[This is an edited version of a talk I recently gave at a MOI Global event.]
I’d like to share some of the lessons I learned from being a startup founder, and how these can be applied to investing:
Lesson 1: I’m a better investor because I was a founder
As Warren Buffett famously said: “I’m a better investor because I’m a businessman. And I am a better businessman because I am an investor.”
This rings very true to me, and I can confirm it based on my own experiences.
I was in the middle of my startup, back in late 2008, when I discovered Warren Buffett and Benjamin Graham. My main takeaway for my business was that I realized how bad our gross margins were. At the time, our gross margin was around 30%, and we were burning money. Then, when applying this insight over a period of 3 years, we were able to double the gross margin to 60%, which helped us to achieve break-even and ultimately lead to selling our business. Without those gross margin improvements, it would have been much more difficult.
Lesson 2: “Creative accounting”
The second lesson is what I call “creative accounting”.
We were sending our investors monthly updates. But, brained-washed by the venture capital industry, and suffering from our own insecurities, we believed that everything that didn’t go “up and to the right”, was hurting our story. So we made a conscious effort to keep the story going, by applying what we called “creative accounting”.
We took advantage of the grey areas, and applied somewhat loose and not very consistent accounting practices. We played with the capitalization of certain expenses, to move them off the profit and loss statement. We recognized revenues in different ways, sometimes at the start of a project, sometimes in the middle, and sometimes at the end of a project.
In good months, we rolled over revenues to the next month, to have a head-start and create a cushion. In bad months, we scrambled to recognize everything we could, to avoid reporting bad news.
So based on these experiences, I’ve learned to become more skeptical of accounting statements, because there is always room for “creativity”: adjusted numbers, not expensing stock options, playing with accruals, playing with revenue recognition, and similar tactics.
Lesson 3: Seek owner-operated businesses
The next thing I learned is what it means to be an owner-operator.
I’ve been a founder of my own startups, but I’ve also managed startups that other people have founded. A founder is an owner-operator. He holds a large stake, and the whole responsibility lies on his shoulders. There is “skin in the game” and a sense of “ownership”. It’s a different quality than managing someone else’s company.
When the company is mostly you, you cannot escape. You have to “go forward or go under”. We had very tough periods in our startup. On multiple occasions, I was very close to giving up. But I didn’t, because I was an owner-operator. As a manager, you can quit much more easily. It’s a different situation.
That’s why in my investing today, I gravitate towards owner-operators. I’ve been one, and I understand them much better than hired managers.
Lesson 4: Strong sales organization
Number 4 on Phil Fishers 15 point checklist is: “Does the company have an above average sales organization?“
I had to learn this the hard way. For the first two years, I was the only sales person in our company. It wasn’t working well. I had no prior sales experience, and I wasn’t enjoying the job. I realized that we need to build a sales team.
So I took a deep dive: I read sales books, went to sales seminars and hired our first sales manager. We ended up hiring 4 sales managers in one year, and quadrupled our revenues.
So today, I have a much better sense for what Fisher means by “above average sales organization.”
Lesson 5: Strong marketing & lead generation
A sales organization cannot be effective without a strong lead generation. If all you do is cold sales, you likely won’t get very far. You need qualified prospects and hot leads.
Here we had an advantage. Because it was one of the areas we were above average.
Our core product was sponsored postings on blogs, what today is called influencer marketing. To not be misleading, we required every blogger to label their sponsored posts. And not only label them with something like “This is an ad”. Instead, we branded the label with our company name, and most importantly, included a link to our website. So each campaign for our clients, be it NIKE or RedBull or Disney, turned out to be a free campaign for ourselves. It was a marketing flywheel. And it was our #1 lead generation source.
So, in order to assess the sales capabilities, you need to be able to understand the whole marketing & sales funnel.
Lesson 6: The Flywheel Effect
Ever since reading Good to Great by Jim Collins, I keep thinking about flywheels.
I’ve learned that great companies have a strong, self-perpetuating and ever-increasing engines. Our viral marketing tactic was a one example. Network effects are another example.
So my lesson is: look for strong flywheels.
Lesson 7: Innovator’s Dilemma
The Innovator’s Dilemma describes why established companies have great difficulties to cannibalize and re-invent themselves, and why startups can be so disruptive.
It was one of the favorite business books of Steve Jobs, and he was a master of solving the dilemma.
In times of ever faster technological change, it’s important to keep this concept in mind, and seek companies that have demonstrated that they have the courage and stamina to solve this dilemma.
Lesson 8: Certain things don’t show up in the accounting statements
I’ve learned that certain things don’t show up in accounting statements.
Hiring procedures, HR practices, company culture, early R&D experimentation all don’t show up at all, or only much later.
As a startup, we had a strong company culture. It was a matter of necessity. We couldn’t afford to pay market salaries, and the job required every team member to put their heart & soul into the company.
Startups not for everybody, but if done right, they create a strong culture and a high level of productivity. If a company can preserve this startup ethos, it can be a huge asset.
So the lesson is: don’t forget the soft factors.
Lesson 9: All eggs in one basket / Take something off the table
As a founder, especially a young founder who has no meaningful assets outside his company, you are not only concentrated, you are hyper-concentrated. All your eggs are in one basket, and as this would‘t be enough, the odds are stacked against you. 8 out of 10 startups fail.
It’s not a healthy situation, because you are over-exposed. That’s why it can be good to take a portion, say 10 or 20 percent of your stake, off the table, if you have the opportunity, to reduce the psychological pressure. Not right away of course, but maybe after 2 or 3 years, depending on how your startup develops.
So while insider buying is usually a good sign, insider selling doesn’t need to be bad. It could be prudent from a personal capital allocation perspective, and also a risk-taking perspective. If essentially your whole net-worth is tied up in your company, it might be hard to take the necessary risks to maximize long-term potential. So you need to understand the motive of insider selling before drawing conclusions too fast.
Lesson 10: Be a Learning Machine
Books have been super important for me. Whenever I faced a problem, I ordered the best books on a the topic, and tried to apply the best practices. That’s how I learned how to organize myself, how to build a sales team, how to build a positive company culture, and much more.