Venture capitalists call it the Valley of Death, the period after afounder has begun to spend capital but has yet to find a steady streamof revenues. A large percentage of new business attempts never makeit through this first phase, which is why startups are known to be haz-ardous and the word “entrepreneur” conjures an image of a daring,swashbuckling gambler. But, as Matthew J. Eyring and Clark G.Gilbert note in the May 2010 issue of Harvard Business Review, thestereotype of the risk-loving entrepreneur is a myth, at least among those who are highly successful. Effective entrepreneurs recognizethat some level of risk comes with the new venture territory and isnecessary to create value, but they are not the bold risk-takers thatthey are made out to be.
They are, instead, in the authors’ words, “re-lentless managers of risk.” They understand that not all risks are cre-ated equal, so they identify and prioritize threats that pose thegreatest danger to their venture. Gilbert and Eyring call these “deal-killer risks,” and wise founders find ways to creatively address theseearly in the startup process.
Gilbert and Eyring observe that “when risks are overlooked, fewerthan 15 percent of firms are still in operation three years after initialfunding.”4An important strategy for lengthening your venture runwayis to identify, very early in your planning process, deal-killer risks thatmight stop you in your tracks. These risks usually correspond to fun-damental assumptions and uncertainties that must play out in yourfavor for your concept to succeed—an expectation of strong marketdemand, for example, or the availability of key expertise, favorableregulatory changes, or well-functioning technology. Once you haveidentified the handful of key uncertainties to be addressed, you canthen work to reduce the likelihood of their occurring and build con-tingency plans to deal with them if and when they do occur.
Here are some examples of how successful entrepreneurs have ad-dressed early-stage risks to clear their runway of potentially venture-killing obstacles.
For enthusiastic founders, the most fundamentalassumption of all is that an abundance of paying customerswill be waiting to buy your product or service as soon as it isreleased. These expectations are often too rosy, which meansthat the existence of adequate market demand is almost al-ways a pivotal area of uncertainty for the new venture. Youcan mitigate this risk through piloting, prototyping, and re-lated approaches, as outlined in Chapters Four and Six.
A powerful approach for radically reducing market risk isto sell your product before you build it. Starting with $1,000in funds in 1984, Michael Dell, founder of Dell Computer, launched a build-to-order computer business from his Uni-versity of Texas dorm room at age 19. To avoid the cost andrisks associated with holding an inventory of components andfinished products, Dell got his orders from customers upfront, and then he secured necessary components to createeach customized computer. This approach brought advan-tages from a cash flow perspective, but its most fundamentalvalue was that it directly tied his incremental investment ofresources to the presence of validated customer demand, ef-fectively eliminating market risk from the startup equation.
In 2006 and 2007, Mark Williams and hisModality co-founders were developing a technology for de-livering content to the Apple iPod that they felt was compat-ible and secure within the iPod’s architecture. Overcomingthis technical barrier required them to continue to iteratetheir software solution, called Modality Manager, but alsorequired Mark to convince key technologists and senior lead-ers within Apple that Modality’s solution was safe and effec-tive. As he wrote in a planning brief in January of 2007,“Currently, Apple developers are uncomfortable with theModality Manager solution because of potential to causeproblems for consumers as the iPod platform evolves.
The stakes attached to gaining Apple’s approval could nothave been higher. Modality’s offerings were exclusively de-veloped for Apple’s vast customer base and designed to fitwithin Apple’s products. Mark’s goal was to earn Apple’s fullsupport so that the powerful company would embrace andchampion Modality and its innovative solutions. But in termsof scale and clout, Modality was the proverbial flea riding onthe back of a bear. At a minimum, Mark needed Apple lead-ership to tolerate his early attempts to integrate his technol-ogy with theirs. Anything less would amount to a deathblow.
Mark focused a great deal of time and energy intostrengthening his relationships with key Apple leaders, work-ing to understand their objectives and concerns, and devel oping solutions that worked for both companies. The ap-proach paid off, as he noted in an e-mail to advisers in lateFebruary 2007. “A key development occurred yesterday,” hewrote. “Following a meeting between the World wide Devel-opers Group and iPod Marketing, it appears that Apple is comfortable enough with our current software solution towork directly with us on distribution in the Apple Retail Stores and in their online channels.”6Mark’s partnership withApple would continue to improve and mature.
Modality de-veloped a reputation within Apple as a talented, trustworthypartner, leading to a host of opportunities over the next fewyears. Increasingly, Apple championed Modality and itsproducts, and recommended the Modality team to its insti-tutional and educational partners.
Every entrepreneur’s plan contains assump-tions about how the product or service will be created anddelivered to customers. In the passion and haste of a launch,these assumptions are often untested or unexamined, al-though they are usually fraught with uncertainty and, insome cases, pose tremendous risks to the venture. Gilbertand Eyring note that these operational risks can often beevaluated in surprisingly simple ways. They cite the exampleof Reed Hastings, founder of Netflix, the movie-by-mailbusiness, who conducted a simple, early test of his concept’slogistical viability: He mailed himself a CD in an envelope.“By the time it arrived undamaged,” the authors write, “hehad spent 24 hours and the cost of postage to test one of theventure’s key operational risks.
Operational risks can also involve reliance on key person-nel. One of my startup clients began as a spinoff from an ex-isting company, having negotiated a deal that allowed it totransport nine major client accounts into the new venture. Butuntil the new company could develop its own technologyplatform to service the accounts, a task requiring at least sixmonths to complete, the original company’s operations team would continue to service the accounts. In my first meetingwith the founders of the spinoff, we acknowledged that thedependency on the original company’s operation representeda significant area of risk.
What if key team members in theoriginal company favored their own client accounts over thosethat had been transferred? Worse yet, what if one or more keymembers of the operations team, already stretched to capacityand openly unhappy about the spinoff decision, decided tocall it quits? Revenue from the inherited accounts would beimportant to the new company’s startup runway, so any majordisruptions to client service could pose serious problems.
The next day, the operations leader in the original com-pany confirmed our fears and submitted her resignation.While not a deal-killing blow, this event required a lot of at-tention and problem solving from the new team and detractedfrom other priorities. Fortunately, the team had identifiedback-up plans for communicating with clients and servingtheir needs until an in-house platform was up and running.
These are just a few examples of areas of early-stage risk. Each ven-ture will bring its own unique set of uncertainties that can lead to afatal early blow. To address these, scrutinize and test key aspects ofyour concept sooner rather than later, even if your entrepreneurialpassion and optimism tempt you to assume the best. Eyring andGilbert note that many venture managers succumb to this tempta-tion. “Instead of testing their assumptions,” they write, “they becomemore and more invested in confirming them. But successful entre-preneurs do the opposite: They devise low-cost experiments to dis-prove a concept before it’s too late.