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Weekly Column

Rules of the Road: High Tech Startups Are Set to Boom Again, So Here Are Some Rules for Getting Rich, Then Getting Out

Status: [CLOSED]
By Robert X. Cringely

I sense change in the wind. After months of gloom and high tech despair, I am beginning to get a feeling that times are about to improve for those who want to start new companies. It had to happen, you know. There is so much money standing uninvested in venture funds that the taps had to open again sometime, and I think that sometime is about to begin. So get ready, you would-be entrepreneur, because I'm about to tell you how to play the startup game.

First, we must understand this period of slow investment, a time when more venture money was invested in New York than in Silicon Valley. What have the VCs been doing all this time when they haven't been investing in new companies? They have been sweeping out the financial detritus from the dot-com meltdown, consolidating portfolio companies in an attempt to minimize the overall effect on their books. But mainly, the VCs have been rushing about soothing their limited partners, the folks who actually provide the money. Those limited partners, after decades of 80 to 100 percent annual returns, lost money last year. They don't like to lose money. Who would? So their General Partners (the VCs) have been jetting all over the country trying to hold together the venture funds they built so easily in 1998-2000.

But now I think they are ready to start spending money again, so it is time to get our ideas and business plans ready. If it seems early to you, think again. By definition, startups have to come first, so if the market still seems sketchy that's because public companies are lagging indicators of startup activity. Trust me, things are about to boom. But forget the wacky times of a couple years ago when any idea on the back of an envelope seemed to get funded. Now we're back to a more realistic venture climate reminiscent of the 1980s. So here are my rules for how you, as a would-be entrepreneur, should behave.

Conventional wisdom says that nine out of 10 startups fail. My friend Joe Adler, who eschews conventional wisdom in favor of statistics, claims that the real numbers are even worse. He says that 19 startups out of 20 fail. And since Joe has done both successful and unsuccessful startups and teaches a class about them at the Stanford Graduate School of Business, let's believe him.

If 19 out of 20 startups fail, then it seems to me that the books on how to be successful in Silicon Valley are taking the wrong approach. My guide will let success take care of itself. Instead, I'll concentrate on the much harder job of how not to fail. High-tech startups fail for only three reasons: stupidity, luck, and greed.

Starting a mainframe computer company would be stupid. In general, starting a company to do any me-too product, any non-state-of-the-art product, or any product in a declining market would be stupid. My guess is that stupidity claims 25 percent of all start-ups, which would explain five of those 19 failures. Fourteen to go.

No start-up I know of ever failed because of good luck, but bad luck takes as many companies as stupidity does — five out of 20. Bad luck comes in the form of an unexpected recession that dries up funding. It often means the appearance of an unexpected rival, introducing a better product the month before yours is to be announced. And it even means getting loaded on the day your company goes public, driving your new Ferrari into a ditch, and getting killed, scotching the IPO. That's what happened to the founder of Eagle Computer, an early maker of PC clones.

Tip one for would-be entrepreneurs: Avoid stupid and unlucky people. If you are stupid or have bad luck, don't start a high-tech business.

That leaves us with greed, which I say causes at least half of all high-tech start-up failures. If we could eliminate greed entirely, 10 out of 20 start-ups would succeed — 10 times the current success rate.

Greed takes many forms, but always afflicts company founders.

Say you want to start a company, but can't think of a product to build. Just then a venture capitalist calls, looking for someone working on a spreadsheet program for the Acme X-14 computer, or maybe it's a graphics boards for the X-14 or a floating-point chip. Anyway, the guy wants to invest $2 million, and all you have to do to get the money is tell him that's what you had in mind to work on all along.

Don't do it.

After the success of Compaq Computer, every venture capitalist in the world wanted to fund a PC clone company. After the success of Lotus Development, every venture capitalist in the world wanted to fund a PC software company. After the success of Netscape, every venture capitalist in the world wanted to fund an Internet company. They threw tons of money at anyone who could claim anything like a track record. Those people took the money and generally failed because they were fulfilling some venture capitalist's dream, not their own.

We're talking pure greed here, on the part of both the venture capitalist and the entrepreneur. VCs love to do me-too products and have had a tendency to fund simultaneously 26 hard disk companies that all expect to have eight percent of the market within two years. It doesn't work that way.

Tip two for would-be entrepreneurs: Do a product that you want to do, not one that they want you to do.

Or maybe you already know what your product will be, and one day a venture capitalist drops by, hears your idea, and offers you $2 million on the spot in exchange for a large percentage of the company.

Don't take it.

Startup founders generally have only ideas, charisma, and equity to work with. Ideas and charisma are cheap, but equity is expensive. To make a start-up work, the founder has to divvy out parts of the business at just the right rate to keep everyone happy until the product is a success. Give away too much of your company too soon to a venture capitalist, to your co-workers, or even to yourself, and you risk running out of distributable shares before the product is done. And that probably means the product won't be done. Ever.

Tip three for would-be entrepreneurs: Don't take venture funding too soon.

If you are doing a software product, don't take venture money until you need it to introduce the product. If you are doing a hardware product, don't take venture money until you have used up all of your own money, your mother-in-law's money, and everything you can borrow.

Bootstrap. Rent, don't buy. Don't hire people to do things you can contract out because contractors don't require stock options. Don't hire marketers too soon because that will only dilute the equity pool available to the technical people who are finishing up the product. You don't want to alienate those guys.

In fact, you don't want to alienate anyone. As founder, your job is to keep everyone else happy by giving away your company. Give it away carefully, but give it away, because not doing so guarantees you will be the majority shareholder in a worthless enterprise. Don't be greedy.

As the founder, the man or woman with the grand plan, your function is to manage the distribution of your own holdings so that you end up with fewer shares but more wealth. The idea is to end up with a thinner slice of a thicker pie. When Bob Metcalfe started 3Com Corp. in June 1979, he owned 100 percent of nothing. When 3Com went public in March 1984, he owned 12 percent of a company with a fair market value of $80 million.

Tip four for would-be entrepreneurs: Invite me to lunch. I'm a cheap date.

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