rapport with the founders & ask the key questions – Sometimes as an investor you have to ask difficult and probing questions. Some are questions that signal your doubt on a current company strategy or perhaps on how the company’s thinking revolves around any operational area. As the VCIC teams ask questions to get these answers and better understand the founding team’s thinking, they need to do so while at the same time respecting the founders and not making them feel like they, just because they have money, know it all, for no one does, no matter what their experience. I consistently saw VCIC teams failing in this area, but a few that really stood out made an effort in asking questions not from a position of patronising the founders, but from trying to understand them and dig into the right issues.

* The best VCIC teams understand the opportunity & dig only into the right issues with their time- Doing your homework is an important part of any mutual discussion. Some VCIC competitors haven’t even looked at the product that the company makes. The VCIC teams that fared better were the ones that, logically, didn’t get hung up on semantic arguments, but rather dug deep into any number of issues that are important. As a founder, you know what are your biggest challenges. If an investor identifies those as well, particularly without you spoonfeeding them on it, that’s a good thing and bodes well for having them on your board. As an investor, don’t show up unprepared and pretend like you can make up for it by picking up a trivial argument. In the competition itself, sometimes you have to dedicate your time to researching a specific company at the risk of showing up unprepared to interview the companies that you are not interested in for investment. This counts against you, so keep that in mind. In real life, as a VC, its as if  you took a coffee meeting with a founder, and then were rude to them.

* The best VCIC teams demonstrate value to the founder – One of the things that VCIC teams have to do when they are asking questions of the startups, is explain who they are. In the context of the VCIC they can fictionalise their ‘fund expertise’ since none of them are running real funds, but part of this exercise is also marketing the right attributes vis-a-vis what the startup team needs. For VCIC teams where a resident expert exists it can be useful, but also consider that you can showcase value by bringing in the right people external to your fund to help the company along.

* The best VCIC teams demonstrate an understanding of the financial requirements of the company – Some VCIC  teams fall short of true analysis and research here, they just take whats given to them. Sometimes they underfund companies and sometimes they over-fund the companies as part of getting their numbers to work. There is probably more to say on this point than can fit into this post, but what I’d recommend is that the VCIC teams explore proxy companies in the market and truly understand the impact of offering too little (or too much) to the company. One point on VCIC valuations: Teams, DCFs don’t work well on companies that don’t have historic data!

* The best VCIC teams don’t overcomplicate their termsheets - First of all, if you are a VCIC competitor, you should familiarize yourself with actual termsheets, and word of advice: keep it simple. Check out the Series Seed docs for the USA and the Seedsummit Docs for the EU as a starting point. Secondly, as a VCIC participant (and real investor) keep in mind that term sheets can actually signal quite a bit to the founder of what you think of them and that this does have an emotional impact on the founders. Do they have too many control provisions, for example, or are the economics of the deal indicating some concern? While supervision isn’t necessarily bad, as a founder, the smart thing to do is ask what the investor’s expectation is engaging with founders post investment. Are they meddlesome, for example? Are those control provisions there to protect you or are they draconian in how they operate? Ask to speak to the CEOs of other portfolio companies of theirs. Regarding the economics of a deal, perhaps the economics imply that they think you are overpriced. Ask them to walk you through how they came to that value and why. As a VCIC team, be mindful that overly complicated termsheets can come back and haunt you by providing perhaps too many mixed messages to the founders. As a founder, push back on items that don’t make sense.

If you are a team about to participate in the upcoming finals, I wish you the best of luck. If you are a founder, keep the above points in mind when you are doing a review of your investors-to-be. As for me, I look forward to continuing to be part of the VCIC experience in the future, I always learn a ton and am continuously impressed what teams achieve in such a short amount of time. I find that every time that I judge it, I’m reminded of the delicate interplay between investors and founders and how trust needs to be built over time.

Related articles

• What Tier is your Investor (or what to look for in an investor)?
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One question that I often get from founders is what ‘tier’ a prospective investor is. As in, what differentiates their prospective investor over another as ‘better’ or ‘worse’, relatively speaking, and on what basis.

Just to clarify, although there is no formal ‘ranking system’ for the tiers of investors, generally speaking, every investor sort of knows where they ‘rank’ relative to others or at least relative to the top investors. The best funds, generally known as ‘Tier 1 investors’ are the most in demand, and then, the tiering is largely subjective from that point onwards as to whether a fund is Tier 2, or Tier x, so there isn’t a huge benefit to spending too much time trying to actively find the ‘objective’ rank of an investor.

That said, what IS worth exploring is what differentiates the better ‘tier’ investors from the rest. Below are the seven attributes that I believe differentiate ‘the best from the rest’.

As you seek out potential investors, keep an eye out for these variables, the more of these your prospective investor has, the likely better off you will be as a founder.

1) Has a great network – the biggest value-add, in my opinion, that an investor can bring to the table, is their network. The larger their network, the more doors they can open for you. Nothing beats a direct intro to someone you need to meet.

2) Has a great brand-name – this helps with the network, but having an investor with a great brand name, either as an individual or fund, can help not only open doors indirectly (as in not requiring an introduction), but also to provide your startup with instant validation to potential customers, partners, and new investors.

3) Has sufficient levels of capital to support you – Although different investors have different strategies around this (eg. an Angel rarely can follow-on as much as an institutional fund), it is generally a good thing to have an investor who can invest in your company throughout the lifecycle of your company.

4) Has sector expertise – One way that investors can differentiate themselves as a top tier investor from the usual suspects is by having focused experience in your sector. For example, an investor could be a generalist Tier 2 fund (remember that this is subjective), but as an ecommerce investor they may be a Tier 1, great if you are a ecommerce company, but just ok if you’re a fintech company. This is because they will likely have a large network (see point 1 above) in their sector of expertise.

 5) Has deal experience – You will go through a lot of unique and stressful situations during a fund raise. It really helps to have someone who has gone through the process before and can help smoothen things out between all parties involved if needed.

6) Isn’t burdensome - An excellent investor does not burden the founder during the investment process with unnecessary or unusual diligence requirements for the stage your company is in. For example, a company that is very early stage will likely not have much to be ‘diligenced’, if an investor is requiring you to have an accurate version of what will happen in your company 5 years from now and you started your company three months ago, question whether they truly think the information you will give them has any likelihood of being true (and whether you think they’d make a good investor for you).

7) (Lastly, and most importantly) Has a big vision – Good investors on your board will help you by working with you on best practices for company building, but great investors will help you by helping you set the right vision for your company. The better investors help you think big because they think big themselves. This means not only having an attitude of can-do vs can-not, but also having the experience on how to coach you through this type of thinking.

Now, keep several things in mind, however, after reviewing this list:

1) There are many new investment funds and or individual angels that come to the ecosystem and therefore may not have an established brand name, but have great networks and experience. Don’t dismiss them prematurely, however, do ask others that they’ve worked with what it’s like to work with them.

2) Although founders that have done well and gone on to join a fund can be awesome people to have on your board, however, investors don’t have to have been founders themselves to be great investors. Experience as investor, having done many deals and knowing how the best companies operate, can count for a lot, so look for  a blend of all attributes in your investor and not just look for a founder-turned-investor that can empathetically relate to what you’re going through, but provides little beyond aged anecdotes about how they did things.

3) If you’re ever stuck between two potential investors, really really consider that the person that will be working with you on the board will help you define many things about your company over the coming years. Choose wisely and ask yourself who you would rather work with long term, you wouldn’t want too chose someone on a brand name alone, but causes you hair loss, heart burn, and emotional stress on a regular basis.

I hope this helps you in your quest to find your potential investor.

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• Rise of the angel investors
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• Debunking Myths about Activist Investors

The importance of having great mentors in your career or company cannot be emphasized enough. Mentors can generally provide you with a structure and feedback that school or books alone cannot provide. If you don’t have access to great mentors where you work, look for them in structured mentoring programs such as Seedcamp’s if you are a startup, or in your school’s Alumni if you are a student, or your industry’s groups if you are an employee. Look for mentors that can help you on functional areas as well as ‘bigger picture’ areas. Build your own ‘advisory board’, per se, of people who can help ‘polish’ you, your skills, and your thinking process over time.

From a personal perspective, I’ve been lucky in having had some great mentors throughout my career, and lucky enough to have had them as my co-workers as well. In my first post-university job as a network consultant with what was then called GTEi Professional Services and led by one of the most supportive bosses I’ve ever had, Adam Lipson, I had the pleasure of working with two great mentors: Allen Gray and Walter Urbaniak. Allen Grey is one of those guys that if you ever had a weird technical problem, he was the guy to call. He was the Navy Seal Team Six, all by himself, for any problem a client had. He was a hacker in the truest sense of the word. One of the most impressive things at the time for me, was when I visited Allen’s house and witnessed what had to be the closest thing to having a “HAL” from the movie 2001, controlling every aspect of his home environment both locally, and even more impressively, remotely.

Walter Urbaniak, shared many traits with Allen, in that he too, was a one man army, but if Allen was the Navy Seal, Walter, ‘Doc’, as we called him, was the General who laid out the plans and arranged troop movements. Being one of the contributing creators of ‘Layer 2 routing’ and someone who regularly collaborated with the inventors of the internet’s backbone (you can read more about some of the early works here: Where Wizards Stay Up Late: The Origins of the Internet), Doc always ‘knew’. In its simplest form: Doc excelled and the “Why”, and Allen at the ‘How’.

Working with Allen and Doc together taught me the value of not just smart mentors, but about the process of smart mentoring. Allen would inspire me to come up with cool ideas and hacks, but would never ‘finish’ the job for me.. always leaving me halfway for me to figure out the rest. I can vividly remember us playing around with a Gnome hack for Red Hat Linux on my live ‘work’ machine and him leaving me mid-way through the hack and with a full work day ahead of us and my basically having to blunder my way through to ‘a’ solution.

Doc’s teaching style was 180 degrees from Allen’s. I remember one day when I was stuck with some subtlety of TCP/IP and Doc took me to his blackboard and asked me to walk him through every step a packet takes from the moment it leaves your computer until it arrives where it needs to go, with him heaping me fill-in the blanks along the way where I couldn’t. This ‘overview’ of the bigger picture helped me understand where things could go wrong, rather than just focusing on the specific micro-problem that I had, and getting bogged down with just those details.

Fast forwarding to a closer time period after my days as an engineer, I had the pleasure of working with Ivan Farneti & Nigel Grierson while I was at Doughty Hanson Technology Ventures. Ivan was personally responsible for some of DH’s greater exits, including the sale of Gomez to Compuware back in 2009 for $300m and had seen many a deal in all their varieties leading to his deep understanding of just about any situation and question I could throw at him. What made Ivan great as a mentor was his ability to help you analyse & dissect businesses for their business and not get distracted by other attributes. He regularly admits not understanding the ‘technology’ of a company (or at least that’s what he likes to say), but curiously, he is always dead-on in understanding the business challenges that a company can and will have. Nigel, similar to ‘Doc’ from my days at GTEi, was excellent at providing the greater context of an industry and explaining how things came to be. Nigel is also passionate about teaching and more importantly, learning about teaching, a key attribute of good mentors.

Of course I can’t say that these mentors were ‘it’ for me, quite the contrary, I have a number of friends and colleagues spread out throughout the industry who have provided me with invaluable direction over the years in every aspect of a company’s development and my own personal development as an investor. I know I still have so much more to learn, but am glad that I work within an industry and environment where I can continuously learn from others.

Over the past several years, I too have become a mentor to others. The feeling is always a bit strange when it starts happening to you, but many people underestimate their ability to help others. As a mentor, other than developing your own style of mentoring, I believe your three main duties are 1) to have a passion and desire to continue learning about the subject your are mentoring on, 2) to know what you know and what you don’t know and be clear about it during mentoring, and 3) to continuously seek to improve your mentoring skills so that you can structure the advice you are giving for best effect. This does require a discipline of self-analysis to catch yourself when you are falling short on any of the above, but that is a good price to pay when you see the progress you’ve helped others achieve.

And with that, I encourage you to seek out the best mentors that you can for what you are trying to achieve, but also, perhaps so you can also be a great mentor to someone. Don’t discard the idea until you try it!

HM Revenue & Customs at Mevagissey Harbour (Photo credit: Cross Duck)

Most founders have desire to share their equity with people that helped them along the way, both as a thank you, but also as a motivation tool. However, how to share is always a big question mark for every Founder. The two most frequently asked question is, “How much equity should I assign an advisor?”, which is shortly followed by “How do I know when to issue shares to new employees and how much do I give them?”.

So, let’s take step back and look at why we are doing this in the first place.

Motivating employees and or advisors is a key part of having a productive workforce. One key element to unlock this productivity is by creating a culture of fairness. In his book titled ‘Drive’, Daniel H. Pink talks about how an employee’s productivity can be binary provided that the right results-oriented work environment is created AND they are treated fairly from a compensation point of view. Effectively, if you don’t create a feeling of fairness in terms of compensation, relative to the market, employees will simply not be ‘open’ to be fully motivated as they will feel slighted. It’s a simple concept on paper, harder to implement in practice.

Therefore, the word ‘fairness’ is what’s important here.. how do you define the fairness culture in your startup?

Let’s start with advisors:

Advisors need to commit some time to your company to ‘earn’ their equity. The first thing to do is to define what kind of role this advisor is going to take. Is he going to provide board-level feedback and help or just operational help (marketing, for example). Is she going to meet with you once a week or once a month?

Then, define a time period for this relationship before you review it for extension. As in, Joe, your marketing advisor, will work with you once a week for 9 months, at which point you can review your working relationship to see if he is needed any further or if it is working out.

It’s really quite simple, find someone that can help you, narrowly define expectations you have of each other and for how long, and then find an equity amount that is in line with the market and that makes them happy.

For the USA, the Founder Institute has come up with some guidelines on numbers, and you can read about those here:
http://techcrunch.com/2011/09/22/free-startup-docs-how-much-equity-should-advisors-get/

They also include an agreement you can sign with your advisor to narrowly define the engagement. For the UK, I’ll be linking to one soon… stay tuned.

Onto Employees (which is a bit trickier and I’ll include the topic of valuations as a bonus):

Back to the topic of Fairness… Fairness is defined by having the total compensation of your employee meet his or her expectations as defined by the market. As such, you need to think of your employee’s total compensation (cash + equity) as something that is within the boundaries of the market norm for his or her role. Deviate too much and not only is hiring hard(er), but you will have inherently unmotivated employees. Total compensations at startups usually have low or no salary, so that fairness is established by assigning equity.

So in order to quantify the value of the equity portion of the total compensation of an employee, one important thing to consider is that the total value of the option package issued, is a function of both the total number given, but also the strike price they have. The two go hand in hand.

But before we go any further, a quick definition check on Strike Price:

An option’s strike price is the fixed price assigned to an option for the purchasing of the underlying share (typically ordinary shares) in the company. In effect, you have to pay the [strike price x  the options] you’ve been granted, to exercise your right to buy the underlying shares. Once you’ve ‘exercised’, you own the shares.

Pricing strike prices is a bit of a pain. In the USA, you have to do 409A valuations. More on that from Fred Wilson here:
http://www.avc.com/a_vc/2010/11/employee-equity-the-option-strike-price.html

Pricing in the UK is both simpler and more difficult. More difficult because it isn’t as clear as the USA, but simpler, because there is more flexibility.

Here is the exact language from HMRC (http://www.hmrc.gov.uk/shareschemes/emi-new-guidance.htm#10):

If EMI options in an unquoted company are granted the company can, if it wishes, agree the market value of the shares with HMRC Shares and Assets Valuation (SAV). To agree a market value with them the company will need to propose a value for the shares and provide background information to support the proposal. It will need to complete form Val 231 for EMI options.
The form outlines the information needed to support the proposed valuation. When it is complete, it should be sent it to HMRC Shares and Assets Valuation (SAV).
If the form is not used or the company does not supply all the information requested, it may be asked to supply the missing information before a valuation can begin. This could delay the agreement of the valuation. When HMRC Shares and Assets Valuation (SAV) receive your completed form, they will tell you within ten working days if they need any further information.
Asking HMRC to agree a valuation is not the same as:

•    notifying HMRC of the grant of EMI options
•    or making the annual tax return required for EMIs

This language does give you some flexibility on how you want to value and define your company’s value at the time you are setting the strike price. Book an appointment with someone like
http://www.completeaccountingsolutions.co.uk/ to discuss how you might go about setting this, or with your lawyers. Getting this right is important because if you don’t get it right, it will have serious tax implications for your employees or any other option recipients.

So back to strike pricing and its effect on the value you give to your employees:

If you have a very high strike price, you affect the employee’s total return on an exit. In a simplified equation (that isn’t designed to give you the present value of your options (Black–Scholes), but rather just the mechanics of cashing out), the value of the options will be:

(Share Price at Exit * Options you have) – (Strike Price you have * Options you have) = value to employee in cash at exit

You can see where to match employee 100, who comes in when the company is worth a lot more, with employee 10, who came in early, you’d have to issue employee 100 many more shares to ‘equal’ the same given to Employee 10. Try explaining all that to your hundredth employee and also to your first few, who might feel slighted that someone has more ‘shares’ than they do for the same job function.

Also, here is an interesting point to consider: different exercise prices for fully vested employees will cause them to behave differently. An employee who has 100 shares to buy, but only at $1 each will act differently (buy the shares and be a passive shareholder) vs an employee that has 100 shares at $100 (more likely to make a calculated decision as to whether to exercise (or not) the options upon a departure). Remember, if you set an exercise period after someone leaves the company, the question is, do you want them to keep the shares as a bet (low price) or only keep them if they really believe in the company (high price)? Again, no right answer as you balance between equity you give out.

So how much equity to give them?

After the above exercise, you see the challenge between articulating fairness mathematically, but also in terms of how employees chat between themselves and can sometimes get the wrong impressions based on not having all the facts.

Transparency is very useful in the early stages of a business, but as you grow, you may choose to just share the basic information of your company’s equity buckets, or strata. It’s really up to you and how you want to stratify the different kinds of employee equity issuances, for example: director level, supervisory level, and admin level.

The trick here, is really in how to ‘define’ who is what. I’d say that the important strata are:

•    Those that set strategic direction overall (typically the founders or CEO)
•    Those that set functional strategic direction (typically someone like a CFO, or CMO)
•    Those that set budgets to hit strategic goals (Directors, VPs)
•    Those that manage people according to budgets (Supervisors, Line Managers)
•    Those that execute (Developers, Sales people, etc)

Then, you define what’s a fair total comp bucket value for each of these, and then use the math equations to give you the relative values of equity for each strata.

As with most things of this nature, however, there are more than one way to slice the onion.

Fred Wilson’s post below on what to issue each strata is useful as a guide for both an equation to calculate absolute numbers, but also to help understand the different tiers of employees.
http://www.avc.com/a_vc/2010/11/employee-equity-how-much.html

And here is Guy Kawasaki’s suggested split (via @brandid):
http://blog.guykawasaki.com/2006/03/nine_questions_.html

Lastly, here is another version of how to divide things ‘fairly’ between everyone (via @gosimpletax):
http://answers.onstartups.com/questions/6949/forming-a-new-software-startup-how-do-i-allocate-ownership-fairly

Once you’ve chosen your preferred method, one mistake to avoid is to promise early employees ‘percentages’. Meaning, don’t say, I’ll give you 2%, but rather say, I’m giving you 2,000 shares which represent 2% of our current cap table. The reason is that if you leave it verbally at 2%, you may inadvertently make them believe that at the next round the will continue to have 2%. Don’t assume all employees understand the mechanics of financing rounds and/or dilution.

Another mistake to avoid is not including a vesting period. Without a vesting period, your employees have full access to what you’ve promised them, whether they’ve spent time to ‘earn it’, it is dangerous for the company to not have one. Read here an explanation of why that’s important:  http://www.seedcamp.com/2012/11/seedhack-founders-collaboration-agreement-version-2-0.html

In the end, this is more of an art, and you will get it wrong at least once, and don’t be afraid to experiment, but as long as you have a process, I believe you will have less issues going forward, particularly when the company grows larger, than if you leave things entirely open-ended.

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I haven’t had as much time to read as I would have liked this year, but three books stood out so I’ve added them to my bookroll:

• Positioning: The Battle for your Mind – Al Ries and Jack Trout
• Drive – Daniel H Pink
• The Art of Pricing – Rafi Mohammed

I can wholeheartedly recommend them all.

The Positioning book stood out in recent reads beyond this year mostly because it goes counter to what many consider convention.
Likewise, Drive shares many of the similar attributes due Positioning in that it rocks your world with some changes to general conventions around motivation.

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http://blog.howtoweb.co/2012/11/how-to-web-2012-day-1-ignite-stage-full-video/