12. Tom Eisenmann & The Other F Word (Failure) | FOMO Sapiens with Patrick J. McGinnis

My name is Patrick J. McInnis, and I coined the term FOMO. That's short for fear of missing out. And it's why some people end up following the crowd. But we're not like them. We're part of a new species that isn't afraid to do things differently. I call us FOMO Sapiens. And this is the show where you'll meet people like us, phenomenal FOMO sapiens, to learn how they find the courage and the ideas to live exceptional lives.

Welcome to another episode of Fomo Sapiens, the show for people who don't just follow the crowd, but instead take their own path to success in business and in life. I'm your Host, Patrick J. McGinnis, venture capitalist by day, author and podcaster by night, and FOMO sapiens 24 7. And since we're coming up on the end of the year and it's a good time to start reflecting on the lessons learned to today, we are going to focus on failure. That's right, failure. The other F word. And my guest today has seen lots of failure and he has analyzed it and gives us tips on how not to fail when building something. My guest is Tom Eisenman, who is the Howard H. Stephenson professor of Business Administration at Harvard Business School and the faculty co chair of the Arthur Rock center for Entrepreneurship. Now, that is a big deal because the center, so the Rock center for Entrepreneurship, is kind of like the nerve center of entrepreneurship at HBS. Since joining the faculty in 1997, he has led the Entrepreneurial Manager, an introductory course taught to all first year MBAs. I took that class. I think I got an okay grade in it. He has launched 14 electives on all aspects of entrepreneurship, and he has authored more than 100 case studies. He has written for the Wall Street Journal, Harvard Business Review, and he has taught the many entrepreneurs that have gone on to become household names. So he is a very knowledgeable guy. And his new book, why Startups Fail, catalogs what he has learned in this prodigious career about why companies fail, where entrepreneurs go wrong, and what we can learn from them so that we don't do it ourselves. And on this episode, you're going to learn exactly that. What are the patterns? What are the things that are unfortunately repeated over and over again? We're going to hear about stories of how these things happen, and then we're going to learn how to avoid these failures. So if you're thinking about doing something new in 2022, whether it's starting business or starting a social enterprise, or just trying to do something new. Thinking about why companies fail can apply to all of that too. Now, my small ask for you this week relates to this because my whole philosophy, which I wrote about in my first book, the 10% entrepreneur, is that going in full time is risky. And if you start part time, you can actually mitigate risk by starting small and then scaling up from there. So I am a big believer in the fact that one way to avoid failure is to engage with entrepreneurship flexibly. So go check out that book if you're interested in it. Or you can check out an audio course that I put together for himalaya.com it's called how to be a Part Time Entrepreneur. And it's basically like a podcast in 10 lessons where you can learn all about this. So go check it out. And if you're interested in learning more, you can Also check out patrickmcginnis.com where I have tons of free resources on part time entrepreneurship. All right, so I'm going to mix it up this week. Yes, I know I always start with the same question, but you know, I just want to try something new because Tom is a person who has taught a lot of very interesting people over the years. And so I started out our conversation by asking him this question. You've taught many students over the years, I'm sure some that have gone on to great fame and others that have gone into some relative infamy. So I'd love to just hear a couple of the people that you've taught over the years that might, might be familiar to the listeners.

Wow. I actually, Patrick went back. I had to go back. You were class of 2004 at Harvard Business School, and I had to go figure out I had thousands of students, so you can't remember all their names. So I had to figure out whether you were my student and went back and looked at the students I taught that year and it wasn't. You weren't among them. Shame on you. But one was who stands out. And I don't know if the listeners may remember the company, but wow. Joseph park was in your class at Harvard Business School. Joseph, for the listeners, was the founder and CEO of a business called Cosmo, which probably epitomized the dot com boom like nothing else I can think of. Cosmo was a bunch of people on bicycles.

Delivering Mars bars and video cassettes when that was still a thing all around first New York City and then, and then the world raised a quarter of a billion dollars, including money from Amazon and stepped on the gas. Joseph had been a business analyst at Goldman Sachs, I think, or some Wall street thing, had this idea. And back in those days you could raise a quarter of a billion, a quarter of a million dollars with an idea. And the, the thing I best remember about him is there was this fascinating set of profiles in Vanity Fair of the young entrepreneurs, you know, the dot com barons. And he was among them. Sort of glitzy, full page picture of him and a quote from him that. So they pulled out the quote and sort of big letters and he's saying, so in the quote, this is almost verbatim, look, what's the worst thing that can happen.

Is I lose a quarter of a billion dollars of other people's money and then I go to business school and I have incredible stories to tell. Wow, this is 2000, probably the year 2000, this article. And sure enough, he lost a quarter of a billion dollars. The thing went bust, tried to grow too fast and had. I mean, imagine there's not much of a business model sort of bicycling Mars bars around town, even though many businesses today are sort of making it work with exactly the same formula. And sure enough, four years later, Joseph shows up in my class. And there he is in the flesh, this entrepreneur who promised the worst thing that could happen is he'd end up at Harvard Business School. And he was an astonishing entrepreneur.

This was a point when a lot of new technologies were coming on stream. WI fi was relatively new.

And Voice over ip, sort of how a lot of us talk on the phone these days was brand new. So we were working through all these technologies and he was like a jazz musician. We'd cover something in class one day and then we'd cover.

Another technology the next day. And Joseph would come back three days later and he'd have combined the two. And so the concept he had was, okay, you've taught me about WI Fi and that's going to be all over college campuses and you've taught me about voice over IP and it works over WI Fi. I'm going to launch a business for colleges. So, you know, a huge money drain for families is like buying their kid a telephone from universities. Used to make a lot of money by selling telephone service to graduates. They don't anymore because now everybody uses their cell phone. And so he conceived this whole thing and had a whole plan. And then of course, you could hang all sorts of goods and services off of that once you had your hooks in them with phone service. He was an astonishing entrepreneur. Went on to after business school to launch.

Amazon at a point had a question and answer service like Yahoo Answers. And Joseph built that business. I've lost track of him. I don't know what he's doing now.

Well, according to LinkedIn, he works at Samsung, so. Hey, Joe, please call Professor Eisenman and say hello. And the thing I'll tell you about Joe, so I didn't know him because I was. I was, like, easily intimidated at that point in my life. So I was, like, too shy. But I knew his business because, number one, I used to order from it all the time because they would, like, sell things really cheap and deliver them in an hour. So, like, as a. An investment banking analyst, or I guess I was at my VC career at that point, but, like, I would order stuff all the time from them. And another company called Urban Fetch that would bring you cookies. And then the other thing is, our firm had invested in Cosmo, actually. And so I remember the meetings when the company was burning through this money and things were getting ugly and it was crazy. And there was one junior analyst who I will not name names, but has. Who has gone on to become quite well known as an entrepreneur who stood up. She stood up to the partners and, like, question why they were doing this deal. And people just were, like, freaking out because they were like, how could you question these partners? She was a hundred percent right. So good job, you. But I still have a Cosmo glass, actually, that I gave. Wow. To somebody who I will mention in a little bit. I gave it to somebody who was gonna come up later in the. In the interview. So I should have sold it on ebay, but. Or giving it to Joseph, you should have saved it.

So for the listeners who are fascinated by the character. And Joseph was a character. He's again, an amazing entrepreneur. And the story, there's a documentary that was done around, I think it's called Stardom, and I'm sure you can find it on Netflix. And it's riveting because it does tell the rise and fall story and gives a feel for the. I mean, those days were like, we're pretty frothy right now. Um, but, boy, it was an unbelievable time.

It really was. And there's another one called startup.com, which is incredible. So go watch those guys, everybody, now. So, Tom, your book is called why Startups Fail. And I, you know, it's really good and I love it because right now we are in this bubbly time where it's like, you feel like you can't fail other than, like, the spectacular. Like, we Work in type failures, which are so it's like real. I mean, I called it we don't work. Because I was always like, I was a member and I was like, people aren't working. How can this be a good business? But, but you write about these six sort of like problems that can tank a startup in the book. And so what I wanted to do today is, you know, we have a lot of people listening who are entrepreneurs or want to start companies, just get into some of those so that folks who are listening when they start their company or as they build their companies don't fall in their trap. So let's start with the first one you talk about in the book, and that one is called Bad Bedfellows. What is that all? What's that all about?

Bad Bedfellows, Strange bedfellows comes from Melville, from Moby Dick for the English majors out there. And so this is the idea the entrepreneurs have got. It's good idea, comma, bad Bedfellows. And it's a tragic situation where the entrepreneurs have got a really good idea and they just can't pull the team. And I mean capital T team, the founders, the rest of the team members, the investors and entrepreneurs will often have partners, right? Because they're starting with nothing. So somebody else can help with the marketing or supply key technologies. And in this case, despite having a good idea, they can never quite pull together the set of call them resource providers. They have to either provide money or time or something. They're marketing channels. And as a result, the, the business never works.

And the example, each of the failure patterns in the book is built around a case study. At Harvard Business School, we do everything around case method and that's the approach I pulled into the book. So the case for Bad Bad Fellows is an apparel company, Quincy Apparel, that had a great idea, real demand for the product, but just couldn't get the thing, couldn't get the team together in enough time before the money ran out.

Now what this also relates to the idea. There's a book that I'm, I'm sure you've read, it's written by one of your colleagues called the Founders Dilemmas. And it's, you know, it's like, I remember there was a story from the book that like, the company didn't fail, but it like really blew my mind, which is the founders of Zipcar, they had a handshake deal to split the equity 50 50, and then one of them, like kind of never did all that much and the other did everything. And when they went Public, they each owned half. And it's like getting things right, you know, setting things up in a thoughtful way early on. If you don't do that, you can end up with bad situations. So is that the kind of thing.

You'Re thinking of, Patrick? I love that story. We, we now we have a video. Robin Chase was the founder and CEO of Zipcar and she made the biggest of big rookie mistakes in, in creating the company. She didn't have a founders agreement. They agreed 50, 50 to split the equity exactly as you say. But normally a founder's agreement would have the equity vest. You don't really own it until you've, until some period of time has elapsed over a period of time, often three or four years. And so in this case, the co founder, as you'll remember from the story, never quit her day job, really didn't contribute much to the venture. Robin was doing all the work and was CEO. So a CEO had the ability to fire her co founder but the co founder retained the 50% of equity. If she'd left after a year, she would have not, you know, three quarters of her equity would have been unvested and would have been basically recovered back to Robin. And we have video of it now, we still use the case 20 years later and we have video of Robin explaining this. And you can just, you can feel the.

Anger and heartbreak to give away so much wealth over something as simple as not having a proper contract. So for all the entrepreneurs out there, if you're at the beginning stages, the most important thing you do is have a founder contract. And that founder agreement needs to basically specify who owns what percentage and at what rate that equity is going to vest. And it also needs divorce provisions, right, because founding teams, Noam Wasserman is the colleague, former colleague that you mentioned and he shows that founding teams are not stable. They break up. There's a lot of conflict. And this is indeed a big part of bedfellows. The company in question, Quincy Apparel. Two best friends coming out of business school, like so many MBAs, wanted to be the boss, both shared the CEO. And that can work, but really when you both want to be the boss, you're going to have different views. In this case, they had different views about what the apparel should look like, which is pretty fundamental to a fashion company. And that slowed them down. And you can't as an entrepreneur afford to be slow. So yeah, you got to sort out responsibilities, you got to sort out ownership, you got to sort out, if you don't agree over this stuff how are you going to split? You know, can you both take the company, all the intellectual property and all the work, you know, can you each go start your own version? Who gets to own the thing if you split up?

Yeah, and listeners, if you want to hear more on that topic, this is super important. We had on the founders of Primary, Galen and Christina, who are co CEOs and they talk about how they have divided the responsibilities in the business and what they've been able to do in that front. So it's an episode for a couple of years back. Go find it in the, in the old, the backlog and check it out. Now you have another, the second one, the second sort of mistake you talk about here is called false starts. So what's that all about?

Yeah, that's the big one, I would say of all that. So the six patterns you mentioned, three of them are early stage. So ventures that are just getting going are still searching for a market, assembling all the resources. And this is probably the biggest killer of early stage startups. And the problem here is just like in track and field or swimming, where the athlete will jump out of the blocks trying to get an edge, but goes too early and suffers a penalty as a result. Here the entrepreneur, so eager to build and sell the thing with a burning conviction that they've got the next best, greatest thing, just starts the engineering work and gets the product to market as fast as they can. By the way, all this behavior, if your readers, if you talk with, with your listeners, excuse me, about lean startup, this is consistent with a lot of the rhetoric of lean startup fail fast, you know, just do it mentality. And it reinforces every bone in an entrepreneur's body bias for action. Right? Entrepreneurs are people that make things happen. And what they've done is they've skipped a stage of upfront research that should happen in every venture before you launch the venture where you're really familiarizing yourself with the customer and their problems. Have you really, really found a strong unmet need? And have you explored all the solutions to those unmet needs too quickly? These entrepreneurs latch onto a problem and a solution and they go as fast as they can. And it might work. Sometimes it works. Those are lucky entrepreneurs. But too often the first version of the product, if you haven't done this upfront work, misses the mark. You spend four months on a failed version of the product, you'll pivot away. Good entrepreneurs will pivot, they'll take the feedback and move. But if you've raised 12 months worth of capital or 18 months. Pick it, pick a number. And you waste the first four months on a flawed version of the product that actually if you just spent, I mean, we're not talking about a year here. This is, this is three weeks of work, maybe two months. And you know, you're basically exchanging four weeks of upfront work for four months wasted. And that's a pretty good trade for an entrepreneur who's on borrowed time.

It reminds me I'm having like pangs in my heart right now because I invested in a company with us, the retail startup in Turkey. If anybody's in Turkey, you might remember it's called for you. And we were trying to do like a hard discount drugstore. And so we, I remember we put a lot of money. I think the company raised like $50 million and we were like opening like nine stores a week. It was crazy town and, and I remember it was going badly. And so I went to one of our stores in Istanbul and I stood outside and I watched as customers walked by, looked in the window, looked confused and then kept on walking because we'd never figured out. And it was just, it was a failure. Like by the way, it went bankrupt and it was a disaster. And so yeah, it's like had we. And I remember I was talking to a buddy of mine from business school who had invested in a bunch of retail like, you know, pan, he's like, well, did you talk to customers? And I was like, you know, I think we put, probably could have done a little bit more of that. So get out into the world, leave the confines of the office and meet with the people in the street and you will avoid this kind of problem. Now you, you, you're. We're going to skip over false promises and move on to number four, which is speed traps. Because you, you, you have an. This is like my favorite chapter in the book because you talk about a company that I kind of know and was there for a little bit as an observer and it's Fab.com. so talk about speed traps and tell a little bit of the story of Fab.com.

Sure, Fab. So speed trap is just what it sounds like. This is now a later stage startup pattern for the listeners. By later stage we mean you've got a product that you've sort of demonstrated that you can sell something to people. You've started, you've assembled a team, you've raised some money. And the shocking thing is you'd think you were out of the woods. But if the measure a failure is didn't make money for investors, which is one way to measure failure, then it's still the case that about one in three of late stage startups fail to get a positive return to the investors, which is pretty bad. And Fab was one of them. Raised 300 million and lost almost everything, sort of sold for about $30 million at the end. And Fab was an online retailer of home furnishings. So look around you. The stuff you see, you know, the stuff on the table, the table itself, the stuff on the table, the pillows, you know, all that jazz. And there were some notable failures in that sector. They weren't the only one. And the way the speed trap plays out, and it certainly did at Fab, I think they're.

The poster venture for this is you get off to a great early start. And at Fab they had. Brandon Schellhammer was the co founder who had brilliant, quirky design taste and knew how to find products that people who were into that would say, you know, I gotta have that, I have to have that chandelier made out of martini glasses, I have to have a rhinestone encrusted motorcycle helmet. And so he would find these things really one of, not literally one of a kind, but very, very unusual. And they created a flash sale business around that and it took off. The word spread like wildfire through social media. People came back and bought again and again and passed on word to their friends and so had a tremendous launch. And Jason Goldberg, who's the CEO and co founder, brilliant at managing the social media around all of this, investors poured in. This is part of the speed trap. So at a very high price for the equity, expecting continued growth, hypergrowth and entrepreneurs are happy to oblige. Like what entrepreneur doesn't want to grow? That's sort of the point. It's how many people keep score. And so the next wave of growth in a lot of businesses is, isn't as easy to get as it is with the early adopters. The early adopters find you and they spread word about you. The next wave isn't as interested in rhinestone encrusted motorcycle helmets. And to get their attention you have to do paid marketing, paid advertising. And they don't come back and repurchase, they don't spread word of mouth. You probably have to discount more to get them to buy. So you're getting this squeeze between how much a customer brings you, the price you charge them and the revenue they bring and the cost of acquiring them. And this very much happened at FAB pretty quickly. Insult to injury with FAB they were quickly cloned in Europe, as happens with a lot of businesses. There's an outfit there called Rocket Internet, and they had already made a brilliant set of moves copying companies like Groupon and Pinterest. These are sort of early 2000s, mid 2000s, and the Birchbox they cloned. And the drill was buy our clone or, you know, basically we'll conquer Europe. And if you come here, you'll face trench warfare. So you don't want to do that. So just buy us and then we'll will reap a big happy return. Fab said.

That'S a horrible thing, you know, great design. You can't possibly do this. We're great, you know, we understand great design and our designers will back us. So they poured into Europe, spent like $150 million building a giant business in Berlin and learned that European tastes were different than US tastes and that the complexities of doing e commerce across a whole bunch of European countries was exceed expensive. And they were facing trench warfare with the players there. So that was a mess. Meanwhile, the US business, because it's maturing and it's facing these customers who aren't as interested.

Is just burning through cash. So cash is going out, flying out the door. But Jason Goldberg, who's a dazzling, charismatic salesman like so many great entrepreneurs, is able, just based on the strength of the growth they're still growing, to raise a couple more rounds.

He has a quote in a postmortem of the business where I know I'm not allowed to swear on the podcast, so I will abbreviate it. But he's raised money at a unicorn valuation, billion dollar valuation, but it's only about half or a third of what he needed to fulfill his plan, which was burning up through all his capital. Here I'm getting all these congratulations. Not too many people know what it's like to raise money at a billion dollar valuation and know that you're headed straight into an S storm. So yeah, and they were. And you know, other things happen in speedtrap companies if you have humans in your business with some software businesses are fortunate to not have. But if people are answering phones and answering emails and packing stuff in a warehouse, then you got to recruit all those people. You need systems in place which don't exist in the original startup. All this stuff has to be put in place, the systems, the processes for coordinating everybody's work and you get a cultural mess. Too often in these speed trap companies where you get old guard, new guard, people who are present at the creation know the founder believe in its mission. Compared to all these specialists, some of whom, this is just a job. Others think their contributions aren't understood or appreciated. You get fiefdoms. You know, the warehouse people have a different cult subculture than the marketing people. The marketing people blame the engineering people for being late on features. And so the culture tends to go bad. And sometimes it didn't happen at fab, but you get slippery slope behavior. You know, this is Zenefits, if anybody is familiar with that story. Or Theranos, for sure. You know, so people go over an ethical line just to sustain the growth. Ubiome was a great example of that. And eventually you need to raise more money. And the new investors look at this and say, whoa. Suddenly you go back to your existing investors and say, we need a bridge. We need more funding. And they say, you know, it's just, sorry, yeah, it's unclear whether you're ever going to get there. And the whole thing can unravel remarkably fast once the money stops coming in. And that's what happened to fab.

Fomo.

Yeah. You know, so I love the story. And I sent this story to those of you who have been longtime listeners. Know Beth Ferreira. She's been on the show twice. She was the CEO of fab, and we talked about it in the previous interview. And I kind of teased her a little bit because I remember when she worked there, going to their office, and it was like, it's actually where Venmo is now, actually in New York City. Wow. The office of Venmo. Yeah. Which is. It was this beautiful office in the West Village. And I would see Bradley around the neighborhood. He's a very, you know, this guy, he wears, like, very interesting clothing. I think once I saw him wearing, like, a sailor suit. And she was always in Europe because she was dealing with that mess. And so I sent her. I was like, taking pictures of the pages of Tom's books and sending them to her. And she wrote back to me. She said she felt the business was working in the US but headed to Europe too soon, and that it chased growth to. To grow into a huge valuation. And it was a train wreck. So listen, I mean, she thought it was a great case study. So, you know, I think it's great for anybody who wants to be an entrepreneur who is thinking about working at a startup like, you can only. I have a friend who joined WeWork, like, the week before it blew up. All of the things that Tom's talking about here, when you look at some of these large companies, that it's like, oh, we just raised another $3 billion at this crazy valuation. If you get below the surface, a lot of these speed traps, you could see them now. Tom, you have over the years, obviously you've seen tons of companies.

Even really smart people who've seen a million companies fail and make bad investments. That's just entrepreneurship. But for our listeners who are maybe investing in companies or who maybe are thinking about joining a company, what are some basic things that they should consider to make a smart decision about investing their time and money in a company?

Yeah, the. I think the mistakes I've made as an investor mirror some mistakes that entrepreneurs can make in building a business.

And the bad bedfellows company Quincy Apparel is a good example. I had invested in Rent the Runway, knew the found were closely with the founders, loved them, loved the business. You know, I mean, it's had its own pandemic issues, but it's basically they built a company at a point with a $900 million valuation, and they didn't know anything about fashion, really. And so that gave me the confidence a year later to back another pair of Harvard Business School women who had a concept for building a fashion company, fashion tech. And it turns out that renting dresses and designing and selling dresses are two completely different businesses. In the latter, you really need domain expertise. Like, it's this incredibly arcane process of coming up with a pattern and cutting the pattern and sourcing the fabric and quality control, all of these specialized functions that the Quincy founders didn't understand. They just didn't have the experience. And they hired people who could do it. But those people weren't right working inside a startup where you sort of have to scramble from one thing to another. And it gave me a real appreciation for how wild it is that domain expertise is super crucial in some startups, but really not that important in others. I mean, I'm very close to the co founders of Cloudflare, one of Harvard Business School's biggest successes.

Amazing company.

Yeah, it went public last year, has a $30 billion valuation that does Internet plumbing infrastructure. Sort of speeds up the Internet, makes it safer. And Matthew knew something about Internet infrastructure, but.

They basically were able to build this great company without the deepest of domain expertise. But it killed the apparel company. So I'm much more tuned into that.

The other thing I've learned.

Entrepreneurs can get seduced by false positives. So just. Just as in the sense of. Of COVID Right? COVID testing, medical testing. Entrepreneurs are very vulnerable to false positives. You think you've got a good thing but you don't and false negatives which it actually can cause you to throw in the towel too quickly. It's like it's not working, but maybe if you tried some other things or persisted it would. And the false positive happens and happens to a lot of entrepreneurs because there's often a group of crazy foaming at the mouth enthusiasts out there that will like your early product, your shoestring and bubblegum product, and you need them. Of course they're going to spread the word about your thing. These are the people that got FAB going. But if you.

Focus too much on them, design the product or the service only for them, you may end up over engineering. Like often it's often the case the early adopters have more sophisticated their power users, more sophisticated requirements than the mainstream customers that you rely on to build a big business. So it can lead you to scale prematurely, as it did with fab. It can lead you to design the wrong product. And everybody gets excited because you just love the momentum you've got with the early adopters. So investors are, I think, just as likely to get excited about it as the entrepreneurs are. So I try to figure out if domain expertise is important and I try to figure out if we're, if we've got a false positive when there's early signs of success.

Those are very, very good pieces of advice, everybody. I just, I was taking notes. All right. The book is called why Startups Fail and I just learned out in the UK and Commonwealth countries it's called the Fail Safe Startup. Or I guess it'd be the Fail Safe Stop.

Tom Eisenman thanks so much for being here Patrick.

It was a blast. Thanks so much.

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