Venture Capital on Luke Kanies

Do I Hate Investors?

luke@lukekanies.com (Luke Kanies) — Tue, 22 Aug 2023 00:00:00 +0000

Of course not. But the fact that people think I do says a lot.

Photo courtesy of Andre Hunter.

Seeking a round of funding is about the most miserable thing I’ve ever done. Truly. Fundraising was less pleasant and more demeaning than anything else I did at Puppet. But Clickety’s final (abandoned) round was uncomfortable in a new way.

Two different investors asked me the same question:

Why are you fundraising if you hate investors?

The question caught me flat-footed. Mostly because it’s such a stupid one.

I don’t love working with real estate agents. I feel like I’m being scammed. Even if I like my own agent, I usually don’t like the other one. I’m uncomfortable the whole time.

But in the US, it’s way harder to buy or sell a house if you don’t use an agent. And even if I went without, the other side of the party probably would hire one. So, I use a real estate agent. And I work with the agent on the other side at the same time. You want the house, you use the system.

And when I buy that house? I ask my banker for a loan. It’s not because I love bankers. It’s because I need help buying the house, and he’s in the business of helping people buy houses. Seems pretty straightforward. It has nothing to do with whether I like bankers, banks, or the mortgage financing system.

The legal system is similar. I actually do like a lot of lawyers. But… god, not all. And the way lawyers often work is stupid. I don’t actually think lawyers designed modern legal documents as a form of job security, but it sure looks like it sometimes.

But when I need to work with complex contracts, I hire a lawyer. It doesn’t matter whether I like lawyers or the US contract system; I have a job that demands legal help, so I go get it.

There’s a huge difference between all of them and venture capitalists, though: Bankers, real estate agents, and lawyers don’t demand that I act like I like and respect their industry. But VCs don’t just want me to start a great company. They want me to like and respect them for trying to make money off the work of me and my team.

Why was I fundraising from VCs?

To paraphrase Willie Sutton (maybe?), because they’re the ones with the money. If I want funding for my company, I need venture capitalists. What does it matter how I feel about the venture industry?

If you’re an entrepreneur today, there is no other source of capital. You can either bootstrap, or raise money from VCs. There are a few firms experimenting at the edges, like Calm, but they have a minuscule amount of money compared to the venture capital industry.

Yes, I could bootstrap. I’ve done it before. But it took four and a half years. I’m not as patient today as I was when I was 29. I also thought it made sense to start this company as a CEO and product manager first, rather than as a programmer. (In retrospect that was a mistake.) That made it impossible to bootstrap. I needed a team.

This question is just offensive, though. Its implication is “you should not raise money from investors unless you are willing to show respect and appreciation for the money they give you”.

Why? The world famously hates bankers and lawyers, yet continues to work with them. Why does this field get to demand our respect, when others don’t? Finance, especially, is just here for the money, and everyone – them included! – knows it. We just have to convince them we’ll help.

VCs are gatekeepers

Investors display their power by demanding your respect. They don’t invest in people who don’t show fealty to their image of themselves.

It’s how banking used to work: Some people got money, and some people didn’t. Fundamentals had nothing to do with it. You had to be in the right network, have the right skin color, the right class. Eventually bankers realized they made less money when they only loaned it to their friends. (And the US government forced them to back off their discrimination a bit.)

Most investors today will tell you to just “play the game”. This is what they mean: Participate in our discriminatory process, and show us proper respect. This is why you usually need a warm introduction to even be allowed to pitch them.

It’s a broken system that leaves broken people in its wake.

But I raised money within it, many times, because that’s where the money is.

Hate the Game, not the Player

No, I don’t hate investors.

But I do hate the world of venture capital. It is fundamentally flawed. It incentivizes behavior I can’t stand, and quashes behavior I find respectable and moral.

For what it’s worth, I also hate the larger finance industry. It’s not like venture is some rare target for my ire. There’s a reason I’ve never considered working in finance. (Well. There are several.)

Venture is an amazing engine for creation and invention. But it mostly invents stuff I wish didn’t exist. And it does not seem to be able to solve the problems that matter most to me or the larger world.

People appear to hear my dislike for their industry and think I hate them, personally. I can’t do much about that. I respect and like some investors. I dislike some others. But I generally have no particular feelings about a given individual.

That being said…

I don’t tend to respect investors.

Being a venture capitalist doesn’t automatically disqualify you from garnering respect. But it also does not automatically deserve it.

In the 1980s, finance was at its peak. People made ungodly amounts of money ruining the lives of thousands and thousands of people. And they were held up as heroes of business. We’ve largely learned that stripping financial assets is maybe not something we should be proud of. These people still get rich, but we have learned not to lionize them.

Is the modern venture investor as heartless and shameless as a PE investor from 40 years ago? Generally, no. (Although there are definitely exceptions.) But like those 80s wolves of Wall Street, VCs have found a money-making edge, and they’re ruthlessly exploiting it.

I’m just not that impressed.

I can see why someone would read that disregard and disrespect as hate. Especially given the power dynamic: I’m asking them for money, yet I’m not showing “proper respect”.

My banker didn’t demand I “play the game” when I applied for a mortgage. He just needed evidence that I could afford the house I was buying, and that it was worth what I was paying.

Being autistic means I’ll never be able to “play the game”. It’s literally constructed so only the in-crowd can join. I can mask for a while. But it takes hundreds of meetings to raise a round. Most people in the meetings look the same, dress the same, went to the same schools, and ask the same questions, yet think they’re special geniuses. And most of them give the same answer (“no”). It becomes hard to hold a facade.

It’s not a choice, or a lack of skill. It’s a hardwired neurological limitation. You might as well ask me to be taller, or have a lower voice.

For better or worse, I’m not sure it matters now. My personal limitations are likely to prevent me from trying to raise money again. But I hit those walls in large part because of how harrowing fundraising is.

Will I do it again?

My experience at Clickety tells me I’m unlikely to run another venture backed startup.

It looks like I’m already a bit of a pariah, which might explain part of why it was so hard to raise. (Not that I don’t deserve some of that reputation.) It’s not about to become easier for me. The older I get, the less I can handle gatekeepers. And I was already crap at tolerating them when I was younger.

My health — both physical and mental — would need to significantly improve. Running a company is stressful enough. Raising money was too much.

I won’t rule it out. I know my future is going to look different from my past. I have a lot of healing to do.

But I still believe in the power of software to make people’s lives better. And venture capital is a fantastic source of acceleration. I hope to continue to work with founders, and intrinsically that means working with investors, too, sometimes.

I also love solving problems. I hope to help others do it. But I won’t rule out trying to solve some problems on my own.

And maybe one of those solutions will be so good they can’t ignore me.

Designing Tomorrow’s Privacy

luke@lukekanies.com (Luke Kanies) — Thu, 22 Oct 2020 00:00:00 +0000

Privacy expectations are changing. How will companies change with them?

Photo courtesy of Tobias Tullius Change is coming to how tech companies handle privacy. Everyone is going to have to adjust, but new startups are caught in the middle: Be as useful as the companies built in the old world, while following the new rules.

Today’s dominant tech companies don’t care much about privacy. Many of their businesses couldn’t exist if people were careful with their data. Facebook only survives if people are willing to share widely and publicly. Google’s ad engines feed on reams of public data.

Privacy will matter far more to new companies. Google has taught companies the cost of sharing their data publicly. Consumers are slowly waking up to how pernicious Facebook’s data practices are. And the laws themselves are changing.

Regulation is already happening at the state level, and internationally. You might not want federal legislation, but state by state rules would strangle growth of new startups.

I know some say government can only create problems, not fix them. I am not so cynical. The creation of the EPA is a great example of government taking industry in hand and making the world better. I am eager for Congress to take privacy as seriously.

The Business of Privacy

But I’m not a legislator. I’m a builder. I’m more interested in understanding how people’s behavior will change, and what that means for the products I’m creating.

For some, the future of privacy is already here. DuckDuckGo is thriving (despite its silly name) on promises of providing great search without all the tracking. The Brave browser is growing for similar reasons.

But how big is this change? Will the average person in the next decade expect to retain privacy, demand companies respect their data? (I originally wrote “computer user” here instead of “person.” With the smartphone, there is no difference.)

Or will privacy concerns continue to be like security concerns have been for the past decade: the domain of the few, the nerds?

This starts as a moral question. Privacy is a fundamental right. We deserve applications whose business model requires it, rather than neglects it.

But it’s also a business question. What kinds of companies thrive in the current privacy framework? Will they thrive in ten years? What about a world with little privacy? Which companies might do better if people cared more about it?

It’s worth elaborating on what I mean by privacy. Google and Facebook have very different definitions, for example. Facebook’s business is built on promising as little privacy as possible, and delivering even less. They share your data with pretty much everyone. Google just uses your data internally. They don’t share your browsing history; they just use it to market ads.

There are far more companies out there like Google than Facebook. Everyone shouting “data is the new oil” is advocating for Google’s business model: Collect a ton of data and profit off of it. It might start as your customers’ data, but if you collect enough it, and tie it all together, it becomes your data.

By policy, these companies (usually) care more about privacy than Facebook does. They rarely sell or share your data. This is better. But privacy isn’t restricting data to only a few trillion-dollar companies. It’s sharing my data with people, not companies.

It’s instructive to look at one company offering less privacy today than in the past: Microsoft. In the old days, all of my documents sat on my computers. My email ran through servers run by corporate. Microsoft could never have gotten to any of them.

Now it’s all “on the cloud.” What does that mean? Microsoft has it. They might not be sharing it with others, but they’re certainly looking at it. Oh, maybe individuals aren’t. But their programs are.

This can be good. Usage data can help vendors improve their software.

But mostly, it’s bad. These promises of better software tend to be hollow. I don’t want better ads. I don’t want your algorithm picking what I see. And I certainly don’t want machine-learning recommendations based on a statistically average user.

People are beginning to see the downsides of handing all of their data to companies. They know that Facebook, Google, Microsoft, Apple, and Amazon have too much power. They are changing their privacy expectations. Not just the nerds, but average people.

But how much? How fast?

The Cloud Conundrum

Privacy in the modern era is a special quandary. The cloud is pretty great. No synchronization. No management. Easy sharing.

No one wants to give that up. Yet today, cloud usually brings severe privacy compromises.

Do I try to build without the cloud, enabling more privacy, and try to compete with what might be less functionality? Or do I build on the tools everyone else uses, where a lack of privacy means there’s little limit to what I do?

Is there a world where you get all of the benefits of centralization, of the cloud, of being online, but don’t have to sacrifice your privacy? Can you be in the cloud, but keep your own data instead of letting a company put it all into one bucket?

I think so. For many cases, I don’t even think it will be that hard. It will just require thinking differently. It will require new answers, maybe slightly harder ones. But not whole new forms of math or science. Something attainable and reasonable today.

As a founder and investor, there still might be big downsides. It might mean you can’t be the next Google. The next Facebook. Or even the next Salesforce.

It might be that a company is worth less if it does not exploit your data.

What if ethical, privacy-conscious companies stay small, and unethical privacy-destroying companies get to keep growing? There is precedent. Prior to the creation of the EPA, an industrial plant would be committing fiscal suicide to spend money reducing pollution.

I worry about this. I’d sure love to see better behaved companies get rewarded with growth. But that’s certainly not the world right now.

Of course, this is partially why we need new regulation. The rules need to change. There was a time when big business just dumped all of its waste in the local rivers. It was cheap. Why should they care if it killed people and ecosystems? Gotta protect shareholder value! But then the rules changed. Nixon (!) created the EPA, and now we take it for granted that industrial players are forced to protect the air and water at least a bit.

The rules will matter less if enough people change. If you stop buying from companies who abuse your data, they’ll stop doing it. If the next Facebook can’t be built off of your data, then someone will need to find a new way - and hopefully a better one! - to meet your needs.

But maybe those businesses won’t be quite as big. Or get there quite as fast.

Are you ok with that? Is that a reasonable trade off?

It is for me. Facebook didn’t make me a billionaire. I’m not at risk of some other data-centric company making me rich. I’m not investing in companies that collect and exploit your data.

But a lot of people are. A lot of our industry is built on the idea that access to this data is good. Many companies could work without it, but choose not to.

Take the smart home, for example. My smart thermostat is in my house with me, right next to my phone. On the same network. But how does my phone configure it? Not by talking directly! No. My phone contacts cloud services, which then contact my thermostat. Why? Partially because it’s easier. But mostly it’s about data.

There’s no chance Google would have bought Nest for $3.2B if that data weren’t available.

Maybe Nest would be a better company if it were more concerned with making better devices instead of extracting our data. But I don’t think Google would be as excited about that other company. Investors like the multiples that all that data gives them. And product people like what the data allows.

Like industrial effluent, this data is toxic. Dangerous. I’m afraid of what’s being done with what leaks out. I’m afraid of all of the bias. I’m afraid of businesses built on my lack of privacy, my lack of boundaries.

My Bet on Privacy

My new company assumes people will care more about privacy than they have. I expect I’m giving up some long-term potential by doing so. There are things we can’t do as a result. Things that our competitors might find easy to do.

But we’ll be able to make promises no one else can. And we’ll find new ways - hopefully better ones - to solve our customers’ most important problems.

Even writing this frightens me a bit.

I’d love to believe that promising privacy would make my company more valuable, make it easier to raise money. I know it will make it easier to hire people.

Some users will choose us specifically because of our privacy model. But how many? And will it be enough?

I know the bet I’m making.

But I also know it’s a risky one.

Don’t Make Board Decks

luke@lukekanies.com (Luke Kanies) — Wed, 22 Jul 2020 00:00:00 +0000

Why and how my team built board reports instead of PowerPoint decks. Fifty pages, less work than slides, and more valuable. Image courtesy of Drew Beamer.

Board meetings are a critical time of communication and reflection for a company. You have to share enough information that the people in the room can make existential decisions about the business. Yet most CEOs I know share only slides (the “board deck”) with their board.

This is a huge mistake.

People who worked for me at Puppet claimed I hate PowerPoint or Keynote. Nope. I use them myself when presenting on stage in front of a large crowd. But they are a horrible choice for communicating without a talk track, and are incapable of conveying large amounts of information, or anything of detail.

Don’t trust me? Ok, how about Edward Tufte , The Godfather of information design, who partially blamed them for the Columbia space shuttle explosion:

These [NASA] review boards examined what is probably the best evidence available on PP for technical work: hundreds of PP decks from a high-IQ government agency thoroughly practiced in PP. Both review boards concluded that (1) PowerPoint is an inappropriate tool for engineering reports, presentations, documentation and (2) the technical report is superior to PP. Matched up against alternative tools, PowerPoint loses.

What’s that you say? Running your business is easier than shooting rockets into space, so you are fine dumbing down your communication? You’re not in great company.

Amazon forbade PowerPoint in staff meetings, switching to a six page written memo:

Bezos revealed that “narrative structure” is more effective than PowerPoint. According to Bezos, new executives are in for a culture shock in their first Amazon meetings. Instead of reading bullet points on a PowerPoint slide, everyone sits silently for about 30 minutes to read a “six-page memo that’s narratively structured with real sentences, topic sentences, verbs, and nouns.”

Scott McNealy banned it at Sun Microsystems years earlier.

It’s not just that slides are bad.

There’s a much better option right in front of you.

For most of my time running Puppet, we prepared a board memo: A text document written in normal English, with supporting images and charts. It averaged between 35 and 55 pages in length.

It worked great.

It took less time to prepare, and conveyed the state of our company more effectively. I recently shared my last board report, from 2016, with a friend, and he protested, “This is an SEC filing, not a board report!”

I’m not sure if our process is a fit for you, but hopefully it will at least inspire you to find a better solution than slides.

I used to be like you. Well. I never walked through slides in the meeting. I always drove a short (3ish items) agenda. My goal was discussion, not presentation. But I did start out using a deck.

I still cringe a little at the thought. But one of my startup principles is “Innovate only when necessary.” Your business requires a certain amount of breaking new ground. But don’t add risk by doing something unnecessarily new. If I avoided everything I thought was dumb I’d never get anything done.

Everyone else did board decks. My team was used to them. 🤷‍♂️ Sure, we’ll give them a try.

I hated it.

We spent too much time, on the wrong work, and did a poor job in the end.

Wow. The team spent so much time on fonts. And arranging images. What, exactly, is this adding to the board meeting? I understand: An ugly deck makes us look bad. But it seemed like we were spending a third of our time prettifying something instead of actually communicating.

There’s a good reason it was so hard to make them attractive: We had a ton of information to convey. We had to include detailed information about sales, marketing, engineering, and operations. The reader needed to quickly gain a sense of what was working, what was not, and what the vectors were around the company. No amount of picking fonts and rearranging images could deliver that understanding with PowerPoint.

So one quarter we ran an experiment. It was early on, only a year or two after our first round.

I gave each member of my team a choice: You can produce slides, or prose (i.e., plain text, using full sentences and paragraphs). Unsurprisingly, sales and marketing picked slides, and engineering and services picked prose.

What a stark difference.

The prose was done faster, communicated more, and just felt so much better.

Experiment over, prose won, we switched.

But how?

I don’t remember exactly how the process evolved. I do remember where we ended up, six years into using producing what we called board reports.

We did all the writing in Google Docs. We could all work at once and not step on each other’s toes.

I would build a skeleton of the report: Write out each section heading (“Summary”, “OKRs”, “Product”, “Marketing”, “Sales”). Then I’d use a comment to assign each section to the relevant executive. They’d either produce the text themselves, or do so in partnership with their team. Sales, marketing, and finance would include a lot of charts and graphs; product tended to stick to prose with a couple of diagrams or screen shots.

As people filled out the document, I played a few roles.

I spent most of my time assessing when someone was done. I’d read through people’s work and mark something that was insufficient, unclear, or missing with a comment in Google Docs. These are easy to spot even when scrolling through a fifty page document. As people worked, they marked their progress as done or ready to review. A completed section was easy to recognize: All comments and suggestions were resolved.

In this way, I could scan a large document and instantly see where work remained to be done.

My second job was overcoming a shortcoming in Google Docs. Or maybe a lack of training of office workers. Docs has built-in headings, and if you use them, your document is visually consistent, and auto-generates a table of contents. However, most people who worked for me never used the headings. They’d make a headline bold and increase the font size. So I had to go through the entire document and correct the markup. This was probably a quarter of my time.

By the end, I delegated this to a senior copy-editor who we trusted to see the entire document in process.

My last major role, and the only one that resembled the work of a CEO instead of an editor, was to ensure we were telling a single, coherent story. I’d write the summary to set the key messages. Then as I assessed everyone’s work, I pointed out inconsistencies or gaps. Most of this simple editing: Ensure all of the text used the same voice (first person plural, usually). It involved plenty of strategic work, though: tying company goals to team performance, ensuring the whole story was told, and asking everyone to cover the ‘why’, not just what happened.

You can guess this process triggered a few tense side conversations as I dragged information to light.

That, in the end, is the real point of the board report: Make sure we all understand the true state of the business. The writing was more important than the reading. It was on me to ensure we did the real work, rather than just packing it with information without saying anything.

I usually spent about four hours on it. Again, on a fifty five page report. My team each spent 1-3 hours. I did have the odd executive here or there or spend more like four or five hours on their part. We also never invested enough in automated reporting, so I’m confident some parts of the org had to work harder than I’d like to admit to generate their charts.

We targeted completion at least a couple of days before the board meeting. I’d share it with the board as a PDF. A couple of times I tried sharing it as a Google Doc (copied, so they can’t see the edit history), in hopes they would ask questions that could drive the agenda. It never got much engagement so I stopped.

Without a board deck, what did we actually talk about? I mean, without slides driving every minute, don’t you lose track?

No way. I ran a tight ship. But we measured time in half hours and big topics, not individual clicks.

My board meetings were usually three hours long. I’d spend an hour with just the board discussing high level status of the business and team. Then we’d take an hour and a half to cover our agenda, usually with portions of my team in the room. Then we’d spend half an hour at the end again just with the board, discussing what we learned and what we expected to do about it. This is when we also assessed individual executive performance. By the end of my tenure we also had a few minutes set aside for just the board, with me absent.

This process created space for deep conversation in the meetings. Everyone who read the report (which was, well, nearly everyone) was caught up on the business. They were fully prepared to discuss the three topics. And we had no structured flipping of slides to get in the way of discussion.

After the meeting, I edited the report as needed then sent it to the whole company.

Usually this involved removing just a line or two. Sometimes it was larger surgery, and others no changes at all. Mostly I cut out discussion of personnel changes, or removed sentences that required more sensitive, political phrasing than I practiced in these reports.

The end of this cycle ensured everyone involved in the company was up to date on, well, everything. Goals, status, progress, weaknesses, strengths.

I don’t know if everyone should use this process. I know many people were raised by American business to think slides are the best form of communicating. That’s a hard habit to break. I won’t even judge you if you use slides during the meeting to display the agenda and schedule, and maybe key images.

Slides are perfect if you want to tightly control the message, and not leave much room for hard questions.

But if your goal is to do real work in board meetings, skip the deck and write a report.

Entrepreneur, Stage 1: Bootstrapping, Burnout, and Babies

luke@lukekanies.com (Luke Kanies) — Tue, 07 Jul 2020 00:00:00 +0000

How I got here, how it went, and what happened along the way. I didn’t want to start a company. But I had no choice.

I was a SysAdmin after college, because I tried everything else and got fired from them all. I had seven jobs in two and a half years. I’m very fireable. System administration was just the chair where I happened to be sitting when the music stopped. More a safe, fun place than a source of deep passion.

By that point in my career, I was a little easier to keep around. More importantly, I had become worth the hassle. I did good work because I liked the puzzles.

I had a particular way of working. My boss would say, “You should do this thing, and you should do it this way.” He did not look at how I worked, only the result. That gave me the freedom that made the job worth it. When I told him I had finished he would say, “Great, how did you do it?” and I’d say, “Look, is that a bird?”

I automated everything I could, whether it needed it or not. Automation has a built-in reward mechanism. I would take this well-paying but stultifying job - Type this command 1,000 times - and I would reframe it: How about I tell the computer to type the command 1,000 times? It will work. I’ll watch. Bam! Now I can move on to other fun stuff.

Over time I did so much automation I kind of ran out of work. I was in Nashville at the time, while my wife was getting her PhD, so there were no interesting jobs that needed my skills. Hmm.

I could go to business school, but - sorry! - I don’t have any respect for the MBA. Everything I hear about business school is how valuable the network is. If I want that, I’ll take a cruise. I thought about going to law school, but it is so expensive you have to become a lawyer afterward. I didn’t want to be a lawyer. I just wanted to change my career.

So I was like, I’ll find someone who’s doing what I want to do-building a product to help people like me-and I’ll go and help them.

Oh my god, that was miserable. I lasted five months.

Commuting back and forth between Boston and Nashville did not help. I also had the brilliant idea of commuting seven miles each way by bike. In the winter. In Boston. I gave myself permission not to ride if it was under twenty-seven degrees. Being on the road in Boston is dangerous in a tank. On a bike, in the snow, was a cruel joke.

But mostly I just hated our software. I hated what we were building. At one team meeting, a senior developer said, “What does it matter what our customers think? They’ve already bought the product.” Reaction to that statement - nothing at all - told me I was in the wrong place.

So I left.

I got home. I said, I have a little money saved up, and I’ve tried everything else, and now that I think about it, I guess my dad was kind of an entrepreneur. I mean, he did run his own business for thirty years. Technically. I suppose.

Maybe I should start a company?

I know everyone in the world who is building automation tools for sysadmins, and none of them are going to build a business. “I built this, so, obviously, it’s the best.” But they’re only interested in publishing papers and getting academic tenure. Their software was already perfect, so they saw no reason to listen to anyone’s reasons for not using it.

I thought, what if I build something? And then listen to the people who are using it? (And maybe those who aren’t?) Hmm. Could work.

I quit my job. Well, I quit my job first and said, “Eh, I should probably find a way to eat.” So after trying everything else, I started a company.

We lived on my wife’s generous graduate student stipend of $23,000 a year - the job I quit paid $110,000 a year - and, like I said, I thought I had some money saved up. At some point the IRS sent me a letter that said, “We disagree,” and it turns out when the IRS disagrees with you, well, you know how that goes. And even if you’re right, by the time you prove you’re right, “Ok, I had ten grand, and I spent ten grand on a lawyer proving I have ten grand, and…” Just send them the check.

So I was broke when I started my company.

As a sysadmin, you’re not a developer. People will tell you: In DevOps, everyone’s a developer. Those people are lying to you. Or selling something. Which, you know. So I had to become a developer. I had written some code before Puppet, maybe 5,000 lines total. But by the time I handed it over, it was 130,000 lines of code.

The people I handed it to regretted my learning experience.

I adored it.

I learned a lot. It was, to be frank, super fun. One of the densest learning periods of my life. Programming is the best puzzle. I find it harder to step away from it than anything else I’ve ever done. It’s been two days since I ate, I think my wife has been trying to get my attention for the past twelve hours, I should probably … and then I try to move, my legs don’t work. I’m lightheaded from hunger and my feet are tingly.

Good times.

After about ten months I got my first paying customer.

I often advise other entrepreneurs. Much of what I tell them is to avoid what I did. I only had a vague idea for how to make money. I figured, “I’m confident I can make something valuable. I kind of have a plan, but I know my plan is stupid. If I bring my plan to people and listen to them, that could help make my plan less stupid.”

This is not that bad of a strategy! But it’s not exactly specific.

I didn’t really ask myself: What is my overall business going to look like? How will I get there? I started with services, because I’d been consulting for a while, and I was confident I could make enough money to eat. I know investors are down on services businesses, or anything that doesn’t look like a founder throwing themselves off a cliff with what they hope is a parachute. But you gotta eat. And services are a fantastic way to make money while you’re figuring things out.

I had a lot to figure out.

At the time - 2005 - there were a lot of open source companies out there. When I say a lot, there were four. I thought, “They’re doing well, I will copy one of them at some point later on.” That was not that great of a plan. Two years later Red Hat was the only one left. They’re a software powerhouse today, but they went public during the bubble as a T-shirt and mug company. There’s no copying that.

I did start making money, though. We consulted for three-and-a-half years. “We.” I was the only employee. About three years into the company, I discovered one day that I was incredibly burned out. This was the first of three major burnouts for me at Puppet.

Burnout Strikes

I distinctly remember realizing I was burned out. I was standing next to my wife, at the doctor’s office, looking at an ultrasound. We just learned we’re going to have twins, and I get a sudden flash of insight: My life is unsustainable.

I personally can’t recommend, when you’re in a bootstrapped startup, planning to have a baby. I would work especially hard to avoid having more than one at a time. But that’s what we did.

(Speaking of which: All you people who had your babies serially, you’re lazy and you don’t know what you’re doing. You think you had it hard. We were tested. Y’all are amateurs.)

The technician said, “Oh, you are going to get scanned a lot.” Um. You’re going to have to explain that one. She told us we were having two. We laughed. She must be incompetent. Just because you have twins (she did) doesn’t mean you can recognize them in someone else. While using an ultrasound wand. Which is your job. Scan… scan… BING! The two fetuses clearly popped into view. My wife would have fallen over if she weren’t already lying down. My knees shook. I thought, I can’t do this anymore.

I had been working every hour I could. I counted once: It was about 72 hours in my busiest week. There are people who say, I work 100 hours a week. You might stand there 100 hours a week. I’m skeptical you’re working. Based on what I know about productivity, I hope you’re not.

I couldn’t do it anymore. Since February 2008 or so, coincidentally the same day I found out we were having twins, I haven’t worked more than 40 or 50 hours a week. No evenings and weekends. I might dabble sometimes, but I won’t let it become a pattern.

Don’t worry. I managed to burn myself out two more times without those extra hours. It can still be just as bad. Pack that intensity into fewer hours, and you’re all good.

So. I need help. How?

Getting Help

I had tried to hire people in the past. Both of them were misses.

The first hire was the most notable. In the three months it took to figure out he wouldn’t work out, the best person I could possibly have hired became available and then unavailable. This guy’s biggest impact was ensuring I couldn’t hire the person who would have been most helpful.

There’s one more crazy story about him. In the middle of his interview at my house there was a drive-by shooting next door. He had taken a bathroom break when the shooting happened. They weren’t trying to hurt anybody, just shooting up a car to send a message. One of the bullets ricocheted off the car, then my porch, and broke my front window. He came out of my bathroom, and I said, “Are you ok?” “Yeah, why?” “No reason.”

I needed him to work in my house.

(Yes, I did actually tell him. Eventually.)

When he didn’t pan out, I concluded, I guess I just can’t hire. I’ll do it all myself.

Pro tip: Don’t do that.

Puppet worked in spite of these decisions, not because of them.

Things had changed, quite suddenly. I needed help, and now.

I hired the only people I could think of who might do me a favor: my college roommate and my best friend. Two separate people. Again: Don’t do this. I paid them full salaries.

Years later, I realized, “Wait a minute, if I was paying them full salary, they weren’t really doing me a favor, were they?”

Burned-out people make low-quality decisions. Your brain is gone, and you’re stupid. You work too many hours, you get burned out. You hurt your business doing this kind of thing. Get sleep, eat well, get exercise, step away from work. It’s good for you.

We were making a few hundred grand a year. And by “we” I mean “me.” I’m the only person consulting. I’m getting a little help with the code and stuff.

But now I’m going to hand all the consulting off to my best friend. “Ahh. I can see the light.” And by light, I mean impending twins.

The transition is bright in my memory. He was shadowing me. Μy last gig, his first one. “Hey, funny story, tomorrow this is your job.” We were in San Francisco, my only development gig fueled by Red Bull. I had made a promise to Stanford University, in exchange for some money. If I did not keep that promise by - I think it was - August 31, the Sunday after my gig ended, I had to give the money back. Of course I didn’t have the money anymore. I had to give them the code instead.

I’m at my client’s office during the day, and back in my hotel room at night pounding energy drinks and my keyboard. My kids are due any day, it’s my last flight, my last trip before they are born.

I finish it. I ship it at 1:00 a.m., send Stanford a note with all the details, and go to sleep.

My wife calls me two hours later and says, I don’t think it’s a drill, my water broke.

Well. I’m in San Francisco, and she’s in Nashville. You cannot get from San Francisco to Nashville fast enough to catch a baby. Everyone told me, “Now don’t worry, it’ll take 24 hours.” The kids had other plans.

Seven hours.

I was a father before I landed in Dallas. Cell phone pictures in 2008 were terrible, but they were enough to make me cry in the aisle.

Once again, things not to do, but it mostly worked out. My kids didn’t even notice.

My mother-in-law is actually thankful. She got to be in the delivery room instead. She would have been staring through the window if I had been there. It was great for her, and a great bonding experience for them. It was just, you know, complicated for me. If I’m going to flail at fatherhood, I could at least be present for it. Absent bad father is just a step too far.

That was summer of 2008. We were a little over three-and-a-half years in at Puppet. Lots of change all at once. We added two people and two babies. The business was picking up. I was spending more of my time at events and out in the community than writing code. Mostly this meant that the code wasn’t getting written, rather than that I had delegated it.

Again, my wife was getting her PhD. Nashville is kinda my hometown, and so as a result I, you know, hate it. I always told her I wouldn’t be at her graduation, I would be in the U-Haul honking the horn.

But she was pregnant with twins when she graduated. I was running a bootstrapped startup. We couldn’t afford to go anywhere.

What it all means

The birth of our kids was more than a turning point for our family. It transformed Puppet. It forced me to acknowledge I could not do it alone. I brought in help before they were born, and by the time they turned one I’d raised a funding round and moved to Portland.

In the four-and-a-half years of bootstrapping, we went from zero to around $250k a year in revenue, and from one to three people. In the seven years after funding, we grew to five hundred people and more than seventy million dollars in revenue. More importantly, we had an impact on thousands of people and thousands of companies.

I think founder stories are important. They’re usually educational, and often inspiring.

But they’re myth. They are a specific version of what really happened, refined and presented. Often, the myth so obscures what really happened that the lessons are dangerous rather than helpful.

This is a key story in my founder myth. For better or worse, I’m not afraid of you making catastrophic mistakes by trying to emulate me.

They say you can either be a good example or a horrible warning.

I think this story proves you can be both.

The First Two-Million-Dollar Check

luke@lukekanies.com (Luke Kanies) — Tue, 30 Jun 2020 00:00:00 +0000

A single drink perfectly captures the weirdness of raising money for the first time. Photo courtesy of Dylan de Jonge

I found myself at a hotel with some friends. I was visiting Portland for a conference. Puppet’s first investment round – and mine! – was closing. The money was being deposited.

Have you seen a David Mamet movie, like The Spanish Prisoner? They’re fantastic. But eerie. Disquieting. They build up a story, brick by brick. Then they yank a few bricks away, exposing the whole story as a lie. Only a hollow truth remains, unrelated to your built up belief. It makes you question everything.

I’m waiting for the closing in this hotel, and I order a Macallan 18 to celebrate. This was back when it was only expensive, not egregious. I lift the glass, and I think:

The money is being deposited into my bank.

I think it’s a real bank.

I mean, they had, like, a website. And websites are pretty hard to… wait a minute.

Who introduced me to the bank?

The investors introduced me. They specifically wanted me to work with this bank. They’re the ones giving me the money. They wouldn’t say they’re giving me the money then give it to someone else. That’s a silly kind of fraud. I just have to trust them.

I sit there. Sipping my whiskey.

I think it’s a real bank.

I think I’m getting $2.25 million.

I had never seen a bank account with that many zeroes - and I still may not at that point! I have no idea what to do.

So I sit there. Savoring that delicious, delicious whiskey.

I didn’t mean to raise money. I was just focused on running the company. We had bootstrapped for almost four and a half years. I figured we were going it alone.

I had talked to people in the past about raising money. It was like Groucho Marx’s joke about clubs: I wouldn’t take money from the investors willing to give it to me. “Wow, I would love them as an investor,” you get nothing. Or, “I would happily give you money and ruin your life.” Hmm. Not really the deal I’m looking for.

One day at an event, an investor tracked me down. He said, I’d like to invest in your company. I said, That doesn’t sound right. A lot of investors say, We should talk. He said: We should talk on Monday. That specificity made all the difference.

He made a very confusing offer: We would like to write a $1.75 million check into a $2 million round. I said, how can you be that bad at math and work in finance. He said, Go find other, rich people that you know to give you the rest of the money. I said, you are, literally, the only rich person I know. He said, I just joined this firm. I am not rich. Then we’re stuck, I said.

I lived in Nashville at the time. There are a bunch of rich people there. But they’re all musicians. They don’t do technology. We most emphatically did not hang out. We weren’t going to fill this round through my network.

Eventually, by connecting me to their network of rich people, I was able to raise $2.25 million. Mostly through luck not skill. I didn’t build a deck. I didn’t run a formal process. I didn’t pitch multiple investors to get competitive term sheets. I pretty much did the exact opposite of the play book. The investor who filled out the round turned me down at first, but I heard his wife persuaded him. I don’t know if she liked me or was cursing him.

Once all of the investors are in place, you wait.

The things you learn in your first round.

Closing takes about thirty days. Five rounds later, I have no idea why. It takes thirty days, and it costs $30,000. One of the terms in the term sheet you get from your investors states that you pay for closing. “We’re going to give you this money, and then you’re going to give some of it to the lawyers.” Investors cap the fees, and the lawyers coincidentally hit that exact number every time.

I honestly don’t know what the lawyers do at closing. The documents are massively long, but they’re pretty much the same. At a late-stage company, I can understand: There is diligence to do (although not by the lawyers), financial data to look through (done by analysts, not lawyers), customers to talk to (by the investors, not the lawyers). At an early stage, though, there just isn’t much information. I don’t know what they do.

But it takes thirty days. And costs thirty grand. Says so on the term sheet.

So you wait.

But when that waiting stopped, boy howdy did things move.

The money did get deposited. It was a real bank after all.

Within a month I’d moved from Nashville to Portland. Within two months, I had my next three employees. And within six months I had a team of ten.

Raising money set us off like a rocket. Bootstrapping for more than four years provided a fantastic foundation for quick growth.

Looking back, I’m glad we raised money. I only wish we had done it earlier.

How TechCrunch is like the Iliad

luke@lukekanies.com (Luke Kanies) — Thu, 21 May 2020 00:00:00 +0000

The drive for social status created the worst, most important part of the Iliad. Now it’s filling up investment announcements. Picture by Mikuláš Prokop

My fancy liberal arts school hazed me, like it does all students: I had to read The Iliad and The Odyssey.

We did more than read. We wrote. We talked. We dissected, for meaning and history. Me, and a dozen other kids I’d just met. It was school, after all.

The Odyssey is great. A proper story. Easy to read, and easy to see why it stuck around.

The Iliad is… not. It’s hard to read. Everyone in it is kind of a jerk. The biggest jerks are the biggest stars. The entire story rotates around a woman - Helen - without giving her agency. Maybe she didn’t want to go home?

For all its difficulty, it’s the more important book. Studying it taught me a lot.

Founders could learn from it even today.

In a hard book to read, one section is by far the hardest, weirdest, and seemingly most pointless. We called it the Parade of Ships, but Wikipedia uses the less glamorous “Catalogue of Ships.” It is exactly what it sounds like: A description of a lot of ships. More than a thousand. You know. Because Helen’s face was so beautiful it launched a thousand ships.

This gives us the millihelen: Enough beauty to launch one ship.

The Catalogue is scintillating:

First the Boeotians, led by Peneleos, Leitus, Arcesilaus, Prothoenor and Clonius; they came from Hyrie and stony Aulis, from Schoenus, Scolus and high-ridged Eteonus; from Thespeia and Graea, and spacious Mycalessus; from the villages of Harma, Eilesium and Erythrae; from Eleon, Hyle, Peteon, Ocalea and Medeon’s stronghold; from Copae, Eutresis, and dove-haunted Thisbe; from Coroneia and grassy Haliartus, Plataea and Glisas, and the great citadel of Thebes; from sacred Onchestus, Poseidon’s bright grove; from vine-rich Arne, Mideia, holy Nisa and coastal Anthedon. They captained fifty ships, each with a hundred and twenty young men.

That’s just the first paragraph! Every time I read this I delight in its nothingness. Now that I don’t have an essay due.

This litany, 2,500 years later, wakes our deepest fears about dusty old books. You’re probably feeling pretty good about skipping it. Yet it drove people to tell this story again and again. Being in it mattered. To your family. To your village. To everyone in Greece. Without the Catalogue of Ships, The Iliad might not survive.

Retelling a great story would always draw a crowd. (Remember: Both of these books were told in oral form long before they were ever written down.) But giving every listener a chance to brag or shrink because of the behavior of one of their ancestors… jackpot!

I was reading a funding announcement recently, and was struck by this:

Investors in the $10.1 million round for the company were led by ArcTern Ventures and joined by new backers Capricorn Investment Group, Incite Ventures. Previous financiers in the company included Wireframe Ventures, Congruent Ventures, Ulu Ventures, Energy Foundry, Hardware Club, 1/0 Capital, and Wells Fargo Strategic Capital […].

That’s a long list. Especially so for a company likely raising only its second round of funding (based on the amount).

Then it hit me:

These investors are listed for the exact same reason the ships are catalogued in The Iliad!

The Greek warriors were fighting for timé, a kind of honor and fame. The stories helped them pass it on to their descendants.

Investors are fighting for the modern equivalent (named, ironically, after a different, also unpleasant Greek story). Now it’s earned in investor announcements on sites like TechCrunch, not ship descriptions in stories told in the town square.

This is more funny than bad. There’s value in being able to track down which investors work with what kinds of companies. More openness is a great trade-off for a little exposure for the investors.

Still. Seeing the parallel was a delightful lift to the morning. I have a science degree but a liberal arts education. I love what the combination has done for my career. It’s nice to have it be a source of humor, too.

The parallel provides a lesson for founders:

The catalogue of ships describes a thousand vessels, and far more people. But most of them were never mentioned again in the story.

Don’t look for those involved in the investment. Look for who helped the company succeed. Who wrote the first check.

The Automator's Dilemma

luke@lukekanies.com (Luke Kanies) — Fri, 24 May 2019 00:00:00 +0000

Automation is not to blame for all the job destruction and wage stagnation. But you can still do great harm if you build it for the wrong reasons.

We’re told that automation is destroying jobs, that technology is replacing people, making them dumber, less capable. These are lies, with just enough truth to confuse us. You can have my robot washing machines when you pry them from my cold, wet hands.

I’m not some Pollyanna, thinking tech is only ever positive. Its potential for abuse and hurt is visible across the centuries, and especially so today. But I’m more optimistic about the upside than I am pessimistic about the down, and I’m uninterested in scaremongering screeds against it.

And yet. Technology and automation are not forces of nature. They’re made by people. By you. And the choices you make help to determine just how much good or bad they do. Even with the best of intentions, you might be doing great harm. And if you don’t have good intentions at all, or you don’t think ethics are part of your job, then you are probably downright dangerous.

I’m here to convince you that you have a role in deciding the future impact of the technology you build, and to provide you - especially you founders, tool builders, automators - some tactical advice on how to have the best impact, and avoid the dark timeline.

As I was building Puppet, explaining that I was developing automation for operations teams, execs and sales people would think they got it: “Oh, right, so you can fire SysAdmins!”

Ah. No.

When prospective customers asked for this, I offered them a choice: You can keep the same service quality and cut costs, or you can keep the same cost, and increase service quality. For sysadmins, that meant shipping better software, more often.

Their response? “Wait, that’s an option?!” They only knew how to think about their jobs in terms of cost. I had to teach them to think about quality. This is what the whole DevOps movement is about, and the years of DevOps reports Puppet has published: Helping people understand what quality means, so they can stop focusing on cost.

And those few people who said they still wanted to reduce cost, not increase quality? I didn’t sell to them.

Not because they were wrong. There were real pressures on them to reduce costs, but I was only interested in helping people who wanted to make things better, not cheaper. My mission was completely at odds with their needs, so I was unwilling to build a product to help them fire their people.

This might have been stupid. There are good reasons why a CEO might naturally build what these people want. The hardest thing in the world to find for a new product is a motivated prospective customer who has spending authority, and here they are, asking for help. The signal is really clear:

You do a bunch of user interviews, they all tell the same story of needing to reduce cost, and in every case, budgets are shrinking and the major cost is labor. Great, I’ll build some automation, and it will increase productivity by X%, thus enabling a downsizing. The customer is happy, I get rich, and, ah, well, if you get fired you probably deserved it for not investing enough in your career. (I heard this last bit from a founder recently. Yay.)

This reasoning is common, but that does not make it right. (Or ethical.) And you’ll probably fail because of your bad decisions.

Let’s start with the fact that you have not done any user interviews. None.

The only users in this story are the ones you’re trying to fire. Executives aren’t users. Managers aren’t users. It seems like you should listen to them, because they have a lot of opinions, and they’re the ones writing checks, but nope.

This has a couple of consequences. First, you don’t understand the problem if you only talk to buyers, because they only see it at a distance. You have to talk to people on the ground who are doing the work. Be careful when talking to them, though, because you might start to empathize with them, which makes it harder to help fire them.

Even if you do manage to understand the problem, your product will still likely fail. As much as buyers center themselves in the story of adopting new technology, they’re largely irrelevant. Only the people at the front line really matter. I mean, it’s in the word: Users use the software. Someone, somewhere, has to say: Yes, I will use this thing you’ve built, every day, to do my job.

If you’ve only talked to buyers, you have built a buyer-centric product, rather than a user-centric one. Sure, maybe you got lucky and were able to build something pretty good while only talking to managers and disrespecting the workers so much that you think they’re worthless. But I doubt it. You’ll experience the classic enterprise problem of closing a deal but getting no adoption, and thus not getting that crucial renewal. Given that you usually don’t actually make money from a customer until the second or third year of the relationship… not so great.

Users aren’t stupid. Yes, I know we like to act like they are. But they aren’t. If your value promise is, “Adopt my software and 10% of your team is going to get fired,” people know. And they won’t use it, unless they really don’t have a choice. Some of that is selfish - no one wants to help team members get fired, and even if they’re safe today, they know they’re on the block for the next round of cuts. But it’s just as likely to be pragmatic. You’re so focused on downsizing the team that you never stopped to ask what they need. Why would someone adopt something that didn’t solve their problems?

What’s that you say? You ignored their problems because you were focused on the boss’s needs? This is why no one uses your software. Your disrespect resulted in a crappy product.

Call me a communist, but I think most people are skilled at their jobs. I am confident that I can find a learned skill in even the “low skill” labor. I absolutely know I can in most areas people are building software.

I was talking to a friend in a data science group in a software company recently, and he was noting how hard it was to sell their software. He said every prospective buyer had two experts in the basement who they could never seem to get past. So I asked him, are you trying to help those experts, or replace them?

He said, well, our software is so great, they aren’t really necessary any more.

There’s your problem. You’re promising to fire the only two people in the whole company who understand what you do. So I challenged him: What would your product, your company look like if you saw your job as making them do better work faster, rather than eliminating the need for them?

It’s a big shift. But it’s an important one. In his case, I think it’s necessary to reduce the friction in his sales process, and even more importantly, to keep those experts in house and making their employers smarter, rather than moving them on and losing years of experience and knowledge.

The stakes can get much bigger than downsizing. In his new book, Ruined By Design, Mike Monteiro has made it clear that designers and developers make ethical choices every day. Just because Uber’s and Instacart’s business model requires that they mistreat and underpay workers doesn’t mean you need to help them. While I don’t think technology is at fault for most job losses, there absolutely are people out there who see the opportunity to make money by destroying industries.

This is not fundamentally different than the strip mining that happened to corporations in the 1980s, except back then they were making money by removing profit margin in companies and now they’re making money by removing “profit” margin in people’s lives. Jeff Bezos of Amazon has famously said your margin is his opportunity, and his warehouse workers’ experiences makes clear that he thinks that’s as true of his employees as it is of his suppliers and competitors.

Just because they’re going to get rich ruining people’s lives doesn’t mean you have to help.

I think your job matters. I think software can and should have a hugely positive impact on the world; not that one project can by itself make the world better, but that every person could have their life improved by the right product or service.

But that will only happen if we truthfully, honestly try to help our users.

When, instead, we focus too much on margin, on disruption, on buyers, on business problems…. we become the problem.

My Losing Battle with Enterprise Sales

luke@lukekanies.com (Luke Kanies) — Fri, 25 Jan 2019 00:00:00 +0000

I’ve hated enterprise sales since long before I started Puppet. I just didn’t know why.

Photo by Tim Trad

You can either be a good example or a horrible warning. When it comes to enterprise sales, I had two horrible warnings before I started Puppet.

In 2000, I worked at Bluestar, a business DSL startup in Nashville. Pretty much everything that can go wrong with a startup did with this one: Founder was pushed out the week I started (I swear it wasn’t my fault), they raised too much money ($450m) and then spent it badly (e.g., on hardware that didn’t work and on salespeople that didn’t sell), they brought in a big business CEO who had no idea how to run a growth company, and then the regulatory framework shifted to highly advantage monopolies again so they all went broke. But in the meantime, I got to learn a lot, both about the problems that eventually resulted in my starting Puppet, and also about what does and doesn’t work in business.

At one point, the company decided to buy a new product. I honestly can’t remember what it was for. Something related to asset tracking? Or maybe some kind of operational monitoring software?

I don’t know. I just know I shifted from being a sysadmin to responsible for making it work. I wasn’t part of the team that decided whether to buy something, and if so, which one to buy, I was just designated to put their decisions into action. In the months I worked on it, I don’t think we ever even got it installed anywhere except on a test server, and at some point we just, ah, decided we didn’t need it any more. The project went away, so I returned to my old job. The executive who had made this horrible decision had the gall to say my moving back to my old role was a strike against me, and it would reflect on my tenure at the company. No worries, he was gone the next month.

This wasn’t just a software problem. While the company was slowly dying, they had an argument with EMC over a storage array they never should have purchased. A million dollars of hardware sat in a receiving warehouse for almost a year, because we would not accept it, and EMC would not take it back.

The second warning was during my brief stint at Bladelogic. I worked there for less than six months, but I learned a lot. Again, mostly what not to do. I was ostensibly a product manager, but in practice they just wanted me to maintain their lab and maybe write some justifications for how their product worked. Certainly they did not want to listen to me. My most memorable experience is being in an all-dev-team meeting when the most senior engineer said something like, “What does it matter what the customer thinks? They already bought the product.” Astoundingly, the CTO did not fire him on the spot, and instead just moved on, ignoring the comment entirely.

It was clear Bladelogic’s business model enabled them to just not care what their customers thought. Only_prospects_ mattered. Once the deal was closed, meh, they got paid, no biggie. You literally could not upgrade their software without losing all of your data - you know, the stuff you’re using to build and deploy your whole infrastructure - and doing any real work with the system required that you do everything twice, once to deploy and the second time to update. But you’d never discover that unless you actually used the software, which would be long after their salespeople left, so who cares? Not them.

You can maybe see why I lasted less than six months. It didn’t help that I was commuting between Boston and Nashville, and I’d managed to rent an apartment at the center of a cold vortex in Boston where my roommate collected Grateful Dead grape juice.

So when I started Puppet, I didn’t know much, but I at least had some anti-patterns. I knew we had to care more about our customers successfully using the product than we did about closing the initial deal, and that selling to people who would not use the software was a bad idea.

It turns out, that’s not quite sufficient to develop an effective sales strategy. Who knew?

I was lucky enough to hire the best sales leader in Oregon, who was not only incredibly skilled and experienced, he was also used to entrepreneurs and found me relatively sane compared to bosses he’d had in the past. Where a bunch of our engineers complained every time I opened my mouth, this guy quietly soldiered on. That made our years-long argument much easier to manage.

Early on, I didn’t know enough to break down what I wanted and what I didn’t, or how to talk about the individual behaviors, so I just wrapped up everything I hated and called it “enterprise sales”. We weren’t doing that. Ironically, our sales leader agreed with most of my concerns, so it wasn’t a real fight in the normal sense, but there were multiple areas he was convinced we needed to change, and it’s hard to do that when your ignorant CEO just puts up a ward against the evil eye and changes the subject.

Within a couple of years, he wouldn’t even say the word ’enterprise’, because I would jump down his throat, proverbially speaking.

In the first few years of building Puppet, I tended to focus on preventing sales from skewing our product plans. I wanted to be sure we built products to be used, not sold, and I didn’t trust myself or the team to be able to tell the difference. I think this was basically right, but today, I would know that you should treat ideas from sales like you treat those from customers:

Always listen to what customers tell you, but never do what they say.

The sales team has a limited lens into the product world. They are smart and highly educated about your customer, but that doesn’t automatically translate into good solutions.

This is a general risk at any company with sales teams, but you have an even more pernicious variant with enterprise sales teams: Being confused on who your customer is.

Are you building the product for the person who buys it, or the one who uses it?

Remember back to that product I tried to set up at Bluestar. It was purchased to solve a business problem, and the person who decided to buy it did so based on discussions with sales and, probably, looking very closely at a grid of check marks comparing it to its competitors.¹ Actually using it was someone else’s problem.

In fact, I was not going to be the user either - I was supposed to be its administrator. Some other team (support or installation, probably) was going to actually use it. So they were even further from the buying decision.

If you’re selling to the enterprise, getting a deal done requires that you convince the buyer that your product is a winner. That makes them the most important person at the customer. Now, a quality company would also involve users, administrators, and many others in a buying decision, but in the end, buyer decides. Two or three decades ago, these decisions were mostly made on the golf course, so schmoozing was the most important feature. Today, it’s a lot less corrupt, but not a whole lot more functional.

This brings us to the other problem in this separation between user and buyer: Enterprise sales is a team sale, not selling to one user. Suddenly you succeed based on your ability to manage the interpersonal relationships of warring sub-teams at your customer, instead of the strengths of your product. I distinctly remember a dinner with tens of customer employees, and there was almost a flashing DMZ between two teams, who had differing opinions on whether our solutions was the right one. Salesperson quality and experience begin to matter more than anything else, because you’re basically managing internal politics to get a deal done.

Where did the focus on our product go? How do we stay focused on building something our users love?

We don’t, really. It’s hard to sustain an effective a feedback loop that includes sales if they’re focused more on people and politics than products. Not impossible. But hard.

At a big company, you can begin to navigate this kind of cognitive dissonance - listen to your sales team, but don’t build the products they demand. But in the early days of Puppet, I knew I couldn’t handle it. I am not good at dissonance in general - I’m a bit too fond of the idea that there’s just one truth - but I especially knew my organization could not handle it. We needed to be 100% aligned, and that meant sales needed to be working on the same problems as our product teams. Thus, no enterprise sales.

As we got bigger, the other big problem with enterprise sales starts to show up: Wow is it expensive. Lew Cirne of New Relic told me the primary reason he sold Wily when he did is because he needed to $150m just to build out the sales team and it wasn’t worth it.

If you’re doing inside sales, you’ve probably got someone who can talk through most of the product, they can talk to ten or more customers a day, and only once in a while will they pull someone in to help get a deal done. Once you go enterprise, you have field reps who might be covering thousands of square miles of territory, so if you’re lucky they’ll do three meetings a day on average, and they need a sales engineer on almost every visit. They pull in an expensive executive for meetings as often as an inside rep would pull in a cheap sales engineer.

Yes, you can get much bigger deals done this way, but think about the disruption to your organization: Essentially everyone on your leadership team is taking time away from running the business, not to learn from customers but just to make them feel loved enough to write a big check. Your deals start taking nine months to close instead of six weeks, and getting a check signed begins to look more like a challenge level in a video game than a partnership to solve customer problems. And the boss fight of that game is the worst part of enterprise sales: Procurement.

I’m not in the habit of disrespecting roles or teams, and I think procurement is often staffed with experts who play a vital role in their company. But they are generally paid based on how much money they “save” the company. All that discounting that you have to do for enterprise clients? It’s because procurement’s bonus is based on how much of a discount they force you to give. Absolutely everyone knows this is how it works, and that everyone knows this, so it’s just a game. I offer my product for a huge price, you try to force a discount, and then at the end we all compare notes to see how we did relative to market. Neither of us really wants to be too far out of spec; I want to keep my average prices the same, and you just want to be sure you aren’t paying too much.

But because companies compensate procurement based on saving money rather than making good decisions about what to buy, we can sell crappy products at a steep discount but not good products at list price.

It’s a helluva boss fight.

There’s often a miniboss, too: Legal. They just want their pound of flesh, and often this seems more like a puzzle level than a direct fight. I recently saw a deal that had been in legal for a year. That’s too much puzzle for me. (Incidentally, I worked on that same customer more than 4 years ago. Talk about long sales cycles.)

So now you begin to see why I fought against enterprise sales: It encourages you to build the wrong product for the wrong person and then sell it the wrong way at the wrong price.

Why, then, is it so popular? Or rather, why is it so hard to avoid that despite my best efforts we ended up in an enterprise sales motion, which I then ran away from?

Well, first and foremost, if it works it’s incredibly lucrative. For all that Lew Cirne built New Relic in response to his experience at Wily, and pointedly avoided enterprise sales for years, once they went public they went through a dramatic transformation and added it in, because the money was just too appealing. The biggest companies buy the most software, and, well, the biggest companies want to be sold a specific way.

In many cases, you just can’t avoid it. That’s a lot of what happened at Puppet: Our products were built to solve problems that big companies have. Heterogeneous environments, every operating system and application known to man, complex networks, and heavy compliance needs. Turns out it’s rare that a company has all these problems but buys large software products like you buy toilet paper.

Our first deals at companies did tend to look very consumer-like. But once they wanted to expand to other teams, and especially if they wanted to cover the whole company, the relationship naturally switched to a team sale, where we’re having to work with legal, procurement, executives, and then reps from three or four other teams. Ideally someone inside the org is an advocate for our product, so it’s more facilitation than direct selling, but the problem still stands: This is a clear enterprise sale.

But when it works… wow. You start closing $100k deals, then $300k, then $1m, then $10m. This starts to add up.

And for all that I’ve said this is hard… it’s actually the easiest way to sell.

What’s actually hard is having the best product, and only ever winning based on merit. Enterprise sales is the default motion, and in many cases it’s chosen to paper over weaknesses in the product. After all, only the user would actually notice those; in a meeting with the CIO, procurement, legal, and project management, no one’s going to install the product and give it a runout.

We’re still super early as an industry in our understanding of how to build a product that doesn’t rely on enterprise sales. For all that Atlassian relies more on sales than it has said, there’s no question that they managed to avoid an enterprise selling motion. I’m hoping the next generations of software companies will learn from them instead of Workday.

In the meantime, hopefully this story of how I fought enterprise sales, and why, will help you make better decisions about how to build your own teams. At the least, maybe I can just be a horrible warning.

These feature check lists are bad ideas. Don’t trust them as a user, don’t make them as a product marketer. ↩

The power of better tools

luke@lukekanies.com (Luke Kanies) — Tue, 24 Apr 2018 00:00:00 +0000

There is a solution to wage and productivity stagnation. Just don’t call it automation

Image courtesy of Washington Department of Transportation

I don’t know what the rest of the world thinks when they use the phrase ‘power tool’, but for me it’s visceral, literal. My experiences using them and watching them transform my family’s work permeated my time building Puppet. These power tools aren’t little plugins to expensive frameworks, they’re large capital investments that dramatically change your job.

I grew up building houses with my dad. The worst task he gave me was trying to paint a set of louvre doors for a closet while in high school; I had to flip the doors over every 90 seconds to catch drips getting through the slats. After three days of misery, my father relented and rented a paint sprayer, with which we finished the job the same day, at a much higher quality.

Around the same time, my dad would rent a pneumatic nailer for big framing jobs. By the time I finished college a few years later, that critical tool went from borrowed to owned and traveled everywhere with him. Initially used only for large jobs, most contractors now have multiple nail guns to cover framing, trim, and every other use case, and the air compressor needed to power it is as important as electricity.

It might not be obvious, but both of these are examples of automation. You replaced a very manual process - applying paint, or nailing things together - with a machine. If this were a factory, these days you’d call those machines robots, but because it’s a construction site, we just call them tools.

And these tools were expensive. Even with how much faster we finished that painting job, I expect it cost more to rent the sprayer than to finish the work manually, because of how little he was paying me. (This does ignore the soft costs of listening to me complain, which were likely high.) Even today paint sprayers and nail guns are often rented rather than purchased, because good ones cost a lot of money and aren’t needed all the time.

It’s no surprise that discussions of tools and productivity are easier to understand from my experience as a carpenter than as a sysadmin. There’s plenty of room for arguments about what is or is not a software power tool, but when it costs more than a week’s wages, it trails a bright orange cord everywhere it goes, and it can nail your hand to the wall while you’re standing at the top of a ladder¹? It’s a power tool.

There’s a common story about what robots and automation do to people like my dad (and both of my brothers, who followed in his footsteps): It steals their jobs and ruins their lives.

What utter poppycock.

If you think of your job as driving metal spikes into wood, then a nail gun is a mortal threat. But if this is your value add, your biggest danger was never automation. My dad never sold his ability to join raw materials together quickly; he sold homes, he sold the opportunity to enjoy your house and family more. How did these new power tools affect that?

They were awesome. Painting and nailing are classic examples of menial, low-value work, and yet we spent most of our time on them. All of the differentiation we offered to our customers was packed into a narrow slice of work, because implementation took so much time and money. As we were able to bring more powerful tools to bear, the menial work shrank and larger portions of our time could be spent on design work, customer interaction, and tuning our customers’ homes.

Interestingly, my father’s next career step was even more pointedly about experiences enabled by tooling. He took a job with a state hospital in Tennessee, fabricating custom furniture for severely disabled patients. Suddenly he was using industrial sewing machines for upholstery, and partnering with medical professionals to design multiple beds for each patient, enabling them to be happier and more comfortable (and also avoid bed sores, thus saving hundreds of thousands of dollars per patient). Given the tragically minimal budget allocation for this kind of work, every dollar saved through automation and tooling directly delivered health and happiness to his patients.

It’s no wonder I see the value in power tools, that I am more conscious of the benefit they can deliver than the loss of low-value menial work.

I had a similar experience as I was building Puppet. I would meet executives and salespeople (I don’t know why it was always them) who would say, “Oh, automation? Great, you can fire sysadmins!” No. Beyond the obvious reality that I was selling directly to my users, who would never buy on the promise to fire their coworkers, that was just not why we were valuable.

Puppet gave people a choice between lowering cost but keeping the current service quality, or keeping your costs flat while providing a much better service. “Wait, making things better is an option? I didn’t know that!” Most companies were aware that their IT sucked, but they only knew how to measure and manage cost, so that’s what they did. Once you believed in the power to make things better, power tools turned out to be great investments for both the user and the buyer.

By letting people spend more time on the parts of their work they enjoyed, the work that makes them special, we also delivered higher quality experiences for their customers and constituents. “Spend less time firefighting and doing menial work, and more time shipping great software.” If the heart of your skillset is clicking buttons or responding to outages, Puppet might have been a threat to you, but our users knew where their real value was. We helped them spend more time there and less time on the boring, low value stuff. The sysadmins hated the work, the customers hated to need it, and the executives hated paying for it. Great, done, don’t worry about it.

When you look around the software market, though, power tools are out of style. There are big data companies building for the non-existent average user, minimalist companies building solutions that do little for almost everyone, and there are power tool companies of yesteryear still hanging around. There just aren’t that many modern software companies building large, clunky, expensive tools that just might cut your hand off if you’re not careful.

That’s partially why productivity has stagnated². The world has not changed that much - some of the greatest improvements to productivity come from making large capital investments in tooling for your workers - but how we spend our money has. People balk at a $5k computer, when the Mac IIci would cost more than $13k in today’s dollars just for the hardware, yet was a powerhouse in desktop publishing. This is to say nothing of how the mobile app stores have driven down what people are willing to spend on software.

Yes, Adobe’s software is expensive, but it’s that price because it delivers so much value. If it didn’t, no one would buy it. Every large market should be so lucky as to have the collection of power tools that graphic designers get. It sounds crazy, but we’re suffering from not enough expensive software. Instead of building the most powerful software possible and finding customers who see its value, companies are building the simplest thing they can and trying to get everyone to use it.

There are bright spots in the industry, like Airtable and Superhuman. I’m hoping they help to shift momentum back to automating away the tedious work and enabling focus on what humans excel at.

More powerful tools improve your life, but they also make you happier even if you can’t buy them. They tantalize you, promising you great returns, if only you can come up with the cash. And they’re maybe just a little bit scary, warning you that buying them is not enough. You must master them.

A friend of ours managed to do this when working alone in the time before cell phones. ↩
Yes, I might be being simplistic to make a point. ↩

The Market Is Wrong About Your Problems

luke@lukekanies.com (Luke Kanies) — Tue, 17 Apr 2018 00:00:00 +0000

What Voltaire and the Flaw at the Heart of Economics Have to Teach Us About Software That Doesn’t Exist

Voltaire’s Candide juxtaposes an optimistic philosophy with unbelievable tragedy. He was angry at the 19th century philosophers who proclaimed that we lived in the best of all possible world while destruction and death unfolded around Europe on an epic scale.

We might hear the claim that we live in the best of all possible words and scoff. Of course, we’re too enlightened to be such naïve optimists. But are we? Isn’t the belief tempting? Or even, doesn’t the behavior of those around you make more sense if you realize they believe this, at least a little bit?

Economists are theoretically rational, analytical, big picture thinkers, but at the root of modern economics is a belief shockingly close to Candide’s parody of optimism. They have what they call “The Efficient Market Hypothesis” (EMH), which roughly states that all assets are valued fairly. This is built off the idea that asset values in an open market are fair because they include all available information, and all the actors in that market are behaving rationally in regard to both the asset and the available information.

This theory tends not to trigger the cynicism that Voltaire does. Intuitively, it sounds not just right, but defined as so. Isn’t an open market essentially a mechanism for finding the fair value of an asset? It’s not so simple. And when it goes wrong, it does so spectacularly.

Modern economists cannot be as destructive as the great thinkers of the 18th century, whose big ideas justified eugenics and many other horrors. Just because they cannot as easily be used to justify mass murder does not mean they should not be accountable for the downsides of their obviously incorrect theory.

“No”, I hear you say, “the EMH is not wrong; it’s correct by definition.”

Economists have convinced us of what Voltaire was protecting us from: We live in the best of all possible markets, where all information is public and all assets are fairly valued. If the market does not value something, that it must actually be worthless.

But of course, if that were true Warren Buffet would not have become a billionaire buying stocks that were worth more than the market was paying, the finance industry could not have been built on advising clients about public stocks, and you’d have no need for lemon laws or other regulations that fight information discrepancies. Nor would Kahneman and Tversky have won the Nobel Prize for demonstrating that actors in an economic system behave anything but rationally, puncturing the EMH for good. Thankfully, this has forced the field to begin to grapple with its flawed underpinnings, but many modern beliefs are implicitly built around these bankrupt theories.

You might be patting yourself on the back right now for not being silly enough to draw Voltaire’s ire, but it’s baked into the value system of the world around you, especially if you live in the US.

The market moves from irrationally ignoring new technologies like the blockchain to irrationally dumping money on them, without any fundamental change to justify the shift
Investments are made based on proximity and serendipity rather than rationality and opportunity size
We tend to claim that the rich earned their status through hard work, rather than recognizing the role of privilege, inheritance, and luck in their status

Of course, not everyone in the market operates with such optimism, but each of us is biased in this direction. It affects our thinking whether we want it to or not.

“Ok”, you say, “even if I accept some people make optimistic investment decisions, what does that have to do with software?”

Great question. If we live in the best of all possible markets, where all information is public and all assets are fairly valued, then we can trust the market’s assessment of what software should and should not exist. Lack of software to solve a problem is a sign that it’s not worth solving.

If, on the other hand, our world could be better, or if our market is imperfect at valuing assets, then we can’t trust intuitive conclusions about where value resides. This is most true when it comes to valuing unsolved problems. It might be that a given problem has no solutions because it is not worth solving, but mundane reasons are more likely to be at fault.

Most great companies exist because they provided something the market did not know it wanted. Their founders encountered a flaw, and managed to build something great in the opportunity created by it. Henry Ford claimed if he’d have given people what they wanted it would have been a faster horse. The market knew how to value them, but not cars. Before Apple, the market did not value personal computers. Before Google, the market valued directories but not search engines. Before the iPhone, the market valued expensive phones for professional use but not personal.

These value statements were market failures, and their resolution generated billions of dollars for the companies resolving them. Now, of course, the market sees great value in what these founders have created, but not because the market is so smart; it’s because it can no longer fool itself.

It’s easy to grow despondent in the face of such obvious market failures. If the wisdom of the crowds, the great invisible hand of the market, can be so wrong, what hope does a lonely entrepreneur have? I take a different way.

I luxuriate in these misses.

They surround us. We bathe in them. Yes, many great companies have grown into critical market gaps, but even with all these successes, there are untold problems whose solution should be valued but is not.

Only once you reject the market’s flawed opinions about what matters, you begin to see nearly limitless opportunity. There are so many more unmet needs than there are perfect solutions. These are your opportunities.

Of course, just because the market dismisses a space doesn’t mean there’s a great opportunity there. It’s your job to know the problem, your customer, your user, your buyer well enough to draw your own conclusions, to develop enough certainty that you don’t need someone else to tell you what to believe.

Because that’s the real point: Trust yourself, not a bunch of paternalistic optimists.

Why We Hate Working for Big Companies

luke@lukekanies.com (Luke Kanies) — Tue, 10 Apr 2018 00:00:00 +0000

Modern capitalism raises the flag of the free market while pitting centrally planned organizations against each other

It’s quite a journey from being born on a commune to raising more than $87m in funding at a software company. This journey forced me to wrestle with existential questions about my true beliefs, and how they intersected my life as an entrepreneur. One’s work is rarely a pure reflection of ideology, but companies need a clear and authentic strategy, which requires a tight alignment between company operations and the founder’s philosophy. I have discovered more about those differences between what I believe and the best ways to grow a corporation while studying economics - that is, how money is made and exchanged - than any other area.

A worldwide conflict between communism and capitalism defined the latter half of the twentieth century. The United States’ ideological battle was the central drama of my childhood, and it was with a combination of glee, pride, and “told you so!” that my fellow Americans watched the wall fall in Berlin, and the USSR dissolve shortly thereafter. I expect few would deny that the US is the standard bearer for capitalism.

Yet, there’s a flaw at the heart of this claim. While the United States operates as a free market economy, the key agent within modern capitalism - the corporation - works more like an authoritarian state. Given how much of our world is built around corporations, this truth and its impacts are critical.

I grew up apart from America’s passion for capitalism. In the era of Reagan, I was living on a commune. My parents did not earn money for their labor, and we didn’t have personal property. My family left the Farm when I was 8, and as I matured, my ideological roots were in conflict with the US’s nonstop pro-capitalism message. As I joined the workforce and eventually started my own company, I found myself attached to neither the communal roots of my childhood nor the Wolf of Wall Street world I moved into. I grew slowly in convictions, as I encountered problems in the course of scaling a company.

The first real conflict came when it was time to hire managers. I founded a company primarily because I did not thrive as someone else’s employee, so what led me to think others would? More importantly, anyone who has ever operated at the front line is aware of the severe costs imposed by the separation between the people who do the work and the people who make the decisions in hierarchies. Hiring managers was just going to make the company do worse, not better, right? Right?

I expect three of you are gleefully shouting, “Yay, holacracy!” right now, while the rest are confused and either offended or think I’m an idiot. I did consider a manager-less world, but a little research provided only examples of disaster, because the only available options just replace an explicit power structure with an implicit one. In other words, it’s still hierarchical with the founder on top, but now decision making is opaque and the system is easy to exploit because of the lack of controls (which looks surprisingly like the cult/commune I grew up in).

Those who are confused or offended by the idea that managers make performance worse would be informed by a deep dip in economics. One of the core principles of the free market is that central planning committees can never be as efficient or as effective as the people doing the work. By definition a free market economy lacks a decision-making hierarchy; the ‘free’ means every agent (individual or corporation) can decide for themselves, without needing permission from a manager above.

While there are many aspects of modern American capitalism I reject, this one I wholeheartedly support¹. The downsides of a strong central executive were taught to me early.

Like many other communes, the one I grew up on routinely failed to feed its people - my parents speak with horror of the ‘wheat berry winter’, when we lived on little else. While his people were short on food, the founder of the Farm was off touring Europe as the 3rd drummer in a band, “bringing our message to the world”.

Thankfully none of us starved to death, but the failing was similar to what most communist countries experienced: The central organization could not feed everyone. For years, I assumed this was just incompetence, whether at the scale of the Farm or China. The truth was far more structural. Millions starved during the Great Leap Forward because the central organization was trying something impossible: Managing the productive output of an entire country. The Planet Money podcast tells a great story of how this central planning was walked back in China, but the general point here is that these communist countries did not just nationalize the means of production, they tried to centrally control all of it from within a small group.²

When people talk about communist countries not being a free market, this is what they mean: They tell the farms what crops to produce and in what quantity, rather than letting them decide for themselves. China even went so far as to dictate what hours a farmer should start and stop working, and then directed managers to ring a bell for transition times to control every little group of farmers. Anyone who’s ever had to punch a clock into a rigid, dysfunctional hierarchy is likely getting painful flashbacks about now.

It should be immediately obvious why this fails miserably: The distance between the central planning committee and the farmer is so great that good decisions are nearly impossible. It’s nearly impossible for critical feedback to make it from the edge, where the farmers are working, to the central planning committee in time to affect decisions, and then for those decisions to make it back to the edge in time to be useful. The podcast linked above also points out how unmotivated the farmers were under this regime, cutting productivity even further. Those who have studied lean manufacturing, agile development, and DevOps are likely seeing parallels here.

The result was catastrophe. When a corporation is painfully inefficient it loses money and might have to do layoffs, but when a country fails at growing food, its people starve to death. I don’t mean to imply that central planning was the only cause of famine under communist rule - there were political operations that led to mass starvation, just like in the West - but learning more about these helped crystallize what I do truly prefer about capitalist models. It also converted the phrase ’the free market’ from a catchy slogan into something meaningful to me.³

The most important feature of free market economies is that each person within them is able to make independent decisions in their own best interests⁴. If you’re a farmer, you can decide what to grow, how much to grow, and when to work to develop your crop. Heck, you can even choose not to be a farmer any more. Success is merely dependent on your finding a buyer for your work at a price you can tolerate. Any given year might not be perfect, but your decision making gets better over time as you learn to respond to customer demand.

This pattern is easy to understand in any system where the people doing the work make the decisions. If you’re a jeweler, you can decide what to make, how much to sell it for, and what to spend your time on. Same if you run a small restaurant, lead local tours, or are a one-person shop doing house remodeling. It’s a free market, where you can charge what the market will bear, and you can quickly and efficiently respond to its whims, ensuring that you are getting the best use of your time.

This was a powerful organizing principle for a long time. The history of human commerce developed largely this way: One person, or as many people as could fit in one shop, would turn labor into a product, then find a buyer for it. Most large-scale efforts were organized by the state of the time: Monarchs and the landed gentry, who were the only ones capable of marshaling enough resources to build palaces, roads, and other large construction projects.

This began to change in the 17th century when corporations like the Dutch East India Company were able to deliver massive windfalls to investors by pooling money and using it to extract resources from colonies. There was a step change in the 19th century, as corporations went from generating wealth to building and owning infrastructure. It’s one thing to outfit a single ship for a year-long voyage, yet another to maintain railroad schedules across the United Kingdom, or run a telegraph network around the whole US. These aren’t just short-term money-making exercises, they’re long-term commitments with big capital outlays and large returns over years and years.

We still live in a free market economy, but it’s not one Adam Smith would recognize. Instead of individual or small operators, ours is composed almost entirely of corporations. Really big corporations. And these companies, they use the same kind of central planning that we so despise in communist systems. I know. I’ve done it.

By the time my company got near 500 people, we had a multi-week planning process, where the leadership (i.e., me and my lieutenants) set out top-level goals, built a top-down plan to accomplish them, then drew information from the front line to see where it needed change. We called this a bottom-up plan, but it was only bottom-up from the perspective of numbers - how much money we’d have, what our costs were, etc. - rather than from the bottom of the organization. We could see no way to have a system where the people doing the work built a plan for the organization. Even thinking about it now, my reaction is, “How would they know what my goals are?”

That’s the kind of question you can only ask in an authoritarian state, not in a free market economy. My goals became my company’s goals, and the only real way to ensure people worked toward them was providing a plan. You might argue that a corporation should focus on shareholder value, but that doesn’t help make decisions about what the company should actually do.

Great leaders find a way to listen to everyone in the company, but in the end, leadership is about making decisions. That’s essentially the definition of the word. And we all know leaders who did not bother to listen, or just did not need to in order to be great; today’s most vaunted tech leader, Steve Jobs, was famously disrespectful of the opinions of others, yet made a lot of world-changing decisions (not all for the better).

This is exactly why working in a big corporation is so stifling. If you’re in a small company, the executives are close enough to the front line that it’s more like working in a tribe, but in a big company, the leadership is so removed from whose who do the work that executive teams operate like the politburo we so decry in communist countries. Certainly the bureaucracies are no more enjoyable or forgiving.

I find it both ironic and painful that my inability to work for someone else resulted in my creating a company that involved a lot of smart, capable people working for someone else.

I wish I had a solution. If this were an easy problem, its solution would already be pervasive, because the benefits are massive. Just in terms of efficiency, we’ve seen how much better the free market is than planned economies, but it also has a hugely positive impact on quality of life. People are happier when they’re in control.

I know the solution is not more freelancing and contract work, which America’s corporations are addicted to. That’s the worst of both worlds: The exploitative nature of capitalism with the inefficient bureaucracies of communism. Transactions on the free market work because they’re good for both sides, but most people only accept part-time contract relationships today when they have no other real choices.

Holacracy certainly isn’t the answer. It’s fundamentally flawed because of its implicit power structure - Tony Hsieh still runs Zappos, even if he does not use a central planning committee to do it - but the biggest problem is it makes no mention of economics. Without a clear system for scoring the transactions (i.e., money) it’s impossible to build a free market.

This problem of how to handle economics within a non-hierarchical company might lead some to think of using blockchain tokens as an internal currency. This is impossible today, beyond the fact that the world of blockchain is mostly about fraud and black market sales. The biggest problem is that we have no idea how to value most of the work people do. I mean, we might know that what a developer should get paid for a year’s work, but how much is that work worth? The majority of the work done in modern corporations is incredibly hard to value, which is partially why companies are so inefficient and make so many bad decisions.

That brings up an even bigger problem - companies today hire workers to make money from their labor. In other words, they generate profit because they pay their employees less than they’re worth. If everyone could trade their labor for exactly the amount of money it was worth, the corporations that employ them would have a much harder time making money. Instead, in modern corporations the shareholders and the executive team - again, the central planning committee we so despise - make the majority of the money, while the front line does all the work and makes very little. This is true even at the big tech firms; software developers might be well paid relative to hotel workers, but they’re paid a pittance compared to the founders and executives. This might speak to why we have no solution yet - free market corporations would tend to reduce concentrations of wealth, which would be terribly disruptive to the current system.

Like I said, I don’t have a solution. But at least now I know what makes the current system so painful, and it gives me some hope that we actually can come up with a better answer. I know I’ll be working harder in the future to manage the downsides of what we have today.

Although I might stress the “well regulated” part more than most modern economists. ↩
Of course, capitalism is just as capable of killing its citizens, whether through starvation or lack of health care. ↩
Note that I’m not taking the capitalist side of the cold war here; while Americans were decrying the oppression of the Soviets, we were actively clawing back progress on civil rights and knocking over democratically elected governments. This article is about principles, which political regimes rarely show a great track record in following. ↩
But not so independent that you should be as pathological as Ayn Rand. ↩

Great design is ruining software

luke@lukekanies.com (Luke Kanies) — Tue, 03 Apr 2018 00:00:00 +0000

The arrival of the smartphone has convinced the world of the value of great software design, but it’s not all good news

The smartphone has reached more people and delivered more value faster than any technology ever seen. Much of the world has had to adapt to this arrival, but software design suffered the greatest reckoning. As the smartphone ascended, developers finally adopted reasonable design principles, realizing that they could not pack every feature ever seen into the smartphone experience. This recognition of the value of design - and especially, minimal design - is a good thing. Mostly.

I could not be happier that the industry finally accepts that there are principles of design, and there is a practice and discipline behind building great software. It’s great that we’re seeing more focused software that does little, but does it very well, rather than the previous age of the GUI when software attempted to own large parts of our lives by doing anything and everything. For a long time, Microsoft Word was used by nearly everyone who had a computer, and their strategy was to ensure no one ever had a reason to choose something else by building every feature anyone might ever need; their toolbar was the canonical example of never saying no.

The smartphone changed all that. Those rows of icons would fill the screen on a phone and leave no room for typing, and of course, no one would use them anyway because of how different the usage patterns are. As people realized they could no longer just throw in the kitchen sink, they began hiring (and listening to!) actual designers, and those designers have been steeped in the culture of Dieter Rams and the minimalism of the Bauhaus movement, which is awesome. Mostly.

Unfortunately, the phone caused everyone to focus on the final design principle of Dieter Rams (“Good design is as little design as possible”), without apparently remembering the nine that came before it, or why they were earlier in his list. I get it; the design constraints in a phone are intense, and it might not be a good idea to minimize everything, but it sure is easy.

The consequence of this mobile brutalism is a new movement building simpleton tools: Software that anyone can use, but no one can become an expert in.

Trello is a great example. I adore Trello. I think it’s great software, and it’s clearly a success by any measure. However, for all that I’ve relied on Trello daily for years, I feel no more an expert than I did just after starting to use it. It’s not because I haven’t tried; it’s because there’s no depth. You can pretty much plumb the product in a couple of days.

That’s fantastic for getting new users up to speed quickly, but deeply frustrating after a couple of weeks. Or months. Or years. Compare that with Vim, which I still use for all of my code editing, yet it’s so complicated that most people don’t even know how to quit it, much less use it. I’m not going to claim its lack of user friendliness is a feature, but I will defend to the death that its complexity is.

Apple’s Notes is the ultimate expression of this trend in text editor form. It’s a fine text editor. I know some people have written huge, impressive programs in similarly simplistic editors like Notepad on Windows. But I personally could not imagine giving up keyboard navigation, selection, text munging, and everything else I do. The fact that complicated work can be done on simplistic tools speaks to the value of having them, but in no way invalidates the need for alternatives. Yet, on the current trends, no one will even be trying to build this software I love because they couldn’t imagine two billion people using it on a smartphone.

I think it’s fair to say that that’s an unfair standard, and even a damaging one.

I miss the rogue-esque exploration that tool mastery entails. It’s not that I want tools to be hard; I want them to be deep. I want to never run out of ways to invest in my tools. I don’t want to have to swap software to get upgrades, I want to upgrade my understanding instead.

But I look around my computer, and everything on it was designed for the “average” user. I was not average as a CEO with 40+ hours of meetings a week while receiving more than 200 emails a day, nor am I average now as someone who spends more time writing than in meetings. There’s no such thing as an average user, so attempting to build for one just makes software that works equally poorly for everyone.

It is a rookie mistake to conflate the basic user who will never plumb the depths of their tools with the expert user who will learn every nook and cranny of your software. It is a mistake to treat the person who sometimes has to solve a problem the same as a person who spends 80% of their time working on that problem.

I don’t want to be an expert in all of my tools - for all that I take thousands of photos a year, I don’t think I’m up for switching to Adobe Lightroom - but for those tools that I spend the most time in, that most differentiate me, I want the opportunity for true expertise. And I’d happily pay for it.

Back in the days when computer screens were tiny, there were plenty of stats that showed that paying for an extra screen would often give people a 10% or more boost in productivity. I know it did that for me. As a business owner, it was trivial to justify that expense. Monitors cost a lot less than 10% of a person’s salary, and don’t need to be replaced every year. Heck, the whole point of the automation company I built was to allow people to focus their efforts on the most valuable work they could do.

Yet, when it comes to software being built and purchased today, to the tools we use on a daily basis, somehow our software ecosystem is failing us. There is no calendar I can buy that makes me 10% better, no email client available that I can spend five years getting better at.

It’s great that people are finally making software that everyone can use, but that’s no excuse to stop making software for specialists, for experts, for people who could get the most advantage from that extra 10%.

Please. Go build it. I know I’ll buy it.

If You Take Venture Capital, You’re Forcing Your Company To Exit.

luke@lukekanies.com (Luke Kanies) — Tue, 20 Feb 2018 00:00:00 +0000

To understand VC, you must understand the consequences of how they make money for their investors. Part 2 of a series.

Originally published on NewCo Shift

Modern venture capital is obviously successful, as demonstrated by the fact that five of the world’s six largest companies were funded by it. However, success is as much about what you say ‘no’ to as what you say ‘yes’ to, and venture capital is no different. In addition to delivering massive collateral damage in the course of its work, the current model rejects all ideas that do not fit within its narrow definition of suitable.

The primary contributor to this wholesale rejection is how VC delivers returns, so to understand why it’s broken we must understand how it works. In this article we’ll go deep on how VCs get their money, how they turn that into more money, and what that all means in terms of what ideas they can and will back. Note that we’re focusing here on the ideas not the people; the structural biases against women and people of color will be discussed in later essays (but it’s worth recognizing that they’re just as baked into the model). Ross Beard’s The Innovation Blind Spot goes into great detail on this topic.

Venture capital firms generally have managers and limited partners; the managers are the people we think of as the investors (they sign the checks), and the limited partners are the investors in the firms; they’re “limited” in the sense that they have ownership but no real control. They don’t actually invest in firms; they invest in an individual fund, and all of the roles are built around the fund, not the firm. This is partially why you might seen an investor leave a firm but stay involved in investments from the old firm: the investor is still on that fund even if they’re not at the firm.

Most limited partners are very large financial institutions, like CalPERS, and they work with venture capital as part of a diversified investment strategy. They have pockets of money in all kinds of places, and VC is added in to ensure they have some high risk/high reward investments. These don’t necessarily even deliver better returns (and in general, VC as an asset class does not do that well), it’s there to get the right mix of risk in the portfolio. In most cases, the LPs are represented by people who would not fit in at a venture firm, because they’re usually finance people at governmental institutions.

A fund is raised by investors (“managing partners”, in this context) seeking money from high net worth individuals, institutions, and anyone else with a lot of money lying around. Money is committed for the life of the fund; except in rare cases there is only one way for an investor to get the money back.

One of the strange things about these funds is not just that they are planned to be locked into a fund for a long time, but it can be awkward if they aren’t. Limited partners invest with VCs as a means of putting money to work over something like a ten year period. If the money all gets returned quickly because of an exit, it throws off the spreadsheets and they quickly have to find somewhere else to put the money. This sounds silly, but it does have a real impact.

Venture capitalists then take this money, and use it to buy stock from startups. So now, the fund holds a bunch of stock instead of a bunch of money. Crucially, this stock is all in private companies, which means it’s generally illiquid (i.e., you can’t easily exchange it for cash). It’s also usually preferred stock, which means the investors get a few extra terms around control and how cash is distributed if there’s a below-value exit.

If this were a normal fund, there would be plenty of ways to make money, and the investors could deliver returns however they wanted; they could rely on growth, dividends, sales, or anything else. However, VC funds are limited partnerships with strict rules about what can be done with the money. No matter where you are in a fund cycle, if a company gets sold for cash, you have to distribute that cash to your investors (keeping 20% for yourself, of course). You can’t reinvest it in another company. (This is only generally true; firms that don’t have this restriction are called evergreen funds, and are usually funded by a single institution or family.)

This distribution on an exit is the primary mechanism for VCs to return capital to their investors. The other way is for a company to go public. This is a weirder one — it’s discussed as an exit, because it allows investors to return capital to their LPs, but it’s not a sale of the company. The difference is that the stock is now liquid, which means it’s basically equivalent to cash; the VCs give distribute the now-public shares to their LPs, who can now all trade it in for cash whenever they want.

Ironically, distributing shares to LPs is a big risk to the company — if 50% of a company’s stock is owned by investors, and they distribute all of that stock to their LPs the day a company’s lockup period ends, what do you think the LPs would do? Well, they’re not experts in tech, or high growth companies, and more importantly, this stock doesn’t fulfill the same needs as the VC fund did in their asset allocation, so they sell it. Of course. And what happens to a newly public company who finds that 50% of its shares are suddenly sold on the public market? The stock gets hammered, because a huge upsurge in supply means an equivalent drop in price.

That’s why VCs distribute shares over a broader period of time, usually 18-24 months. They have some flexibility in how this is handled so they can protect these newly-public companies.

Ok, now you understand how it all works — how venture capitalists get money, make money, and then give it back to their investors in turn. Why does that matter?

It matters because there are only two ways for a VC-backed startup to be a success for its investors: Go public or get bought. As the CEO of Puppet, I always said any company has four options: Go broke, go public, get bought, or stay private indefinitely. If you take VC money, that last option is off the table.

It’s worth saying again: You take VC, you are committing to getting bought, going public, or going broke.

Crucially, that means that investors must push you into one of those outcomes. The reason they deride private businesses that generate cash isn’t because they’re bad businesses, it’s because they’re structurally incapable of profiting off of them. Their system is limited to valuing sales or IPOs; nothing else can have value to them, because nothing else allows them to make money.

This means that if you’ve got a great company that’s taken some VC but is at real risk of settling into a mere 20% growth rate with a sight to profitability but only making, say, $30m a year, they’re going to push you out of that comfort zone. They have to. They’ll ask you to raise a “growth” round so you can “really scale this thing”, or they’ll try to sell the company. If that doesn’t work, they’ll just fire you and put someone in place who will do it for them. It’s not because they’re evil, it’s because their contracts essentially require it. They can’t return the stock of a private company to their LPs, so what choice do they have?

Now that we understand how investor behavior is driven by how capital is returned to investors, let’s discuss what it means to the technology startup ecosystem as a whole. (There are VCs for things outside of tech, but the asset class was basically invented for technology, and that’s where it is centered.)

If you’re seeking funding for your technology company, you essentially have to promise that you can and will sell your company for an outsized return, or that you can and will take it public. In reality, almost no one invests with the expectation of a sale; they’re all betting on an IPO, recognizing that a sale is a good second option. It doesn’t matter if you can generate a ton of profit; they have no use for that. In fact, it might get awkward if you started distributing dividends.

This has two big consequences. The first, of course, is that companies that don’t have a realistic shot of going public can’t get venture capital. This is a striking constraint, given how much of our economy consists of small, profit-generating businesses that generate jobs and cash locally, whereas the ranks of public companies that distribute returns only to the investment class have been shrinking for decades. The story they’ll tell you is that only those really high-growth companies “need” VC money, but it’s much simpler than that: Their business model doesn’t work if your company doesn’t sell or go public.

Bank loans do ok at providing funding for low-risk actions by mature companies, and VC does well at funding high-risk companies with the chance to be huge, but there’s a huge gap in the middle that struggles to get any funding. (Both of these funding mechanisms in the US also suffer from being overwhelmingly biased toward only funding white men, but that’s a different essay.) Medium-risk companies often do need funding, but can’t get it, which in many cases means the businesses either don’t exist or end up much smaller than they could be.

The second major consequence is that a lot of companies are able to convince themselves, and thus investors, that they could get big enough to go public. Yes, this is sometimes true, but in so many cases it is instead a lie that both parties tell in order to get the funding done. If you love your company, and the only way to keep it alive is to promise to keep growing, you will. You understand the risks, but they’re better than just letting your company die.

In too many cases, this absolute demand for continued growth is exactly what kills companies. They never learn the operating discipline necessary to generate cash (which, in the end, actually still is king), and they get too big to sustain themselves. At some point, the lie gets out, they can’t get more funding, the fundamental unsoundness of their business model becomes clear, and the whole thing deflates.

When you hear a VC say you should focus more on growth than cash, what they’re saying is, you should worry more about my ability to return capital to my investors than your ability to still have a company in a few years. It might be that growth is the right thing to invest in, but it isn’t automatically the right thing, and it’s at least fair to say that the investor is not a neutral party in this recommendation.

So now we see that so much of what we find poisonous in the world of venture capital is actually the result of how returns are distributed to investors. The growth-at-all-costs mentality, the huge amount of dead companies, pushing employees to work to the bone until you get an exit, and much more can be laid at the feet of this simple constraint.

I don’t know if there is an alternative model that will work in the world of high-risk tech startups, but I do know there are plenty of other investment models that are able to deliver returns without introducing this kind of dysfunction. Conglomerates like Berkshire Hathaway are able to own significant chunks — or even the entirety — of companies and deliver great returns whether via growth, dividends, or anything else. This provides them the flexibility to let their portfolio companies choose their own best means of returning capital to investors. Coincidentally, Berkshire Hathaway is the one non-VC-backed company in that list of six largest companies.

This essay series is an attempt to capture what I’m learning as I’m looking for a new way to invest in great startups. I think it’s possible to build an investment model that directly attacks the weaknesses of VC; success in this quest would mean both huge returns for whoever cracks it, but also a sudden increase in new companies with completely different promises and risk profiles.

One Investor Isn’t Enough

luke@lukekanies.com (Luke Kanies) — Tue, 20 Feb 2018 00:00:00 +0000

The success of companies and founders in modern venture-backed startups is highly reliant on peer validation of investor decisions. Part 4 in a series.

Originally published on NewCo Shift.

Say you’re an entrepreneur building something new and different, and you know you need capital. After pitching up and down Sand Hill Road (and all over South Park), you’ve finally found a believer, someone who sees what you’re trying to do and thinks you and your team are the ones to do it. Great! Now you can focus on building your business, right?

Nope. Get used to more of the same. You probably raised just enough to get to your next milestone, not enough to get to self-sustaining profitability, which means you’ll be raising again soon. After all, on average startups raise more than three rounds of funding. I know what you’re thinking: But this investor is a true believer, and given how hard it was to convince others, they’ll sign up for the next round instead.

Nope. It does happen, but it’s rare. In general, every round you raise has to be led by a new investor. Part of this is about dollars: Your seed-stage investor writes $500k checks out of a $50m fund, but your A-round investor writes $5-10m checks out of a $300m fund. That seed investor will participate in the larger round (doing what’s called their pro rata, to keep their ownership share the same), but if they led the round they’d burn through their fund too quickly and would not be able to lead enough investments to make their model work.

Even if dollars aren’t the restriction on your first investor leading later rounds, you’ll still likely find yourself pounding the pavement again. Imagine you’re an investor, and you see a peer investor leads follow-on rounds for most of their portfolio companies. One of those companies comes knocking on your door asking you to invest, and of course your natural question is: Why isn’t your existing investor leading? There’s no good answer to that question.

You can’t say, “Well, they’re a bad investor, and I really need new blood”, for pretty obvious reasons. Even if it’s true, badmouthing existing investors will never get you new ones. You can’t say, “Well, they like us, but even though they lead follow-on rounds in 90% of their companies, they don’t like us enough to lead one for us.” You’ve just told this new investor that you’re in the bottom 10% of your investor’s portfolio. Now there’s no chance they’re going to invest. If the investor that knows you really really well doesn’t want to write a check, no one else will.

To prevent this problem, the industry has the habit of not leading follow-on rounds. Again, not that it never happens, but it can’t be the common pattern, because the company that breaks it gets a black mark. I’ve had many investors (including those invested in Puppet, the company I founded) tell me they follow this habit religiously, for exactly this reason. “Nope, as much as I like you, you’re going to have to get the money from someone else.”

Out you go.

Thankfully, venture investors recognize the downsides of this and build deep networks of firms and individuals who frequently work together. There are even later-stage firms who specialize in following specific investors whose track record they trust. But while this pattern was developed for good reasons, it also has downsides that no amount of networking or help can compensate for.

First, of course, it means most CEOs spend a huge percentage of their time either directly raising money or doing the work necessary to do so later. You might not have wanted to become best friends with tens of investors, but if you’re taking venture capital, that’s your job now. Given that investors are professional meeting-takers, they’ve got time to meet for coffee any time, so this can be hugely time consuming. Then when it comes time to actually raise a round, you should expect it to consume your life for at least three months. And that’s the success case.

This time sink is pretty bad if you live near all the investors you need to meet, but what if it’s a flight to the bay area instead of just a drive? Oh, if you’re one of the top companies they’ll come to you, but if you’re not, it’s one more way you have to work harder than the ones they love. It was only in our late-stage rounds we had luck getting investors to come to us, and we were only in Portland, an hour and a half flight away. I can’t imagine trying to raise money in a place that shudder needs a connecting flight to get to. I nearly killed myself in a rented PT Cruiser (the first available car at SFO) trying not to be late to an investor meeting, and of course, he passed on us anyway because I could not convince/did not want his buddy to join us as COO.

This all adds up to a massive tax on the companies that do succeed, where CEOs become experts in fundraising rather than experts in building great companies, which is, of course, stupid. But it has a much worse impact on who and what can get funding in the first place.

Again, put yourself in the head of an investor. You look at tens of potential investments a day, and you have far more opportunities than time or money, so you have your pick of what to invest in. On the one hand you’ve got a woman or a person of color pitching a company that sells to markets they deeply understand, maybe something more focused on customers who look like them. On the other hand, you’ve got a Harvard-educated CS grad who’s found another great use for AI in the cloud.

What we want is for the decision to be made based on what’s the best investment, who’s the best founder, but it’s not. It’s obviously not. If it were, you wouldn’t see such rank discrimination in the world of VC, where women and people of color are almost entirely excluded.

Instead, a key factor is whether the investor believes this person can raise another round. Note: It’s not whether the person actually can, because you don’t know that until you try it. It’s whether the investor thinks they can. And, of course, investors know that women and people of color don’t fit into the pattern of other investors, so they pre-discriminate in expectation that later investors would have anyway. I mean, why give someone $500k if the company won’t be able to raise another round anyway? You’ll lose all your money.

Like with all patterns, it’s as much about the company as it is about the founder. It’s not just about who gets money, it’s about what kinds of problems are worth solving, and what kinds of customers make good markets.

Silicon Valley has a well-known fondness for investing in products that solve the needs of white boys who just got out of college and are having to learn to live on their own, but less obvious is that this means they often consider other customers to be worthless. It is fantastically hard to convince an investor to back a product built for women, or people of color, or international buyers, when the investor is none of those things.

That is, it’s not just about investing in people who are different — it’s that their ideas are different, the problems they care about are different, and the markets they want to attack are different.

In a world where you’re taking risks, where you’re actually focused on brilliant founders in big markets, those differences would be positives, they’d be signs you can do something ground-breaking. But when that world requires multiple rounds of belief, where failure at any round destroys your company, suddenly those differences become reasons for people to say no, for companies not to get funding, for founders not to get support.

There are some firms out there, like K9 Ventures, who make these bets anyway and recognize that it turns their job into finding follow-on rounds for existing investments rather than just finding new companies. Too many investors either don’t see the consequences of this pattern, or preemptively admit defeat and just don’t even consider investing in a company that they are concerned couldn’t get another round.

Once again we see how a key aspect of venture, one that exists for good reasons, has pernicious consequences that help to explain how the world of venture works today, in all its glory and misery.

There’s no obvious fix to the problem, as either an investor or an entrepreneur, if you truly do need capital to grow but you don’t fit the pattern. One of your best defenses is to focus on profitability first, so you don’t need those follow on rounds and the levels of approval required to make them happen, but that’s not possible for every firm, and even when it is it can result in heavy compromises on growth.

Thankfully, there are now firms out there focusing on founders who are women and people of color. These firms will help in multiple ways. First, of course, they’ll provide the direct funding that is not currently available to so many great founders and companies, but second, they’ll begin to build out those networks of social proof that will enable these companies to get as many rounds as they need, rather than just the ones they can provide.

We’re going to need a lot more firms like that to truly unlock the potential of venture capital, to bring world-changing solutions to those who can get the most benefit, wherever they are and whoever they are. I’m hopeful that the competition these new firms bring will change the behavior, and the opportunity, of the existing ones enough to make the difference, but what’s really going to shift behavior is when the companies invested in by these companies start to deliver outsized returns specifically because they don’t fit the pattern.

That’s what I’m looking forward to.

Unicorns Distract Us from a Graveyard

luke@lukekanies.com (Luke Kanies) — Tue, 20 Feb 2018 00:00:00 +0000

Venture capital’s reliance on unicorns provides cover for the huge failure rate of startups, and investors make no effort to reduce it. Part 5 of a series

Originally published on NewCo Shift.

Venture investing is fundamentally uncertain. You’re making big bets on people, ideas, and markets that might never work out, and there are more ways to fail than succeed. As a result, investing has to take into account the likely failure of many efforts. If your financial model assumes each of your investments will be a success, you will have a short career indeed.

Many investors have written about how they need some companies to win big in order to cover for other companies failing completely. As a simple example, Fred Wilson at Union Square Ventures tells his investors to expect 1/3 of his investments to fail, 1/3 to return their capital (which is also failure; they sell for a small enough amount that investors just get their money back, and in most cases the founders and employees get nothing), and 1/3 to “succeed”, where his definition of success is that they return 5-10x the original investment.

He says his actual record is a bit better than that, but like Warren Buffet, he’d apparently rather set achievable expectations.

Let’s use some concrete examples. Remembering that most companies raise more than three rounds of funding, and keeping in mind that investors usually get about 20% of your company through each of those first few rounds, here’s what needs to happen to deliver that 10x return:

Your seed round is $500k at a $2.5m pre-money valuation, so you have to sell for $25m dollars. The investor gets $5m, and founders split $20m.
Your A round is $5m at a $25m pre-money valuation. Now your company has to sell for $250m. Each investor gets $50m, and the founders split $150m.
Your B round is $15m at a $75m valuation. Your target exit price is now almost $750m. By this time the founders own less than 50% of the company, but hey, if you can exit at that price everyone is pretty happy. Notice also that while this is a solid 10x win for the last investor here, it’s delivering close to a 300x return for the first investors (not counting pro rata costs). It’s nice work if you can get it.

Beyond three rounds, investors usually have smaller return expectations (e.g., 3-5x) but also have a shorter time horizon. That growth round investment of $50m is only expected to turn into $150m or so, but it needs to do it in 3-5 years instead of 7-10. Tripling a $750m valuation ends up being pretty hard in any time horizon.

It’s worth noting that if the company sells for $20m after that B round, then the founders get nothing. According to the preference stack (where the later investors all have priority over earlier ones), even with the cleanest term sheet the B and A investors get all their money back, but the seed investor, founders, and employees get nothing. In practice, the buyer will usually negotiate something for the employees and founders — you rarely buy a company without wanting some kind of golden handcuffs on the people who work there — but it’s basically a pittance. You’ve always got to manage your downside, even while you build toward the upside.

Note how quickly the exit price for the company escalates as you raise money. Realistically, it’s only once you’re around a billion dollars in valuation that you can consider going public, so if you’re smaller than that your only choice is to sell the company.

This model helps to explain the industry fetish for unicorns. The returns you get from a billion dollar exit swamp all the failures. And if those unicorns hide a lot of ills, the really big ones overwhelm even the successes. WhatsApp returned $3b to Sequoia on around $60m invested for a 50x return, which means every other investment in the portfolio could have failed and they’d have still made a ton of money.

You can see how the unicorns make or break a firm. How does this affect how they treat the rest of their portfolio?

When you know that a small percent of your bets end up mattering, you don’t worry much about any individual one, and that plays out in the world of venture capital.

Obviously investors don’t actually ignore the other firms; after all, they don’t really know which ones will win big. Equally, though, there’s no evidence they care whether any given startup succeeds.

Of course, investors would say otherwise: They’d say they work incredibly hard to help their companies, they work massive hours, answer the phone late at night, etc. Sure. I mean, they don’t put in nearly as many hours as the founders they’re helping, or even as much as a typical financier does (just thinking of the hours bankers put in these days makes me shudder) but I do believe they work hard. I do have a couple of anecdotes that show it’s not as hard as they’d imply, though.

I had one investor tell me that he loved the transition from operator to investor because the lifestyle is so much better. Again, this is from an investor class that publicly derides “lifestyle” businesses that generate cash for its founders but don’t scale massively. When I asked him about the hypocrisy of him working 9-5 but demanding his founders put in crazy hours, he defended it as their needing to lead from the front. Guess that tells you where the investors aren’t.

I also know a great investor who left a top-tier firm because he said he could not spend any more time working three days a week and being paid for five. Pretty honorable, if you ask me.

But mostly, yes, I do think many investors work hard.I just don’t think the work they’re doing helps their companies much.

Let’s walk through a couple of obvious examples.

Given the high probability of failure of a given investment, you’d think that the industry would be great at reducing the risks for their companies and thus increasing the survival rate. Not so much. For example, many investors have told me that the most likely reason for a company to fail is the team. Ok. So what do they do to reduce the probability that a founding team will fall apart?

Ah… nothing. No coach for each founder, no coaching plan, not even a packet providing best practices. Nada.

Their explanation for this is pretty simple: Coaches are expensive, and the investor can’t afford to have them on staff because the measly 2% on their $300m fund just can’t support bringing on staff to help founders. They could have the company fund it, but then that’s less money going to build the company.

This is the highest risk to your investment, and you’re literally not willing to spend any money mitigating it? Further, you’re tacitly recommending that your founders also avoid this easy bit of risk mitigation? Huh. Ok.

Investors will also tell you that the most valuable resource at a company is the founder’s time, and he or she needs to be laser-focused on building the business. It’s obvious they don’t actually believe that.

We’ve already established that founders will spend about a quarter of their time fundraising, rather than building the company. You could argue that this is the most valuable use of their time, but that’s only true in the sense that it has to be done and there’s no one else to do it. Most founders suck at fundraising and are tortured by their need to focus on that rather than building their business. Investors do help a little with this, but not so much that it implies the founder’s time actually is a precious resource. There’s a pretty clear sink-or-swim attitude around fundraising, even though success at it has little to do with the ability to build and run a company.

You see this same disregard for the founder’s time when you look at what they end up spending it on.

There’s a vanishingly small part of any business that’s truly innovative — maybe some part of your market definition or your solution itself — and everything else you do is disappointingly similar to what every other founder ends up doing. Great, so investors have figured that out and as part of their investment they deliver a playbook that uses the collective intelligence of their portfolio to help founders avoid having to make all the rookie mistakes, right? Hah! Nope!

The best firms do enable founders to talk and work together, but it’s all ad-hoc, and let’s be honest, that’s pretty minimal help. Every founder is basically doing a random walk around the possible solution space for “how to build a great company”, taking on huge technical risk with untried platforms and experimenting with idiocy like holacracy rather than focusing on the most important parts of their business, the one or two bets that will make or break the whole thing.

It shows how little investors are willing to do to help founders mitigate the biggest risks in their business, thus improving its probability of survival. If they cared about their portfolio companies making it, they’d specialize in helping them navigate the different phases of the company, minimizing probability of failure at each phase and especially when transitioning.

So now we see that it’s not just that investors are focused on unicorns, but also that the failure rate that those unicorns cover for is just irrelevant to investors. They know most of you will fail (again, they expect 2/3 to at best return their capital, which is failure in their model and even then only accomplished by a fire sale of the company). Heck, if you don’t fail and instead just continue on being neither a big sale nor a failure, they’ll have to push you into one or the other category in order to close their fund.

As I found running a growth company, success hides many ills. One of the biggest problems in venture capital is how much they let the success of their unicorns hide their indifference to the rest of their companies. This fails their founders, their employees, and the whole market, for no reason other than that it’s easier this way.

I’m convinced that a firm that directly invested in reducing its failure rate would have as many unicorns, but would also have more positive returns throughout their portfolio, and in the midst of building more companies and making more money, they just might do a little good at the same time. That would be a nice change.

Venture Capital Is Built on Serendipity

luke@lukekanies.com (Luke Kanies) — Tue, 20 Feb 2018 00:00:00 +0000

Software has the potential to increase productivity as much as electrification or steam power did, but its impact is stunted by its reliance on random interactions. Part 6 of a series.

Originally published on NewCo Shift.

The venture capital ecosystem bills itself as a meritocratic miasma of genius, with smart founders getting smart money from smart investors. In reality, there is an overwhelming reliance on privileged people bumping into each other at just the right time. This serendipity has spawned some great companies:

Warby Parker was started because someone in an elite graduate program lost an expensive pair of glasses.
Apple was started by a couple of guys who met at a hobbyist group in the computer heartland.
Google’s founders met when one of them gave a tour to the other when he arrived at Stanford for a CS graduate program.

But how many great problems are being ignored because we didn’t get that lucky alignment of particles?

The remodeling industry is a perfect example. It’s an 83 billion dollar market, yet it’s only now starting to see software solutions. The industry itself bemoans neglect by the software industry. The article linked above has some impressive stats about how much waste they experience:

“…studies suggest 30 percent of the construction process is re-work, 60 percent of labor is wasted, and only ten percent of losses are due to wasted materials”

Shouldn’t there be companies fighting tooth and nail over that market? Shouldn’t there be tons of solutions out there, spending money like Uber and Blue Apron are to acquire new customers and take a cut of the productivity gains?

Yet I’m in the late-stages of having a garage built at my house, and as far as I can tell software was only used during design, not actual production. One of the contractors we considered seemed to be an Excel wiz, but wasn’t using off-the-shelf software. How many months of productivity could have been added back into these teams’ lives if they had better tools? How much less disruption could I have experienced, and even, how much less could I have paid if my contractor could get three jobs done in this time because she was so much more productive?

(Did you notice that even I’m relying on the serendipity of my building a garage to illustrate my point that VC relies too much on it?)

In a rational world, every reasonably sized market would have a well-funded ecosystem of software companies vying to take it into the information age. When I got my home equity loan for the garage, I should have been inundated with offers from software companies to help improve the project. Heck, someone should have offered me the loan interest-free if only I required my contractor use their software. Instead, my project is late, costs me more, and makes less money for all the workers because it’s left out of the information technology revolution.

And that’s just one industry, chosen at coughrandomcough. What about all of the other industries the software kings have not yet anointed as worthy, filled with deeply skilled and energetic experts who aren’t lucky enough to run in the right circles, or live in the right zip codes?

Venture investors famously want passion for the problem they’re investing in solving, so much so that the companies also then demand that any employees also be passionate in turn. And we want our software companies started by developers, by product people, not by business analysts. Or carpenters.

So now to start a company you’ve got to have a software developer thrilled about and experienced in a problem, able to accept the risks that come with starting a company (e.g., health insurance and wage loss), who is living in or can move to San Francisco, and hopefully is a white dude who went to Harvard or Stanford. One way to look at that is how discriminatory it is, but another way is just how much you’re relying on everything lining up just right. It might be that you’ll find a Stanford-educated software developer who deeply cares about building houses and can take the leap into entrepreneurship. But what are the odds that that person has the right insight at the right time, and then can find the right people to partner with?

Twenty years in I’m still awed by the opportunity for software to connect, educate, and empower people, but I’m incredibly disappointed by how little of that opportunity we’re progressing against. I think our inappropriately slow revolution is in large part thanks to this reliance on randomness. We have got to get past this if we truly want to get the most out of software before the heat death of the universe (coming more quickly now with all the power being consumed to mine bitcoin). If we can build an environment that does not use serendipity as a crutch, I am convinced we can generate more great companies, and importantly these companies can cover a broader swathe of the economy, and be run by a more representative sample of the market.

Let’s look to biology to see how much of a difference shifting to a constructed environment can make. Living creatures are full of enzymes, which are basically proteins that speed up the rate of a reaction. These reactions are critical to the function of the organism, and without the enzymes speeding them up, life as we know it could not exist. (Conveniently, I did my senior thesis at Reed College on protein structure, so I’ve got some knowledge here.)

In most cases, the reaction that they catalyze (that is, cause to happen) would happen without the enzyme, but it would do so at a far slower rate. For instance, mammalian milk contains the sugar lactose. This sugar will break down in water into glucose and galactose of its own accord, but not quickly enough to digest all the lactose in milk you drink. Mammals have evolved the enzyme lactase, which causes this splitting of lactose into simpler sugars to happen much faster.

Enzymes are incredibly complex — lactase has 1927 amino acids in five separate groups, arranged in an amazing 3D structure: A rendering of the structure of lactase This huge structure is all necessary to enable the protein to place a lactose molecule near a water molecule in exactly the right arrangement to ensure the reaction happens immediately, every time, instead of eventually, sometimes. For all this structure, the site where the reaction takes place is quite small, just big enough for the two target molecules. Those 1927 amino acids mean the protein is about 37,000 atoms. Lactose is 35 atoms, and water is, ah, 3.

That’s a lot like designing a building the size of a sports stadium just to catalyze a meeting of two people.

How much quicker does the enzyme work? About 75% the world’s human population is lactose intolerant, meaning that if they drink milk as an adult, the lactose will cause adverse reactions instead of safely being broken down in the intestines. The rest express enough lactase that they are able to comfortably metabolize lactose, and thus can drink as much milk as they want. Again, remember that lactose breaks down in water on its own, just too slowly to be useful.

So here we have a situation where one of the major sources of calories around the world — cow’s milk — is enabled by this enzyme dramatically speeding up reaction rate.

What does this have to do with venture capital?

Again, venture today is heavily reliant on serendipity; that is, the right people bumping into each other at the right time in the right context. This is exactly how chemical reactions happen normally: Two molecules (e.g., lactose and water) live near each other, and every so often they bump into each other in a way that enables the reaction to happen. Most of the time, however, they fail to hit exactly the right setup, and nothing happens.

When the enzyme is present, though, its unbelievably complex structure ensures that the water and lactose molecules are placed into exactly the right orientation every time, and bam, magic happens.

The probability of a great company getting founded today is a lot like the probability of lactose degrading naturally: It happens, but slowly and infrequently.

I smile at the idea of complexes the size of sports stadiums built for speed-dating founding teams, but that’s not necessarily what I’m recommending here (although if that’s your plan, I’d love to consult on the project).

Even if we wanted to, I don’t think we could build a structure (physical or otherwise) like this, because we don’t yet understand yet what it takes to build a great software company, which means we can’t construct or evolve a perfect environment in which to make it happen.

All I really know is that what we’re doing now isn’t working. We’re not attacking the right markets, we’re not including enough people, and we’re not having a big enough impact on the economy.

For our ecosystem to be healthy, for it to be effective at transforming the industries that need it most, it has to do something differently. We can really only increase the rate of great company creation by increasing the rate of experimentation, or increasing the rate of success. Incubators and early stage investors are doing what they can to run more attempts in parallel, somewhat like a generative algorithm, but this is bound to have little impact because the goals — “be worth a billion dollars” — are so separate from the founding event. Investors are starting to figure this out and pull efforts back accordingly.

That leaves us the challenge of finding ways to increase the rate of success.

Of course, I have my own ideas for doing so, but I was always told as a leader my job was to present the challenge to the team and leave the problem of solving it to them.

Consider yourself challenged.

Venture Capital Is Ripe for Disruption

luke@lukekanies.com (Luke Kanies) — Tue, 20 Feb 2018 00:00:00 +0000

It’s time to develop new sources of capital for founders, to help them generate wealth through solving their customer problems without the massive failure rate. Part 7 in a series.

Originally published on NewCo Shift.

The venture capital world that funds the technology ecosystem appears to be specially designed to back the best founders working on the economy’s most important problems. This series has shown that it has instead evolved over time, with no higher purpose in mind than any other financial instrument.

This evolution is in many ways a strength, as by definition it is built on the successes of the past, but it leaves our ecosystem more blind than we realize. We can fear the fragility this engenders, but should instead see it as an opportunity to reach beyond its artificial limitations, to solve hidden or devalued problems. Technology funding’s demonstrated ability to change should give us confidence we can stretch it further, clearing new paths to success.

Wikipedia covers the history of venture capital better than I could, but it’s worth highlighting key epochs. The system as we know it was birthed by the windfalls from early funding wins, including DEC and Fairchild Semiconductor, so by definition there was no technology funding system in place at that point. Every deal involved people flying around the US collecting enough money to back a new venture.

These early big successes motivated a few people in the west to set up firms dedicated to funding technology companies — prior to this, the vast majority of American capital was in New York. Within a couple of decades, partially enabled by some regulatory changes in the US, there were enough firms around (including modern heavy hitters like Sequoia and Kleiner Perkins) that we had what felt like the first stable system, which of course led to over-investment and the first pull-back in the late 1980s.

What survived went on to fund the internet boom in the 90s, when a huge amount of wealth was created (and then destroyed) and this new ecosystem first made it into the public consciousness. Much of what we believe about venture capital comes from those days, but it was still changing quickly, with no seed funds, relatively small amounts of funding for software companies, and no obvious pattern of success.

Right now, the system looks dangerously stable. There are hundreds of seed and venture funds, all following the same playbook: Try to get their investments to the magic number of $1m in annual recurring revenue (ARR), raise an A round of funding, and keep on the funding train until you go public or go bust. There’s so much pattern matching going on that founders are contorting their companies to fit the funding schedule rather than discovering their destiny.

It’s important to recognize that this appearance of stability is a recent arrival. We might tell a story of how it’s a natural consequence of previous eras of success, but much of current best practice is cargo culting, copying the behaviors of the successful rather than understanding what made them work. If you step back even a little to gain perspective on the industry, you quickly see how much the system is still changing, and still needs to.

Don’t get me wrong: the system we have works. It is, essentially, functioning as intended, and any ideas or recommendations need to take into account not just what we dislike, but what makes it work. I hope this series has educated you somewhat both on how VC works, and why it works that way. As usual, when we dig deeper we find no villain at the heart of a web; we might not love venture capital, but it makes sense, and it works this way for good reason. And indeed, the system is working very well for a few people, and in the process is driving huge change in our economy and lives.

As much as the system of venture capital makes sense, we must ask: What sits outside? The industry generates money through positive feedback loops, but absence from the industry is merely an indication that something hasn’t worked, not that it can’t. What are we missing by doubling down on what we know, instead of exploring the unknown?

Investors are reliant on people near them, who resemble them, and who can absorb the weighty downsides of entrepreneurship. We’ve seen that investors don’t really know what separates great companies from bad in the early days, so they don’t strive to create the conditions necessary for gestation, and once a company is started, they do little for the winners and even less for those who fail. But don’t worry, all of this is hidden by the massive profits that the biggest winners generate for the top-performing investors, and the rest of the industry (while failing to meet its investment return goals) glides along in the afterglow.

(To think I was asked recently if I had become cynical about venture capital.)

It’s a funny thing. I grew up a communist (literally, on a commune) but have become a pretty big fan of well-regulated open markets (although they seem to exist only in theory; in practice we have lost the taste for effective regulation). A self-respecting capitalist can and should argue that this is a market, and it’s performing exactly as it should. I can hear it now: “Capitalism is inherently Darwinian, where evolution gives all prizes to the winners and the losers don’t live long enough to make it into the archeological records.”

It’s a fair point. Humanity can afford stretch goals like less collateral damage than the battle for life and death on the savannah, but we could ask for better even without that ideal. It took millions of years for nature to come up with the Dodo, only for it to promptly die off once it encountered outside species. How convinced are we that our apparently stable system is any more safe from an outside force?

The ultimate weakness in the Capitalist defense of venture capital is that for all the apparent competition we have a homogenous system. Shouldn’t we have multiple types of funding competing for the best companies and the best outcomes? That is, not competition between VCs who all work the same, but competition between different funding strategies?

Because there is no open market here. At best we have a dysfunctional oligopoly (is there any other kind?) with some churn at the top. For all the talk of disruption, everyone is trying to win by copying the winners, rather than seeking to disrupt them. The only people willing to step outside the current system are those who don’t have a choice because they aren’t allowed to succeed within it. Unsurprisingly, they find it challenging to compete not with another investor but with a whole system of funding.

As just one example, the most common barrier I hear to starting a new kind of venture capital is that the limited partners — that is, those who invest in the venture capital funds — would not be willing to support a new kind of capital. This is a perfect example of an ecosystem limitation, rather than a problem with individual players. I hear no argument that founders, employees, and customers don’t want competitive models; only that the source of capital would need to be educated, and that’s just too hard. Except… this whole industry is only a few decades old, and its creation required that same kind of education. Why should we expect a new kind of financing to be any easier to start, require any less systemic change, than the one we’re fighting against? And isn’t it ironic that an industry built on stories of disruption finds the idea just too hard for its own work?

That competition will show up eventually, though. We need it. There are too many software markets lying fallow, unfundable in the current model and thus deemed to be of no value. Someone will figure out how to finance those companies. And just as the first winners in venture were big winners indeed, the first few investors to step out of this world into a new one should make out like the oligarchs who laid the groundwork for our current world.

I’ve said before I don’t have the solution, but there are some market truths give me confidence there are better answers available:

The best way to make money is to hold high quality assets for a long time. If nothing else, Warren Buffett has demonstrated this is both the best way to make money and indefinitely scalable.
The majority of employment and wealth generation is provided by companies too small or too closely held to be public.
The steady state of good companies is cash-flow generation managed by long-term teams who take pride in their work. This is literally the entire history of for-profit enterprises. Any other solution must either fail or revert to this at some point. None of these realities show up in modern venture capital. Companies can’t run on venture capital forever (although try telling that to Uber), and do usually need to show a profit to be sustainable (I expect Amazon begs to differ), but the companies that do either of these are explicitly leaving the world of venture capital.

It’s unquestionable that the financing structure of venture capital is tied in to this separation from market principles. The risky software companies we build today are funded via a structure invented to support the risky ventures of the 19th century: whaling. Suddenly the term ‘venture’ in venture capital makes more sense, doesn’t it? (Tragically, even though it was the days of slavery, those whaling fleets had better representation in some ways than current tech companies, with up to 20% of their employees being African American. Wow.)

We’re using an incentive structure that works perfectly to support individual voyages that might last a couple of years. Is it any surprise it is not great at building companies that last for decades, or have a high survival rate? In fact, whaling had a better survival rate than current venture capital, with more than 80% of the fleet surviving, and delivered better returns (14% IRR on average, and 60% IRR for the best). The funding perfectly matched the ventures.

I should not need to say this, but whaling is unlike company building. It’s unrelated to developing a product, it has nothing to do with creating a new market. It’s inanity to expect a funding mechanism built for one would work as well for the others. The fact that it’s making some people rich, and it hits a jackpot once in a while, should not confuse us.

Venture capital’s apparent stability convinces me it’s at its most vulnerable. Instead of continuing to fund disruptors, I think it will itself be disrupted.

If you’re a founder given a choice between a firm that kills most of its customers and one with demonstrated success at creating long-running companies that generate wealth for everyone involved, why would you pick venture capital? The only reason you do today is because it’s your only option.

Founders want this competition right now. Some want to build Facebook, but most want to build a great company, help their customers by solving a critical problem, and hope to get rich along the way. They don’t want a lottery ticket; they want upward mobility, entrepreneurial fulfillment, and to feel like they made a difference. Unfortunately, low-probability gambling is all the venture world sells.

The new models will start at companies run by women and people of color, because they’re the ones shut out of the current system, but as they start to succeed, they will start to pressure to rest of venture capital, and we will see just how stable the system really is.

I have tried in this series to help you understand not just what venture capital is, but that what you love and hate about it are intrinsic to how it works. I hope this deeper knowledge will help you make higher quality decisions about how to involve yourself in this world. Even more so, I hope it convinces you to seek out, or even create, other ways of funding companies, other ways of building them.

It’s time for founders to have truly competitive options for funding. Let’s go make it happen.

Why the Most Successful VC Firms Keep Winning

luke@lukekanies.com (Luke Kanies) — Tue, 20 Feb 2018 00:00:00 +0000

In an industry built around investing large sums in uncertain ventures, the best companies seek out the best investors, and gains accumulate at the top. Part 3 in a series.

Originally Published on NewCo Shift.

Investing in software companies is inherently an uncertain activity. It’s called high risk, but highly uncertain is a better label. Yes, you’re taking a risk with money, but the real problem is the widely variant potential outcomes. If you invest in a restaurant, you are taking a risk but you will pretty much end up with a profitable restaurant, or lose your money. If you invest in a software company, you can go bankrupt, have a small but profitable company, sell for five times the money in, or end up with a world-spanning multi-billion dollar behemoth that turns everyone it touches into a millionaire. That dramatic range is why you can get a bank loan to start a restaurant but not a software company. It’s exactly why people invest in software, but also why it’s so difficult to do well.

There’s no proven method for managing that uncertainty. The most successful investors frequently get it massively wrong, and a playbook that worked perfectly in one circumstance falls flat on its face in so many others. Yet, even when they frequently make monumentally bad investments, the best investors keep delivering the best outcomes. If no one knows what separates the best from the rest, how can some firms or individuals keep winning?

Of course, many would disagree with my claim, they would say the best keep winning because they can tell a great company from a bad one, but if you look at the trends in venture capital you can see the industry as a whole has given up on a clear system, even if individuals still cling to deserving their greatness. Fantastically successful investor Paul Graham once said that he can be tricked by anyone who looks like Mark Zuckerberg. He’s since claimed that was a joke, but he built his empire by making more bets than anyone else, which is a strategy explicitly designed around the fact that he doesn’t actually know why some things succeed and others don’t. Disgraced investor Dave McClure started 500 Startups with the similar goal of just making lots of bets, rather than making any attempt at making “good” bets.

Even those who invest in venture capital firms have given up on knowing who’s best. Given a pot of money allocated to VC, limited partners will distribute it across many firms, knowing that they have to play many hands to get a winner. After all, the industry average return for venture funds is, ah, absolutely nothing. The winners win big, and the rest balance that out, so LPs need to put money in enough places to be confident they end up with the winners.

If no one knows the difference between the best and the worst, why do the winners usually keep winning?

Access.

Venture capital is all about access: Founders having access to capital, and investors having access to the best deals. If you’re a founder today and you have a choice between taking money from a top-tier firm that keeps delivering hits, or another firm you don’t know and who hasn’t done well, which do you take? Of course you take the best firm with the biggest network and most well-known brand name.

Similarly, if you’re an investor who’s helped take lots of companies public, how does your deal flow compare to those who are just starting out and who don’t have a reputation for building big companies? Of course the best companies come to you.

In other words, there’s an implicit matching algorithm, where companies that are obviously doing really well are able to work with what look like the best firms, and as a result they are able to reinforce each other’s success. The best firms look better because the best companies seek them out, and the best companies do better because they’re getting the chance to work with the best brands. (For all that I am skeptical of repeatable investment skill, I am a deep believer in the value of brands.)

Venture capital is defined by the asymmetric stresses pressed on investors and founders by the need for access; every entrepreneur stresses over how they’ll get access to capital, and every investor’s business model is built around managing deal flow. Entrepreneurs who already had a great outcome magically have no trouble raising huge amounts of money, and yesterday’s great investors have no trouble convincing today’s great companies to work with them.

This focus on access also helps to explain some of the churn the system experiences. If no one knows what makes a great company, how can the best investors always get access? They can’t. There are plenty of great companies that fail to get first-tier support early on. If they do raise money, then those who backed them end up looking like tomorrow’s geniuses, and the cycle starts over with them closer to the top.

This access-based sorting also helps to explain how the VC industry is so discriminatory. Less than 5% of investments go to women-led companies, and just having a woman founder ruins a team’s chance of getting funding , and the numbers are as bad for firms led by African Americans, for example. If we believed investors actually knew what they were doing, then we could only conclude that they were correct to exclude women and minorities from investments, that these founders just couldn’t build great companies.

Of course, the data clearly says otherwise: Founding teams with women on them significantly outperform male-only teams. Because investors don’t know how to pick a good company from a bad one, they are relying on access and reputation, and because they’ve never let women or minorities in before, they can’t now. Their “pattern matching” doesn’t hit here.

This matching algorithm that runs our industry is reliant on privilege and luck. Venture firms and founders are almost exclusively white men from expensive schools (with a huge proportion from just Stanford and Harvard), and if you were lucky enough to be an early employee at Facebook or Google (who have historically used the same sourcing requirements), then that’s a big leg up, too.

To be clear, I think some investors are much better than others, and entrepreneurs haven’t built huge, successful businesses out of sheer coincidence. It’s not that there’s no skill involved, or that the people who get so rich instead deserve nothing. It’s that skill is an over appreciated (and often small) part of what determined their success.

You will rarely find communities admitting that privilege and luck are what determine outcomes. Human nature itself has a deep aversion to accepting this. Instead, we do what humans have done forever: We develop myths.

Humans deeply believe that people get what they deserve, and deserve what they get, despite the evidence to the contrary. So many of our cultural biases are a story created to justify a reality we would like to perpetuate. For millennia we’ve been told that royalty was special, and that’s why they were in charge, when it was patently obvious that their ancestors were just the best and most ruthless at organizing enough troops to control a chunk of land. Genghis Khan was history’s greatest murderer, which enabled him to spawn kings and kingdoms that lasted for seven centuries, but you can bet his descendants didn’t use his skills at genocide as justification for their lofty positions.

Similarly, myths have grown around venture capital exist to explain the winners and losers. Somewhat like royalty, these myths help convince us that VC is more than privileged people using their positions to make lots of money. They must be winning because they deserve to win. Equivalently, people lose because they didn’t deserve to win. You could waste your life reading about how this founder got rich because they were smart and worked hard, or that investor succeeded because of their investment strategy, but you couldn’t consume a whole morning with the stories of equally smart founders who worked just as hard but went broke, or investors who applied that same strategy but somehow didn’t make it on the Midas list.

Thankfully, we’ve seen some really interesting experiments focused on eliminating access as a criteria for investing. Social Capital recently launched a programmatic investment algorithm, and Village Capital uses peer decision making between entrepreneurs. Backstage Capital was founded explicitly to invest in those who can’t get capital from the system as it exists today.

With these and related efforts, I’m optimistic that we can begin to peel back the myths about what makes a great investor, entrepreneur, or company, and instead begin building a more open market around investment and company creation. Only then can we hope to see venture capital include, enrich, and benefit all parts of the economy.

Moving Beyond Silicon Valley Software Companies

luke@lukekanies.com (Luke Kanies) — Mon, 02 Oct 2017 00:00:00 +0000

We need a new financing model to build new, better companies. Part 1 of a series.

Originally published on NewCo Shift

Two decades into a software career, I’m still moved by its potential to improve people’s lives through connection, automation, and access to information, yet I’m less convinced than ever that our financial systems are built to get the most out of it.

This is the first post in a series I’ll be writing on the structural problems in venture capital. These problems aren’t a condemnation of the industry, they’re an attempt to outline where the industry fails the market. This failure helps to explain people’s experiences, but I think also helps to outline the opportunity and need for other ways of funding companies. These ways will also have flaws - they’ll likely not be great at building unicorns - but they’ll be finding people and markets ignored by the current environment.

Like the general financial industry, the world of venture capital has become adept at using money to create more money, but it does not consider of the wisdom of its actions. It chooses easy answers, thus leaving harder but better questions unexplored, and accepts high collateral damage to the employees, customers, and industry that at best is painful and at worst is pure exploitation.

I am pulled to build more software that, like Puppet, helps people get higher quality work done in less time and with more joy. But that kind of utopian phrasing is used by every company in silicon valley, whether they do advertising arbitrage or sell you pet food, all while asking their workers to work crushing hours for lottery pay, no safety net, and 19th century ideas of labor force participation. The devaluing of women and minorities as either workers or buyers is both discriminatory and bad business. It’s true I’ve heard no overt support for child labor, but I expect that’s mostly because kids don’t have CS degrees from Stanford or Harvard.

I believe it is possible to design a kind of financing vehicle that is less subject to these flaws. There is a lot of money to be made in enabling the whole market to participate in the technology economy, and given that productivity has stalled since 2004 (coincidentally around the time that social networks and attention-seeking advertising-driven business models took over), there’s a lot of opportunity to deliver value by increasing productivity.

The major concern about increasing productivity is that it generally means fewer jobs, and the lowest-skilled workers tend to be first and hardest hit. I do actually believe in reeducation and the movement of labor to new opportunities, but you can’t ignore the trauma of career changes and industry churn. My work at Puppet showed that empowering people at the front line is how you drive both change and value. Too many industries focus on getting rid of the experts at the coal face, when instead they should look to elevate them. This would improve productivity while developing careers, instead of destroying them.

Unfortunately, venture capital is structured to require trauma to everyone involved except the investors. Too often, even the limited partners who are the source of capital suffer, with only a few firms delivering the kind of returns that the asset class purports to offer. The industry is built around making many bets and expecting most to fail. Even worse, every company who wants to participate must make a claim to be able to reach these heights, even if they don’t believe it, and then they must risk their own death attempting to keep that promise.

The model itself requires that companies either go public or kill themselves. Nothing else fits in the spreadsheets. Again, this guarantees trauma to nearly everyone involved - even the ones who make it out suffer the whole way, leaving a trail of burned out employees and failed customers.

I think there are amazing companies waiting to be created that can deliver life-changing benefits but can realistically “only” generate $30m, or $50m, a year in revenue. At 25% margins for software, these can be huge sources of profit, but a venture capitalist would derisively call that a lifestyle business and either not fund it, or force it to kill itself in an attempt to scale beyond its natural size. These can be great businesses, but because business funding generally fits into either conservative bank loans, or 10x-oriented venture capital, there’s no model today that respects them. Jason Fried and DHH at Basecamp have done a ton of great writing on this.

Jennifer Brandel, Mara Zapeda and others have launched the Zebra movement, focused on helping founders shut out of the VC world start companies that enrich themselves and their communities rather than their investors. I think this is an awesome effort, and has been an inspiration to me.

It’s true that this kind of company could not have as high a failure rate as venture capital does, but, ah, that’s not exactly complicated. I mean, VC literally requires failures of most of their companies, so I’ve got a nice anti-pattern to work against. There are well-worn practices for improving operations, people, and efficiency at even young businesses, but VCs haven’t bothered to invest in any of them, because again, they expect most everyone they work with to fail. Vista Equity, among many others, has shown that being more than dumb money can be more than just talk.

You might say there aren’t enough entrepreneurs out there, and all the great ones are focused on building unicorns in silicon valley. I say phooey. Tell that to the millions of people who start restaurants, corner shops, and franchises around the US. Frankly, tell that to all the people who pitched the valley but weren’t white men, or couldn’t afford to live in the bay area, and thus could not get funded. Because the valley itself refuses to believe great entrepreneurs can be women of color, or uneducated, or have a humanities degree, there is a long waiting list of great people ready to be given a little money and a little trust.

Silicon Valley today is baseball before Jackie Robinson, golf before Vijay Singh and Tiger Woods, tennis before Arthur Ashe and the Williams sisters. It’s the World Series with only North American teams, the World Championship game with only American athletes. It might do great things and be a great spectacle, but it’s weak sauce, because you know you’re not really competing with the best. In fact, you’ve structurally guaranteed you won’t, with all your stories of pipeline problems, lowering the bar, and various other grandfather clauses.

I do not believe in the primacy of ideas. I do not believe great entrepreneurs are in short supply. I do not believe we will run out of awesome opportunities in software in my lifetime.

I want to collect funding that will enable those unsupported entrepreneurs to reveal and develop their greatness, I want to build software companies in spaces that currently have no software, and I want to generate great returns for everyone involved without hemorrhaging people and money.

Yes, I know that means I have to find a different way to deliver returns to investors, because I don’t want my portfolio companies to have to sell. Yes, I know that means I will be creating a new asset class, with all the complications that entails around convincing LPs to invest in it.

The fact that others dismiss it out of hand for being impractical is exactly what excites me about it.

Please follow along in the rest of my series as I delve into the individual structural flaws in venture capital that I think outline what a competitive funding instrument must find a way around.