Episode 18 | Part One: False Starts

Gregory Shepard, an entrepreneur who's built and sold 12 businesses, a recipient of 4 private equity awards, TEDx speaker, and Forbes author. This is The Boss Podcast with Gregory Shepard.

I've dedicated my entire life to improving the entrepreneurship failure rate. I've been asking the question for years, why do more than 75% of entrepreneurs fail? Why are these startups failing over and over? Luckily, my guest this week is Tom Eisenmann. He's here to answer that question for us. Tom is a Harvard Business School professor and the author of the new book, Why Startups Fail. Since joining the Harvard faculty in the late '90s, he's launched 14 electives on all aspects of entrepreneurship, including one on startup failure. Tom, welcome to the podcast.

Excited to be here. Thank you.

Yeah, this is fantastic. It's a really big deal to me because we both share our passion for trying to help entrepreneurs succeed. I'd like to jump into this if you don't mind. You can teach anything at Harvard. What made you choose entrepreneurship?

Well, I sort of found it by accident. I got a doctorate as my midlife crisis. Some folks get a red sports car. At age 37, I got a doctorate. I had been prior to that a consultant to media and entertainment companies and got fascinated with US cable TV system operators, who in my mind were kind of like the big companies that I'd worked with as a management consultant. But when you get to know them, it turns out these are founders. And I studied their decision-making, specifically which of them would keep growing in the face of growing uncertainty. satellites and fiber and the sort of internet coming and so forth. That was the thesis. I joined the faculty, they put me to work because of the work I'd done as a consultant teaching a course about internet businesses. And, you know, again, I ran into more and more founders. So it actually took a long time before I worked on startup management, sort of where do you get the idea, how do you assemble the team and the money and so forth. And once I did that, I completely fell in love and never looked back.

What led you to be hyper-focused on the startup early-stage company environment? Out of startups, there's all these different stages in the lifecycle. What made you focus specifically on early-stage startups and startup failures more specifically?

Yeah, well, failure, early stage was where so many of my students were focused. A lot of MBAs, I mean, it turns out something like 50% of Harvard Business School MBAs launch a business at some point in their career. And an awful lot of that is in the first 15 years after graduation, and some of it is straight out. Once I got hooked on startup management, I started to work with more and more of these student teams. There's a place where you can, as an instructor, have a huge impact. And so that explains the focus on early stage. The focus on failure came— I had been working with these teams. for a few years. And there was one team in particular that I'd— they were former students. They were out for a couple of years. They went into consulting like so many MBAs, but their real dream was to launch a business together. And I encouraged them. I thought they had a great idea. I thought they had the right stuff as founders. I invested in the company and they raised $1 million, wanted to raise $1.5 million. That's part of the failure story. Launched the product, demand was strong. They had done what I would describe as textbook perfect minimum viable product testing. We were just starting in this timeframe to teach Lean Startup, and these students followed Lean Startup practices to the letter and validated demand. And sure enough, when they launched the business, demand was solid, repeat purchases were strong, but they couldn't get their operations together. And it was an e-commerce business. online retailing of women's apparel, and they had high rates of return for the goods, not higher than a typical e-commerce company, but the promise was better fitting clothing, so that was an issue. And they were making progress, but they couldn't make enough progress to raise more money and shut down after just a year. And it was a surprise and a disappointment for me, heartbreaking to watch what they went through. in failing. I could point to a lot of things that went wrong, but I couldn't pinpoint the cause. And here I was, a supposed expert on early-stage startups, and lots of startups fail, depending on how you count, maybe 2 out of 3 early-stage startups will fail. And here I was, a failure at explaining failure. So this was 2013. It put me on a quest to learn everything I could about startup failure. Were there recurring patterns? If so, could they be anticipated and avoided? And if a founder was going to fail, like, like these 2 co-founders, was there any way to make it less painful and make sure they would heal and bounce back and learn from the experience?

So I'm really encouraged by what you said, and we share a lot of passion for this area. And also going through that startup process, I've done 12 of my own startups and 12 exits, not including the investments. So I've been through that cycle. And I've seen it over and over again. You mentioned a couple of things I want to come back to. One of the things that you mentioned is they couldn't get their management team aligned, and then they couldn't do another round. And I'm interested if you could dig in a little bit into what you mean by they couldn't get the management team aligned and why you think they couldn't get that follow-on round.

So the lack of alignment on the team started with the co-founders. They were best friends in graduate school. And they'd actually vowed to, when they launched the business, to not let conflict over the business get in the way of their friendship. Which is, I think, a mistake that founders who either found with family members or close friends sometimes make, right? They will worry about jeopardizing the personal relationship and suppress conflict. And there's conflict. You have to talk it through as a co-founding team. And so these 2 also, like so many MBAs, both thought themselves qualified to be CEO and were effectively co-CEOs and talked through every major decision and sometimes disagreed, and it would just slow things down. And of course, a startup needs to be nimble, and they weren't when they needed to be. So that was one problem with the co-founding team. The other problem was, so I mentioned they were designing and manufacturing women's work apparel. Neither of them had worked in the design and manufacturing of apparel before, which turns out to be a big problem. I mean, one of the things I've learned from this project is domain expertise, industry expertise is super crucial in some startups, not so important in others. I mean, if you're going to launch Instagram, you don't need to have worked in a photo sharing company or for Kodak or somebody like like that, you know, so, but apparel manufacturing has all these very specialized steps in the design and production process. There's a pattern maker, there's a fabric sourcer, there's quality control, and step by step by step. These founders realized pretty quickly in that they were missing those skills and needed people who had them. So they hired a team out of basically mature apparel companies, companies like Ann Taylor. And those folks didn't know how to do a task, But they didn't know how to do all the tasks. So the usual process in an early-stage startup where everybody's a Swiss Army knife and will sort of jump in and help solve whatever problem is biggest, whatever fire is burning hottest, these people would sit around and say, well, I'm the fabric sourcer. I don't know how to do what these—

This is such a classic entrepreneur mistake that you're talking about. It's like they go in and they hire the big guns and they don't realize that the big guns aren't practitioners and you need practitioners. Practitioners in the startup, not just leadership. They just hired people in the burn, you know.

Exactly, they hired for skill and not for attitude, and you need both to some extent. Sometimes you need more attitude than skills, sometimes you need more skill than attitude. Here they needed the skill, but they also needed people that could adapt to the rhythms of an early-stage startup, right? So the team was dysfunctional in a lot of different ways. Now, that said, I really liked the founders. I mean, one of them was— well, they were a classic outside-inside team where one was charismatic, could sort of spin up the story and really sell, and the other was deliberate and disciplined and could run the operations internally. And I thought based on those strengths that they would complement each other, but they were missing industry expertise and they did make these crucial hiring mistakes.

Yeah, I see that there's 2 types of founders, right? There's the subject matter expert and there's the visionary. And it sounds like you had a couple of visionaries but didn't have the subject matter expertise.

Yeah, exactly. And in a place where it's really important. What I've learned, again, from studying these failures, I mean, food and beverage is another place I've learned that somebody on the team really has to understand all the arcane details, slotting allowances and how you get the packaging right and so forth. And a lot of MBAs have got an interesting idea for a new food or beverage product, And they're missing that know-how. Advisors can provide it, or you could hire somebody on the team to do it, but it's crucial that you get it somewhere. So yeah, so the team had these weaknesses. I look at co-founders, team members, investors, and then the 4th type of player that can be really crucial is partners. And for apparel companies, for apparel startups, it's quite common to outsource the actual manufacturing to a third-party factory. And here again, the company had big problems. They were a peanut, and worse, a peanut with no industry relationships or reputation. So when their orders went out to these factories, if some bigger company needed something expedited, their stuff got pushed to the back of the queue. And so that was a problem that slowed them down and boosted their costs. And then the investors they attracted, So to your point, weren't willing or able to bridge when the company started to get into trouble. A natural thing for the entrepreneur to do is to ask existing investors kick in another $300,000 to sort of get us to the next milestone. And these weren't big funds and they couldn't do it. But they strung the entrepreneurs along long enough with the hope that they would help introduce them to other investors, and that wasn't particularly helpful. So they turned out to be investors who my founders thought they had expertise because they had invested in some direct-to-consumer, this was a direct-to-consumer business. These investors had some experience, but they didn't have board seats on those companies. And so they didn't actually bring the know-how and they pushed the team to do the things that a tech venture capitalist would do, like grow, grow, grow. We want every—

It's so funny. I always tell people it's so classic when people are, The investors are like, grow, grow, grow, and it's so reckless unless you understand the business and its operations. And I tell people, I'm like, these investors most of the time are people that went to school to learn how to do this, and they've never run a business before. It's a bad idea to take instructions from investors who have never done it before.

Yeah, especially if they've never done it in apparel. I mean, you just think it's fashion. Quite literally, things go out of fashion, and you're building this inventory 6 months in advance of selling it, and you gotta make a call about fashion trends and—

Especially women's, right? I mean, wow.

Yeah, so, um, so the VCs said the worst thing in the world you could have is stockouts, um, and so we want you to produce a crazy amount of inventory. The founder said, not so sure, we like— we really need to fine-tune our operations before we manufacture a lot of this stuff. And the VCs had tranched the investment. So for listeners who may not be familiar, usually the VC will write one check and that's it. In this case, there were strings attached. So they broke the investment into 3 pieces and the founders had to meet milestones along the way in terms of net sales. And so that actually, I wouldn't call it adversarial relationships that the founders had with the investors, but they were never comfortable, right? You always felt because you were waiting for that next check to come in, At every board meeting, it felt like you had to sell the company all over again. And you had to be guarded about just what you could reveal in terms of whether the company was struggling for fear that they might hold a tranche back. So yeah, bad investors, bad partners, bad team, and co-founders who were deficient in important ways. All that, Greg, with a backdrop of a good idea. So I call this failure pattern in the book I've written, good idea, bad bedfellows. And you do see entrepreneurs who unfortunately, Nail the idea. The idea here had great promise. The sales were strong. There definitely was customer demand for the product. Customers came back and bought it again. But they could never, in the amount of time they had, they had $1 million worth of time, which turned into 2 seasonal collections, a spring and a fall collection. And that wasn't enough. If they had actually raised $1.5 million, I think they would have worked the bugs out. And I think the company might still be alive today.

Yeah, the funding is such a big component in investor alignment, right? Making sure that the investor believes in you and they're comfortable. That's a big, big deal I try to impress upon entrepreneurs. You're constantly trying to build investor confidence so that they're willing to back you on further follow-up rounds. In your book, you talk about this bad bedfellows, right? Can you unpack that a little bit? And then I want to go into— I mean, you brought up bad bedfellows, False starts, false promises, speed traps, help wanted, cascading miracles. I want to touch on all of these things, and then I want to ask you what you think good startups have in common. Can we start out with bad bedfellows?

Yeah, I think so. So, you mentioned, I think, 5 of the 6 failure patterns in the book. So, 3 of the failure patterns are for early-stage startups. Startups that are still searching for product-market fit, if you'll let me use that term, sort of a product that profitably or someday will earn profits by meeting the needs of the market. And the other 3 are later stage. These are startups that have had some measure of success and are scaling, building the team, building up the revenue. And so Good Idea, Bad Bedfellows is the first of the 3 early-stage failure patterns. And in essence, it's just what we've been talking about. It's a founder or a founding team that has a good idea, but can never get, if you'll let me refer to resource providers, the set of players who have to contribute money or time or effort of some sort. And in this case, the founders, the team, the strategic partners, the factories for Quincy Apparel, and the outside investors. At the core of that pattern was this issue of industry expertise. You could trace Quincy Apparel's problems to the lack of domain expertise of the founders. It led to the hiring mistakes. It led to them not finding the right investors. They really needed investors who understood fashion. And the lack of industry expertise translated into a lack of industry relationships, so the factories didn't pay attention to them. So the message for listeners is entrepreneur know whether you are in a space where that kind of industry expertise is super crucial. And it is in some places and not in others. If you don't have it, you need a co-founder who has it, or you need a senior team member who has it, or you just need to take the time to build it. I mean, these founders quit their consulting jobs to go launch this business. If they'd studied the business nights and weekends for another 6 months, It might have been a different outcome. I think they could have learned a lot in that period of time and recruited more advisors and different advisors. That's one pattern. False starts are probably the number one killer of early-stage startups. And here I'm thinking just like track and field or swimming, where an athlete will literally jump the gun in an effort to get an edge. Here the entrepreneur is so eager to build and sell, starts engineering work as fast as they can, launches the product without doing enough upfront research. You know, they may have spoken to some customers or talked to people about their idea, but they've skipped a big round of customer discovery where they're exploring the problems that customers have and really validating that they found a strong unmet customer need. And they've skipped a step of prototyping out different solutions. Usually there's many ways to solve a customer's problem, and you want to, before you really start the serious engineering work, you want to, through prototyping, get feedback on different solutions. So these entrepreneurs, and I'm not talking about a huge amount of work, this upfront research might take 4 weeks. In order to skip that 4 weeks, these entrepreneurs launch right away, and they've probably wasted 4 months, the amount of time it takes to build the first version of the product, sell it, see that it isn't working, and figure out what to do next. So it's just a bad trade. To save 4 weeks, they've wasted 4 months. And if you've only raised, like the Quincy Apparel founders, 1 year's worth of runway, wasting 4 months, a third of your capital, on a flawed first version is really unfortunate. It goes, Greg, right to the core of who entrepreneurs are. They have a bias for action. That's what makes them entrepreneurs. What could be more natural than just wanting to get going? And many entrepreneurs are engineers. Engineers love to build things. So again, it's perfectly natural. And even non-technical founders, a lot of the MBAs I work with don't have an engineering background, but they hear correctly over and over that you need great product to succeed. How do you get great product? You go out and find a technical co-founder or somebody who can do the engineering or you scrape together enough money to outsource the engineering. And these non-technical founders are good at networking, so they're able to do that. So whether you're technical or non-technical, and by the way, once you have the engineers on board, what do you do with them? They're expensive. You put them to work building. So all of these forces conspire to the very identity of an entrepreneur to sort of build and sell as fast as you can, but skipping this upfront work that could have helped you avoid missing the mark with the first version of the product.

Yeah, we go through— in Boss, we have what's called ABLE, Alpha Beta Launch Experience. And during that time frame, we tell them to get to an MVP and then to go to the customers to build the rest of the product. So I usually tell entrepreneurs, I'm like, your idea is fantastic, but that's all it is. And once you have your idea at an MVP, the rest of it comes from the customer. And a lot of times that offsets that, but I've seen this over and over again. They They want to go to market either too slow, like it depends on the personality. Some of them, you know, if it's an engineer, then they'll build and build and do analysis paralysis and they'll overbuild until they have something. And if it's a sales-type marketing personality, more of an A personality, they'll jump into the market before they're even ready.

Yeah, that's right. You know, a lot of engineers, um, you know, they're fascinated with the next new technology, so they're, they're just playing, um, and having fun. Or they're worried about edge cases, sort of corner cases that might—

Will never come up.

Yeah, exactly.

Yeah, yeah.

Yeah, we'll bulletproof the product against something that might happen 1/10 of 1% of the time. Yeah.

All right, I hate to do this, but we have to stop right there. But coming up in the second part of my talk with Tom Eisenmann, the professor at Harvard Business School and author of the new book, Why Startups Fail, We'll dig into more of the patterns that account for the vast majority of startup failures and some of the traits of successful entrepreneurs.

There are a lot of different styles, a lot of different types of people who can be successful as entrepreneurs. For sure, you need to be able to handle ambiguity. And for sure, you have to strike this balance between being persistent to the point of stubbornness, You can go too far in that direction, and ambivalent.

Learn more about the BOSS Business Operating Support System at bossstartupsience.com, or you can reach Gregory Shepard at gregoryshepard.com. This has been a production of Forbes Books.