My Biggest F-up of 2017: Chasing Shiny Innovation

A few years ago, I was sitting on a plane next to a guy wearing really cool funky green sneakers. Both en route to SXSW, we struck up a conversation:

“So, what kind of coolest, latest wizardry are you up to these days,” I asked.

“Oh, nothing too crazy. Building a digital ad agency in DC,” he said.

“What makes you so different from hundreds of other digital ad agencies?”

He thought and said: “Not sure, I am in DC. Not a lot of digital agencies in DC yet. But I love what I do and we are starting to pick up some great clients.”

Agency model. DC. Tried-before business model. Zero differentiation.

All screamed ‘Oh, l’horreur!’ to me — an entrepreneur who grew his ambitions, career and startup chops around Sand Hill: a place where product-only innovation was an absolute prerequisite to get into the elite boarding school in form of a check from a VC. There was no way to graduate, aka have a successful exit — period —unless you commanded a product that carried with it high multiples that everyone loved and strived for.

So, I started barraging my new-found friend with my age-old Sand Hill wisdom:

“Dude, agency models are terrible. Exit multiples are 1.5x at most. You being in DC as your so-called differentiator is BS. You have to hire people when you get a new client, and fire people when you lose one. The revenue is not SASSy and hugely unpredictable. It’s a terrible, terrible business.”

He smiled, thought about it, and said:

“Dude, you are absolutely right about all those things. But let’s look at your product-focused, cutting edge tech company. You take months, sometimes a year+ to build a product that works (or doesn’t). In the meantime, you are running up credit cards. Then, you might get lucky (1%, by the way) and raise your first round. Yay, you just diluted yourself 30% (if you are lucky). Now, you found a product market fit. Yay, you raised your Series A — another 10–20% (if you are lucky). And say that you are REALLY good. You sell your company for $100mm (0.0001% chance, if not less, by the way). You are awesome!”

But here is the kicker. By the time all is said and done let’s compare ourselves:

You: Losing hair/greying hair while dealing with Boards and VCs. Gotta deal with the change of strategy requires gargantuan efforts to get everyone on board. Probably have a couple of co-founders who want to pull in different directions. Senior engineering talent that’s becoming super expensive/very hard to find. Oh, by the way, did I mention barely making any $$$ while you are at it till your prodigal exit? Oh, and did you see all those % numbers of getting to the next step in parentheses above?

Me: Most likely started as a lifestyle business. Loving what I am doing and calling the shots from the beginning. Controlling the co. Growing the agency, slowly one client at a time. Controlling my destiny. Ya, clients come and go — part of the gig (you have the same problem…that is when you get to monetization). But I am liquid. I can take as much, and as little off the top.

As the plane was descending into the green lush fields of ATX, we started doing super rough math together on a Jetblue napkin greased with leftover peanuts.

Math, that not a lot of people pay attention to. Math, that should be napkined by everyone. Math, that I will think about for the rest of my life:

So, let’s say we both exit. I get my 20x. He gets his ‘subpar’ 1.5x multiple. Say, my great product is doing $5mm/year and his ‘subpar’ agency model has 10 clients paying him $500k, so he is there with me as far as revenue goes (to make things simple).

Me: $5mm x 20x multiple = $100mm. 3 founders. $30mm. first round of dilution. $10mm. second & third round of dilution. $7mm. Liquidation preferences (some doc that someone sneaked in). And if I haven’t gotten ‘promoted’ to step down to Chief Evangelist from a CEO by my Board for having too little grey hair during any of those steps and the benefit of ‘someone else handling day-to-day operations’ while you ‘step back to focus on the bigger picture’…

Final result: $6mm.

Him: $5mm x 1.5x = $7.5mm. But he owns 80% of his company.

Final result: $6mm.

My biggest F up of 2017 (and perhaps earlier years) has been chasing new, shiny innovation. Perhaps, I spread myself too thin doing it. Perhaps, I have become too much of a skeptic, having now done 4 product-focused startups after starting my first company in 2005 at a fun age of 22 — back when hangovers lasted a few hours, not a day-and-a-half.

But recently, I have been fortunate to see the perspective from the funding side: both finance for public companies during my investment banking tenure; being an angel investor and an LP in a few funds; as well as raising money from LPs, then starting & running a highly-accretive venture fund for the LP base of family offices that backed it.

One piece of advice to entrepreneurs: there is absolutely nothing wrong with starting a lifestyle business or an agency-like model.

As long as it’s starting to make cash. Preferably quickly. Make cash along the way. Again, nothing wrong with that.

Do you know why VCs and investors ‘shame’ you during all those meetings?

‘Oh my, it’s a services business. Not a lot of defensible tech here. Come back when you ‘cross the chasm’.

If you are making money, if you are growing (no matter how quickly), if you have a clear path to profitability/high growth in your head, why should you care?

You have to remember: the vast majority of VCs are NOT in the game of innovation. They care about one thing and one thing only: maximizing their IRR in the shortest time possible by getting the highest valuation possible, so that they have a great story to tell their current/potential LPs to raise their own fund in the next 3–5 years.

They do NOT care about your personal struggles of making really crappy income while you are building value for them — they themselves are nicely covered by the 1.5–2% management fee they skim from their LPs — no matter how bad of a VC they are.

They do NOT care about that this is a wrong time to sell the company. For most part, they have much deeper pockets than you and can ‘nudge’ you to do what’s best for their fund, not for you as an individual. Remember how the formula works? Less time spent holding an investment = higher IRR.

While exploring the Hindi culture during my tenure in New Delhi, I learned a valuable lesson that translates loosely into something as follows:

Learn to love yourself before you can project that love onto someone else

It’s not about the ego. The moral of the tale (and translation)?

Go build an interesting business that generates cash flow. Worry about innovation later when you have enough cash flow to not toss-and-turn at night over the payroll on the 15th of the month, or how to pay the check on the next dinner date.

Have fun. Enjoy the ride. Take great, smart, accretive money from people that truly care about your business and understand that you are the one with the hand on the levers of power forward, step back, pivot, turn or push the break . They are there for the sage advice and the capital, yet sitting comfortably (as they should) in the back Pullman car of the train, not in front at the engine.

And never be afraid to build a ‘boring business’ in what could be seemingly the tiniest niche in the world. The true billionaires I have met in my life are the ones that have excelled at one thing: seeing an arbitrage opportunity in a niche space where there is already a business/businesses generating revenue, but it is inefficient. They solve that inefficiency by chipping away one stone at a time, making cash along the way, and then inevitably building very cool tech after they have already made cash.

Multiple examples of this are all over the world of high tech! Look at email: companies such as Adestra and Mailchimp are crushing it in the most boring, yet highly profitable niche (“It’s not the shiny new thing, but more the steady thing that actually works”)

And then a bit of New York realism shook up the Sand Hill dream.

On a balmy Summer afternoon in Manhattan, I had brunch with a friend who was contemplating leaving his highly successful hedge fund career. His next move? He is buying up small, family-operated trash truck businesses all over Eastern Pennsylvania.

‘Dude, who cares about trash? Come do some cool stuff with me in the high tech world. I am thinking awesome AR (augmented reality) monetization opportunities with AR Kit that Apple just released on all new iPhones. Gonna be hhuuuuge!’

‘Bro, love you but here is the deal. If I get five trash truck businesses combined into one, I can chop the second largest cost that all these businesses incur as mom-and-pops in half.

That right there takes my cash flow from 2.5x to 5x.

I am liquid, baby. Gimme 6 months…and I will come to you once I have enough cash flowing thru to completely cover everything up to my new, third mortgage out East.

Then, we can automate all of that and we will build a real product.

In the meantime, your high tech can go Argo F itself.

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About The Author

Alec’s investment activity includes NDCapital (ND=non-dilutive), a newly formed venture fund focusing on early stage revenue-based financing; advantEdge Partners, India-focused early stage venture cross-border fund; limited partner at Eniac Ventures, the first mobile-focused early stage fund; EIR at Capital Factory in Austin. Alec started his investment career in corporate finance at JPMorgan’s media and telecommunications leveraged finance group.

As a seasoned entrepreneur and investor, Alec spent 12+ years building rockstar startup teams and products that realize the future of scalable mobile technologies.

These included companies such as MoVoxx — a leading mobile advertising company reaching over 50mm unique U.S. users, acquired by MOTR for $100mm in 2010; inFreeDA — 411 advertiser-sponsored voice targeting platform, acquired by AT&T in 2007; Fama — a software that automates social media and web analysis to drive smarter hiring decisions and assist in complex investigations; DMR Partners — a 300+ agency/brand executive consortium to discover and validate the best adtech-focused startups, acquired by Industry Index in 2016; AnyoneGame — a mobile short-form video commentary and karaoke platform that has garnered 2.5mm users within 6 months of launch.

Alec is also a regular speaker at conferences such as SXSW, TechCrunch, CES, Digital Hollywood, iMedia, Columbia Business School Venture Competition, Advertising Week and OMMA Global.