London Tech Week 2021 | Elevating Founders - The Fail Safe Startup

Foreign.

Hi everybody. It is great for you to join us for this fireside chat with Professor Tom Eisenman. For those of you that I haven't had the pleasure of meeting before, my name is Pippa Lam and I am a angel investor and partner at Suite Capital, the London based early stage investment fund set up by the founders of King.com, most well known for Candy Crush. We focus on a lot of consumer investing. I have the great pleasure of hosting today Professor Tom Eisenman, who not only is a peer in the technology industry, but I had the pleasure of being his student when I was at Harvard Business School. Tom is the Howard H. Stevenson professor of Business Administration at the Harvard Business School and the Faculty Co Chair of the Arthur Rock center for Entrepreneurship. Since joining the HBS faculty in 1997, he's led the Entrepreneurial Manager, an introductory course taught to all first year MBAs, which I took myself and launched 14 electives on all aspects of entrepreneurship, including one on startup failure. Eisenman has authored more than 100 HBS case studies. Again, I think I've done a few of those, Tom, and his writing has appeared in the Wall Street Journal, Harvard Business Review and Forbes. I also had the pleasure of doing his Startup Boot camp when I was when I was a first year student at Harvard. So Tom, welcome and thank you so much for being here today.

Hello Pippa, and thank you for the introduction and thank you for hosting.

You are very welcome. So topic we have today is obviously to talk about your new book, which it would be remiss of me not to point out, has two titles which I think is just a wonderful insight into the differences in the audience in the US and the uk. So for those of you in the US you may be purchasing a book called why Startups Fail, but if you're buying in the uk, you may be buying a book called the Fail Safe Startup. I love the fact that you have two different titles. I don't know how much I should read into that about risk, reward, appetite on each side of the Atlantic, but certainly it's a brilliant book and I encourage everyone to obviously go out and buy a copy, whichever one you end up getting.

So in our quick conversations today, we're going to kind of draw out a few of the themes of the book. But before we get into the chapters and of course we're not going to go all of it through all of it because I want to encourage people to really go in and explore the topic. But I'd love to kind of get into kind of a bit about you first, Tom.

Give us a little bit about your background. What did you do prior to writing this book and what inspired you to writing why Startups?

Yeah, thanks, Pippa. So I've been teaching at Harvard business school since 1997. Long time. I guess that's 24 years. And a lot of that early on was strategy courses on tech ventures, platform strategy in particular platforms and network effects. Starting around 2008, I started teaching how you manage startups and that quickly pulled me into the lean startup movement, which was taking off at just about the same time. And.

I started building that into our curriculum and working closely with students who aspire to launch ventures. One of the teams, this is in 2013, after graduation, launched a venture, thought the entrepreneurs were terrific, well suited for the role, had a great idea.

They had followed lean startup logic precepts, best practices to the table. It couldn't have been textbook perfect, minimum viable product and launched the business, raised a million dollars, tried to raise a million and a half, and that's part of the failure story. And I invested with a lot of confidence and sure enough, the demand was strong for the product, repeat purchases were strong. They couldn't manufacture the product as well as they thought. It wasn't a mess, but the rates of return, it was an e commerce business. Direct to consumer rates of return were on par for other e commerce businesses.

The promise, however, was better fitting apparel for young professional women. So if the apparel didn't fit perfectly, you weren't keeping your promise. The business was growing, but it wasn't showing enough traction to raise more money. They ran through their million dollars in a year, couldn't raise more, and the business shut down. So I could point to a lot of things that had gone wrong, but I couldn't pinpoint the real cause. And this was disconcerting. Was disconcerting because they'd followed lean startup practices, which I'd been teaching. So was I teaching the right thing? Essentially entrepreneurial failure, since depending on how you count, maybe two out of three venture capital backed startups fail or fail to earn a positive return. And so an important phenomenon in my field, I'm a supposed expert, but I'm a failure at explaining failure. So that set me out on a quest to sort of figure out what everybody had ever written or said about startup failure, the causes and whether they could be avoided. It interviewed literally hundreds of failed founders and the investors who'd backed them and did survey work and all that eight years later. So things move slowly in academia.

We have a book And I have to say, one of the things that I really love about this book is the fact that there are lots of blueprints out there for theoretical failure. As you said, you know, these guys had followed everything when it came to kind of the lean startup. You're an expert, you've been teaching this topic. Yet what this book does really well is it actually, it's a practical guide. I found more than anything of anecdotes and actually you being out in the field and testament to those eight years you spent researching it. So that, for me, is what I've taken away from the book. What would you say that readers should expect from reading the book themselves?

Yeah. So the book's divided into three parts. Part one looks at early stage startup failure patterns, three of them. And for each of them, as you know very well, we teach by case study at Harvard Business School. So each chapter starts with a case, and then we step back and say, you know, is there a pattern here? Can we generalize from this case? Do other startups fail for these? What are the reasons? And are other startups vulnerable? And then a lot of the chapters devoted to, okay, how can you actually anticipate whether you're, as an entrepreneur, you're vulnerable to this pattern and what can you do to avoid it, most importantly. So that's the cadence. 1, 2, 3, early stage, same thing. Then for late stage, it turns out, unfortunately, lots of late stage startups fail too. And then, so again, case study, can you generalize, what's the pattern and can you avoid it? And the last part of the book, if you've done your best to avoid failure but you're still struggling, how do you decide whether to pull the plug on a struggling startup? And if you do, how do you fail? Well, in ways that sort of preserve reputations and relationships. And then having failed in the aftermath, how do you learn from the experience, recover from the grief and strong emotion, and bounce back stronger?

And I do want to leave some time to talk about that human side of failure and entrepreneurship at the end of this. But I think that's one of the things that was really inspiring to me is that on the face of it, not judging a book by its cover, failure itself can sound like a depressing or dark topic. But actually it feels something that's so intrinsically linked with the path of entrepreneurship. And I love that you finish with a letter that we'll come to in a bit, which is actually sort of quite inspiring and positive in terms of learning from failure and how to do that. But I guess before we get into that, you know, how do you define failure? I mean there are different ways that you could look at failure. What angle do you take it at.

On the book question only an academic would love. So maybe you professor someday. Professors love to define things.

Should note that we're, I mean everybody fails in small ways every day. So we're not talking about these small failures that we all have. We're talking about the big sort of in some cases shut down or the, or the businesses struggling to the point where, and here's the definition I use in the book, early investors did not or never will make money. And you know, I should also point out there's such a thing as a good failure, right? There are businesses. Entrepreneur has a hypothesis about an opportunity, an idea and tests it.

Runs an experiment without wasting a lot of time and money and gets a negative signal and then shuts it down. And boy, we should celebrate that all day long. And you as an investor should back those entrepreneurs because some of the time the test is going to be positive. So we're not talking about those types of failures either. These are failures and you have to separate between misfortune, things out of control of the entrepreneur. I mean obviously hundreds of thousands of young businesses have been crushed by Covid and that's not the fault of the entrepreneur and there's nothing really anybody can do about that. I mean obviously you can tighten the ship.

And try to survive. So the focus here is on some mix of misfortune and mistakes that the entrepreneur actually made. And the definition is investors didn't make money or won't make money but should say the focus is not on the so why investors and say not the founder and the reality as you know, well by the time you get to series D, so maybe five years into the life of a company only 40% of venture capital backed startups are still run by a founder CEO. The rest have been replaced by a professional CEO. And so we can't just look at the founders priorities and preferences and goals and, and dreams. We should look at society's objectives. So there are some financially successful startups that we all wish would just disappear, right? They pollute, they have addictive.

We can all guess and there's some unsuccessful, financially unsuccessful startups that actually do good for society and they do that by training the next generation of entrepreneurs or just showing other entrepreneurs what not to do do. There's actually some value in that. So I like so many things in academia, the answer to what do I mean by failure is it's kind of complicated, but shorthand, the investor didn't do well.

I think I've been conditioned to try and think of failure as a positive from my engineer father who regarded it as the successful collection of new data points.

Exactly. In the spirit of Thomas Edison.

Exactly. I'd love to get into a bit of the meat of the book. I obviously don't want to call out all six chapters, the three of, you know, initial three which are early, the later three which are of the latter stages of investing. But I'd love to pick on a couple if that's okay. The first one I'd love you to talk a little bit about is this concept of bad bedfellows, which is the first chapter in the book. Tell us a little bit about what that means.

Yeah. So the case study here is the one I mentioned as a catalyst for the whole research project. It's Quincy Apparel. As I said, this is a company that.

Was trying to manufacture and sell better fitting, stylish and affordable apparel for young professional women. You can get two out of the three, better fitting, stylish or affordable. And getting all three, it turns out to be very difficult. And so they had a good idea and they proved it with their MVP test. And they proved it actually with a good strong consumer response. But they never. We use the term resources for the whole constellation of players that have to come together to make a startup work. So obviously the founders themselves, the rest of the team, the outside investors who were going to put in money but ought to put in more than that. And often a startup will have partners either for distribution or for operations. In this case, the bad bedfellows are.

All of those types of players didn't quite work for Quincy Apparel. So the founders lacked domain expertise, industry experience, they hadn't worked in fashion. And it turns out I learned from this research project, there are some startups where you don't need industry experience, can launch Instagram without ever having worked for a photo sharing company, but if you're going to design and manufacture dresses, turns out there's all these specialized steps that have to fit together well. And founders hadn't experienced this and they hired people who had, but they hired people out of big companies who'd never worked in an early stage startup before and wouldn't dive in and sort of just sort of scrum around any problem that was burning hot at the moment. So the team had the right skills but the wrong attitude. The founders lacked experience. They also, boy, you're subject to this. I mean, you know that many MBAs want to be the boss. So these were two strong women who were both fully qualified to be CEO and shared the role. And that worked a lot of the time, but it slowed them down on a lot of key decisions where they felt obliged to sort of work out, actually what are they going to do? And then the investors, they positioned the venture as direct to consumer, which was hot at the time, still is. And.

You know, when you go get tech VCs who want to invest in a tech business, they expect 10 times or 20 times return on their investment. They don't get it on all the investments, but on a small fraction. But everyone has to have that potential and they're going to push for growth. And this is not the kind of business where you can grow fast. It costs a huge amount of money to build inventory. And if the inventory is out of fashion, you have to sell it at a discount. You're in big trouble. So the wrong investors, wrong team, wrong founders, and then the factories that actually manufactured the clothing would push the orders for this little peanut of a company, a little thing with no industry reputation, to the back of the line when a bigger customer's orders came in. So bad bedfellows all around and lots of things, of course, the founders, we could go into, we could go into what you do to address all these issues, but we don't have time for that. So it's in the book.

I think it's fascinating that you, you know, as an investor and someone who's close to the company, clearly I would call out that you had experience in investing in a. Arguably an adjacent company. Or Rent the Runway, which again, was fashion. It was fashion and technology. Yet, you know, there are just. There were lots of different things there where you wonder whether it was the right fit for venture capital funding. You know, invest.

Exactly. Rent the Runway was my false positive. False positive failure.

Earlier, a year before Quincy, I'd invested Rent the Runway, two strong female founders from Harvard Business School, neither of whom had any fashion industry experience. And they built this and made the company actually filed for an IPO just two weeks ago. So they're doing great. It gave me the confidence to invest in a very. What I thought was a very similar opportunity. It turned out to be very different.

That very elegantly brings me to the next question which I was going to ask, which is this concept that you write about of false positives. And I think what's interesting is that for me, it sort of. It bridges two parts of the, of, of the book, actually. So you have in one of the chapters, which is this concept of speed traps, which is. Which I'll let you define, but it can actually sometimes follow on from what you've described as a false positive.

Yeah.

And just with speed traps, element, I would just say at the moment when, you know, the venture capital market is having its best ever run, you know, the market is the velocity at which capital is moving at the moment, the prevalence of capital in the market. You know, how do founders avoid falling into speed traps or false positives when they've just got so much money to apply to growth and venture capital investors encouraging them to do that.

Yeah. So as we speak, where I hope is maybe the last chapter of COVID we'll see that we're all familiar with false positives and false negatives from that. And entrepreneurs are subject to them. And they often come. They can come in many forms. It can come from the enthusiasm of an early investor. Right. That gives you. It's a signal that you're on the right track when you're not actually. But the trickiest false positives come in the form of early adopters who enthusiastically embrace your product. And this is very hard for entrepreneurs because, of course, you need the early adopters. You don't have a business without them. And so what could be more natural than to embrace them, to drive hard in their direction, tailor the product to their needs, and sometimes the next wave of customers just don't want your product as much as the early adopters or they have different needs. I mean, think of Dropbox, right? Early adopters are software engineers, really sophisticated. The later adopters, mainstream customers are Drew Houston's, the founder's mom, you know, and he wanted to design a product his mom could use to store a recipe. So the speed trap pattern starts with a false positive often. And the case in the book, many in the audience will remember Fab.com, e commerce company off like a rocket with real quirky products sold in an E commerce environment. Flash sale initially, but broadened beyond that. And these things spread like wildfire through social media for people who love the design aesthetic. And there are a lot of them out there. But the mainstream market isn't as obsessed with design as the early adopters were. So Fab started growing very strongly through word of mouth, wasn't to spend anything on marketing. And investors poured money in at high valuations, expecting continued growth. The entrepreneur Jason Goldberg didn't have to have his arm twisted. I mean, entrepreneurs love growth, too. But as they move beyond those first cohorts to the next wave of Customers less interested, less likely to repurchase, less likely to refer the business to other customers. So the value of a customer is coming down. And now we're spending on marketing. So cost of acquiring a customer is coming up. So you get the squeeze in the value of a customer. And at the same time, if it's kind of business where humans have to do things, some businesses are pure software, e commerce. People are answering phones, customer service queries, packing boxes. You got to hire all these people. There are no systems for managing, coordinating them. And entrepreneurs will often be slow to put systems in because it feels like bureaucracy and we rightly hate that.

And you get cultural mismatch between the old guard, the people that were present at the creation, and the new guard, the specialists and generalists. So you get cultural problems, you get economic problems, you get customer service problems. And for a period of time, there's still some growth and investors will fund that. But at a point the investors will realize the growth isn't profitable. And it doesn't look like we're ever going to turn the corner on this. The entrepreneur will find it hard to raise new money and even harder to get the existing investors to bridge. And after this period of growth, fueled by a false positive.

The thing can collapse very, very quickly, which was opportunities for fab and for a lot of other businesses. We've seen it a lot, and I think you're exactly right. I think the huge amounts of capital going in are going to fuel a lot of speed traps.

Sure. It's levered everything. I do want to make sure we have time to talk a little bit about this important end chapter of the book or end section of the book where we talk about more of the practical sides of failing. So.

There'S this concept of failing. Well, firstly, how do you know when it's time to close a business? And then when you do, how do you manage that practically?

Yeah. So so many of the entrepreneur failed founders that I spoke to wish they had shut down sooner. And there's just a ton of pressures on an entrepreneur to keep going. You've got to try out your pivots. You've got, you've got to try to raise more money, you've got to try to raise a bridge loan, you got to try to sell the company. All of these things you have to play out. But there's also people are counting on you and hope springs eternal. Right. There's always some, it's never usually some ups and downs. And you embrace the ups.

And there's danger here because you'll burn through cash and get to the point where.

Where you won't have what I call a graceful shutdown, where everybody who's owed money, not the investors, but customers with who've placed deposits, vendors who've sent you something, tax authorities, are actually repaid what they're owed. So you know, the shorthand for when to shut down is, are you out of moves? That's shut down. And the entrepreneur will usually know that. Are you miserable and are you excited by what you're doing? You know, there's usually a. A powerful mission or vision. And, you know, often after a bunch of pivots, you're very far away from the original vision. So are you doing what you set out to do? And so then when you actually have to shut down, there's all sorts of questions about transparency, sort of in the end game, who do you talk to? And a lot of pressure on the entrepreneur to just be quiet about it. Right. If you're too direct with your employees, they may leave and hasten the downward spiral. If you're trying to get a bridge loan from your investors and you're too direct with them about what's going on, so you bottle it up. And the people who could help you are actually not in a position to help you because you haven't been very transparent. And so graceful shutdown. People who are owed money get repaid what they're owed. And then in the aftermath, it takes months of sort of unwinding the thing.

Sure.

Then the question for the entrepreneur is, I mean, inevitably, there'll be strong emotion in the immediate aftermath. Grief, shame, anger, fury at a co founder who dropped the ball, at an investor who sort of steered the company in the wrong direction. And over time, those emotions will settle down, ideally through some combination of distraction. Right. Find something else to do, get a new hobby, get a side project. And rumination. I mean, if it's pure distraction, it's not good. And if it's pure rumination, you'll make yourself crazy. So at some point, the emotions settle down. You can actually reflect on your role. Too many founders, though, end up at the extreme of either not taking responsibility for what happened, blaming everybody else, or blaming the universe. And unfortunately, some actually blame themselves too much. I mean, it's always a combination of misfortunes and other people's mistakes and your mistakes. And if it's just you think it's all you, you may never be an entrepreneur again. And in fact, society is deprived of the great thing that you could build. So you try to find this middle space where you understand your role in the failure and most importantly, what you can do differently. And in my experience, I hope it's yours as an investor, a founder who failed gracefully and can explain what happened, why it happened, what they learned from it, and what they'll do differently, usually positioned pretty well to bounce back and do it again. Jason Goldberg, by the way, a fantastic example of exactly that. He laid it all out in a blog post where he took responsibility and explained what he learned and what he's going to do differently again. And he's back at it.

It's absolutely a data point that I look at as an investor at the past track record of an entrepreneur. And it's actually not whether successful or not is have they gone through a cycle before? Have they seen what it means to fail and how did they fail? For me, that human side of the book around failure and the aftermath is one of the most important bits. So I do want to just end on one last parting question to you, which is I mentioned earlier you pen a letter at the end of the book. Can you share a little bit of advice for us today on some words of the advice that you give in that letter to founders that are facing themselves with failure?

Yeah. Thank you. So the book does end with a letter to a first time founder. If you just Google those words. Letter to a first time founder, my last name, it was excerpted, republished by an outfit called Startup Nation, so you can find it online too. And the letter basically says you're going to, as an entrepreneur, a whole bunch of conventional wisdom on what makes a great entrepreneur. And it's right most of the time. These are advice like be persistent. True, you get knocked down and you have to get up and dust yourself off. But persistence can turn into stubbornness and stubbornness can keep you from pivoting. When you need to pivot, grow. Right? It's all that Paul Graham at Y Combinator is the definition. Grow, grow, grow. Yeah, but growth. And you do need to grow if you're going to build a successful tech startup. But growing too fast, as we see with a speed trap, can get you into an awful lot of trouble. So there are a bunch, the letter talks about a bunch of these items of conventional wisdom that you do have to not follow blindly. Be careful. Most important of which is, you know, an entrepreneur hears all the time, trust your gut, trust your intuition, and true again, moving fast. And being intuitive is a big advantage. Being nimble mammals scurrying at the feet of dinosaurs are going to survive. But there's some decisions that are so big and your gut will be racked by emotion and you won't be thinking clearly. So don't trust your gut. Sleep on it. Sleep two nights. Write down the pros and cons. Show them to somebody who knows you and your company well. And Daniel Kahneman, the Nobel Prize winner, talks about thinking fast and thinking slow. So an entrepreneur needs to do both. Think fast and think slow. Slow things down.

Tom it has been such a pleasure to get a little insight into the book. It is just an absolute wealth of anecdotes, examples, practical, tangible advice and I really encourage everyone who's joined us today to go out and grab a copy. I've absolutely loved reading the book and thank you so much for sharing a little bit with us today and I hopefully look forward to seeing you soon. At some point on either side of.

The Atlantic, it would be great to come to London. Thank you Pippa and thanks everybody for listening.

Thank you Tom.