Episode 18 | Part Two: 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'm so happy to have you join me for the second part of my conversation with Tom Eisenman, professor at Harvard Business School and author of the new book, Why Startups Fail: A New Roadmap for Entrepreneurial Success. Tom, in part 1, you started to run down some of the patterns that account for the vast majority of startup failures that you write about in your book. So let me ask you about the false promises.

Yeah, let's rename that false positive. So I think in a COVID world, we're all accustomed to false negatives and false positives. And that's what the false promises are. They turn out to be false positives. Entrepreneurs are subject to false negatives. It can be heartbreaking. A false negative is a signal to the entrepreneur that their idea is flawed, when in fact it's a good idea. And a strong signal of a strong false negative can lead them to throw in the towel. And then they have the heartbreaking circumstance of reading in the newspaper 2 years later that somebody just sold their company for $1 billion with exactly the same idea that they threw out a few years ago. The false positive is the opposite. It's a signal that you're onto something, that this is really working based on early results, when in fact there's a problem somewhere and you just haven't recognized it yet. In medicine, false negatives and false positives are both a problem. False negative can lead you to avoid the proper medical care and the disease can really progress. False positive can lead to unnecessary medical care. So false positive for the entrepreneur happens basically because they get a really strong response from early adopters. And every business needs early adopters. You can't build a business without those first customers. And it's often the case that those first customers are foaming at the mouth enthusiastic about what you're doing. Like they've been waiting for you. They've been sort of pounding the door. Table pounding your door, get it to me. That enthusiasm can spread. You'll get word-of-mouth referrals from those folks. But it's often the case that mainstream customers, if you're going to build a business of any scale, you also need the mainstream who will come on board later, that their enthusiasm for the product is much less than the first wave of early adopters. And it's often the case that the needs of the early adopters are actually different than the needs of the mainstream customers. And that can really be trouble for an entrepreneur because they can build a feature set to satisfy the early adopters that turns out to be over-engineered or even confusing for the mainstream customers. And so it takes a really nuanced understanding on the part of the entrepreneur of the differences between the two. And it takes discipline not to expand too aggressively if you get this enthusiastic reception from the early adopters. You gotta make sure that demand is gonna be equally strong for the mainstream. And this is hard to do. So these entrepreneurs that fall victim to the false positive basically expand too aggressively in the direction of the early adopters. And once you've made those commitments, it can be hard to reverse them.

Yeah, this is a very common— is the artificial enthusiasm and support for what you're doing, which I see all the time and they go in and then they double down and double down, double down. And then by the time they turn around, they realize they got something wrong and now they have to go back. And you can't pivot after you've raised a certain amount of capital. A pivot is usually a bad sign to an investor.

Yeah. The further along you are, the more energy it takes to change direction. You know, it's like steering a supertanker. It takes time. You got to reeducate your employees, got to reeducate your customers. And it takes time and it takes money.

Yeah. And you also lose confidence, right? So you lose confidence, your employees lose confidence, your customers lose confidence, and your investors. You know, sometimes it's too late to turn around if you've raised enough money. The investors just look at the scenario and say, well, you know what, move on to the next deal, right?

Yeah, exactly. So, so each of the failure patterns in the book is supported by an anchor case study. And the case study for false positives was a company called Baroo. I love the name, by the way. A Baroo is— it's a word for when a dog perks up its ears and tilts its head when a human is speaking to it. That's a Baroo. So this was a pet care service, and the twist for Baroo was they were going to market their service through apartment buildings. So tenant would move into the building from another part of town or another city, they wouldn't have a dog care solution, and the concierge or the doorman in the building would refer the new tenant to Baroo. It was a good idea. The problem, the false positive, was their first customer was a building— if anybody's been to Boston, they may know a building called the Ink Block. It was the old headquarters and manufacturing facility of the Boston Herald, now defunct Boston Herald newspaper, and converted to condos and converted all on one day. Flip a switch and you have 400 new tenants. And a lot of those tenants were a Hollywood production crew that was in Boston shooting a movie for over a year on per diem, working 15-hour days with their pets. And this was the winter of 2015 where there was a 30-day period where Boston got 9 feet of snow in 30 days. So if you had a pet care service at the Ink Block, you were going to blow the doors off, which they did. They had spectacular demand. And A bunch of other buildings in Boston reached out unsolicited, come and be our concierge pet care service provider too. Those building owners had buildings in other cities. And so the mistake here was Ink Block filled up all in one day. A typical apartment building turns over only about 25% of its tenants every year. So their sell-in rate was much slower with other buildings, but they'd already committed to the expansion. And just as you say, Once you start expanding and you've got that momentum, it's really hard to put on the brakes or change course.

I wanted to dive in a little bit into your Help Wanted. This really— I found this to be really, really fascinating. The whole idea of talent management and talent acquisition is a challenge, especially in startups because of the attitude thing that you brought up earlier, right? You have to get somebody that understands what it takes to be inside of a startup And does it get frustrated with certain things, it gets excited about other things. So maybe you could talk a little bit about what you mean by help wanted.

Yeah, help wanted is one of the 3 late-stage failure patterns. And the help in question has 2 flavors. There's a missing manager, senior manager who the startup really needs and they just can't get the right person in the job. And I'll come back to that. And then the other aspect of this is help wanted from the capital markets. Scaling startups still burning through cash, maybe in a healthy way, you know, sort of acquiring customers who over the long term will be profitable. But capital markets can be flaky, and sometimes they just slam shut, and they do so suddenly, and they can do so for months on end in a particular sector. Biotech goes through this with some regularity. Cleantech went through this like crazy in the 2010 timeframe. And so the company in question here, Help Wanted, was an online retailer of home furnishings. If the listeners look around themselves, all the stuff in the room you're in came from somewhere. Somebody bought it and brought it where you're sitting. And it turns out that shipping couches from Asia to the West Coast, and then from there to Kansas City, is incredibly complicated logistical and operations problem.

Yeah.

It's not like your Amazon books where if they come 2 days early, you're actually delighted. If your couch comes 2 days early, at least, I mean, everybody's home 'cause of the pandemic, but in normal times, if your couch comes 2 days early and you're not home from work, you have a problem on your curb.

Yeah, yeah.

So this company was shipping tables and lamps and all sorts of home furnishings. And they actually did, there've been a lot of demand-related problems in this space. I mean, fab.com, blew through $300 or $400 million. One Kings Lane was a pretty bad wipeout. Wayfair got public, but it has never made a profit. And, but this company had a good demand generation formula. The entrepreneur came out of the TV business, and he conceived the room as a TV episode and the items in the room, the chair, the table, and so forth as characters. And they spun this whole story around it and it was entertaining and people loved it. And they wanted to buy the whole room. So they had big tickets, and people came back and repurchased. And Einstein's Office and Modern Outlaw and so forth, they named the stories. So the demand generation was working, profitable customers buying repeatedly. But this CEO, this founder CEO, didn't have a background in operations. He recognized that and decided his first hire for VP operations should be somebody who could grow into a COO role. role, a chief operating officer role. Big mistake. Good in theory, bad in practice, because this individual had never shipped anything in his previous jobs. He'd done operating for sure, but never logistics. And worse, this is at the stage where the now scaling company is putting in these crucial information systems, in this case, an ERP system, an enterprise resource planning system, which is how you keep track of inventory, how you keep track of customer orders, how you keep track of customer service queries, and they picked the wrong system.

Oh, disaster, because that's a system of record, not a system of engagement.

Yeah, exactly. They lost track of inventory. People were ordering things that weren't in stock. They were telling people that things were out of stock when they were sitting in the warehouse. And, you know, and this generates more customer service queries, and they couldn't staff up customer service fast enough to deal with this flurry of of problems their bad ERP system was generating. So they got rid of that guy and hired a guy who had been senior in operations at Netflix back in the day when pre-streaming, when Netflix was all about shipping little red envelopes with DVDs in them. And so this guy had some shipping experience, but there's a world of difference between a tiny envelope with a DVD in it and a couch. And he was a big company guy who was good at massaging the numbers so it looked like everything he was doing was getting better. But the entrepreneurs decided, the founders, that he wasn't thinking like an owner and wasn't owning the entire system. So he made some progress, but they got rid of him too. And the third try, they nailed it. They got the right person, cleaned up the operations, brought in a new ERP system, which is an incredibly disruptive thing to do. But just as they were getting their operations under control, the capital markets shut down on them. There was a period, some listeners may remember, where e-commerce went— online retailing went out of fashion in 2015. And this was a company trying to raise Series C and still burning through cash at a pretty healthy clip 'cause they were growing. And actually, they had so much demand, it was hard to shut demand off 'cause a lot of it was coming through social media.

Right.

referrals. And they tried to raise more, they tried to get a bridge from their existing investors, but nobody would put the money up and they had to liquidate. It was just a tragedy.

Oh, that's a shame. Yeah, yeah, that's a shame. I mean, you've, you've interviewed nearly 500 entrepreneurs. And so I'm coming back around to something. So what are some of the qualities or strengths that a successful startup entrepreneur has in, in your research?

You know, we all wanna assume there's a template for a great entrepreneur. And this work with 470 early-stage founders, they went through a long— answered a long series of questions, like 50 questions about who they were, what their business was doing, and how they ran their business. Everything you could think of, how they raised money and the culture of the company. I asked them some questions about their own management style and about self-perceived personality attributes. And then I sorted the founders into those who were doing really well, that they were getting good step-ups in valuation, growth in the value of the company, and those who had either failed or whose valuation showed that they were moving in the wrong direction. And the The only personality attribute is— these are things like persistence. We think of entrepreneurs as somebody who's persistent, somebody who's visionary, et cetera, et cetera. And no separation between the winners and losers on any of these things. The only one that actually moved the needle was methodical. And the successful, the more successful founders were more likely to say they were methodical. And that makes some sense to me, although you gotta be careful as a statistician. If your confidence interval is 95%, meaning you're 95% sure you've got something real in your statistics, and you ask about 20 things, one time in 20, something is gonna show up as being significant when in fact it's not really there.

It's skewing everything.

Yeah, yeah, so I guess what I'd say, Greg, is it's a big tent out there. 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, right? Basically, every time somebody, an advisor, an investor, or somebody tells you something new, you sort of change your direction based on the last conversation you had. So you got to find this middle ground between ambivalence and stubbornness. And persistence lives in there somewhere, but you can't be too persistent, right? Because if it's not working, you have to be flexible enough to change direction. And obviously, visionary, somebody who can sell the vision because you gotta recruit your employees, your co-founder, your investors, strategic partners. So that ability to sell the vision is crucial. But I gotta tell you, there's a lot of successful introverted founders. founders out there who just come up with an idea that's so compelling that the idea helps sell itself.

Yeah, I always think of it. I think of headwinds, tailwinds, and lift. Like, I was meditating at the beach and I would see the pelicans, right? And they have a headwind and they have a tailwind and they also have lift, right? And I think like when I'm looking at entrepreneurs, if they have a tailwind and they have a headwind, they still need lift. And the lift comes from the entrepreneur. And some of it is just attitude. Confidence and consistent persistency, but I also think some of it just comes with the ability to be able to take a beating, you know? Just work and work and work and take a beating.

Exactly, the resilience. So I would say my suspicion is the factors that sort out people who try entrepreneurship, who get to the stage I'm looking at here, which these are all businesses that raised at least $500,000 and You have to have some measure of promise to get that. And so I think the big separators are not between successful and unsuccessful entrepreneurs. They're more between the world of people who actually take the plunge and do it and the people who are on the sidelines sort of watching, hopefully cheering. You know, that's where I think you see the biggest differences in personality between the non-entrepreneurs and the entrepreneurs rather than between the successful and less successful.

Right. I always separate it. I always tell people, you know, investors, early, you know, investors that are new, angel investors, typically I say there's the horse and there's the jockey. And the horse is the business. You have to have a good horse that can run and has a chance. And then there's the jockey. Most of the time, the jockey's never ridden a horse, let alone this type of a horse. So, they're going to fall off unless you help them and give them some time and train them on how to ride the horse. horse before you open up its gate. And I found in using that analogy, sometimes it helps both the entrepreneur and the investor understand where they're really at, because a lot of times, like you said earlier, you know, the entrepreneur just jumps on the horse and goes for it and they fall off. Sometimes the product is more powerful than the entrepreneur's capabilities.

Yeah. Yeah. I spent a lot of time thinking about horse and jockey when I did this research and There's a lot to it. You ultimately keep coming back to the jockey though, because unlike horse racing where the jockey can be an employee, here the jockey picks the horse.

Yeah, yeah, good point.

That's a big difference. And so ultimately, if you picked a slow horse, who's to blame? You probably are at some level.

Very true.

The other big difference compared to at least most types of horse racing is Entrepreneurs can change horses, right? You can pivot to a— a pivot implies at least something is the same, right? Like basketball, you keep one foot planted and you move the other one. That's a pivot. And so a pivot is in a sense a change of horses, hopefully to ride something a little faster. And so that's another big difference. But, and again, when—

As long as you don't change it halfway down the track.

Yeah, yeah. Harder and harder the faster you're going.

Exactly. Yeah, exactly, yeah. So I'm also interested in, you know, we have a mix of investors and entrepreneurs. And so when you sit back and you're an investor listening to this podcast, how do you choose a good deal with all of this information that you've aggregated and studied?

Yeah, so I assume most of the listeners who are investors are angel investors, which means they're gonna come into the company early. So I would, if I were them, and I am an angel investor, focus, and I've learned a lot through this research, on the 3 early-stage patterns we spoke about. And you can actually do a real test of, is the company conforming, are they in trouble with respect to each of these 3 patterns? So for the false positive, what you're looking for is the entrepreneur's understanding of the differences between the early adopters and the mainstream customers. Have they studied both? Do they understand whether the needs are the same or the needs are different? And crucially, do they have a plan for migrating from the early adopters to the mainstream? You need to think through, there's lots of ways to do it. You can build a product for the early adopters and then migrate the product over time by basically hiding features or whatever you're gonna do. You can build for the mainstream right from the start. This is what Drew Houston did at Dropbox. Everybody will be familiar with that business. Drew tested the business and really tested the early product by going to the most sophisticated customers you could imagine, software engineers, whose file management needs were working with multiple devices, collaborating, big important need for backup. But Drew wanted to build a business, he talks in his Y Combinator application, that his mother could use, to store her recipes. So he had that vision of the mainstream customer in mind right from the start. And he took a gamble, but a well-informed gamble, that if he built an easy-to-use product, it would be good enough for the early adopters. They wanted other features, they wanted him to add a whole bunch of stuff, and he said, no, I'm keeping it simple. So it just, it takes a plan. So the investor needs to see, is there a plan for managing the migration from early adopter to mainstream? And is the entrepreneur sensitive enough to the differences and the risk of a false positive? First. Secondly, have they done that upfront research? An investor can absolutely figure out if the entrepreneur has spent enough time talking to potential customers, prototyping, exploring how they're going to come up with something that's sufficiently differentiated from what's already out there, or whether they're vulnerable to the false start because they just— they're so eager to get going, they're just going to plunge in headfirst. And then the bad bedfellows is this issue of, you know, especially at the root of it is this industry expertise, the domain expertise. And an investor ought to— a good investor ought to be able to figure out whether you're investing into a space where that industry expertise is crucial or not. It isn't always. I mean, one of the false start examples in the book is an online dating company. You don't need to have worked in an online dating company to launch an online dating company. If you look at the most successful online dating services out there, and a new successful one gets launched every couple of years, Yeah. You know, you'll find an incredible diversity of backgrounds. So sometimes the domain expertise is important, and if it is, where are you going to get it? So I think investors can spot all 3 of these early-stage failure patterns, and, and those ought to be warning signs.

Tom, thank you so much for joining the podcast. I really, really appreciate it. If it's okay with you, I'd like to have you back again. I think you're one of the best guests as far as a fit for the audience that we have. And I hope to follow up and collaborate with you in the future. Thank you so much again.

Yeah, that would be amazing and great to hear that. And thank you very, very much for hosting.

You're very welcome. His name is Tom Eisenmann. I highly recommend his new book, Why Startups Fail. And that's it for this edition of The Boss Podcast. If you enjoy the show, make sure you take a second to subscribe so you automatically get notifications when the new shows drop. Also, if you have a minute, I'd love it if you left us a review so more folks like yourself can discover the show. Thanks for listening, and namaste, my friends.

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.