The First Crucial Decision: Choosing a Location

It’s not obvious to most new entrepreneurs, but location is your first crucial decision. Distance from founders, distance from a supporting business ecosystem, distance from your likely new hires, distance from customers, distance from board members and investors, access to mass transit, the duration and costs of the lease, the ambiance of the environment—all these, and more, play a role.

The venture has a chance to be anywhere in the world, although the founders and investors often have distinct preferences. Investors are usually most helpful if the venture is close to them, particularly if you’re just starting. They can use their network of entrepreneurs to provide assistance in recruiting team members, lawyers, and financial and HR consultants. They can easily visit the company to give advice and support, and they can be an asset in building relationships with customers and partners.

There is a good reason venture capital firms tend to concentrate their investments in a few geographic areas, such as California’s Bay Area. The infrastructure for supporting young technology companies is highly developed in such localities, and it can reduce the cost of operations and speed a productive start. Excellent, experienced talent can be recruited locally. Generally, such attractive locations also have good educational facilities and a good university that provide a source of talent.

There is also an intangible but highly valuable element of “being in the flow.” In hot spots such as the Bay Area, entrepreneurs and venture capitalists network with each other, assist each other, and share ideas with each other. Speed and agility are fundamental assets for a start-up, and introductions to talent or companies can take hours or days, as opposed to months. Knowledge about competitors and important events comes naturally and quickly. Breakfasts, lunches, and dinners become opportunities to learn and build.

The contrast between building companies in California and in Troy (in upstate New York) was vivid to us in one of our ventures. Recruiting was much harder in Troy, a city the entrepreneurs had selected because they had worked at a GE facility in the area and had no interest in moving their homes. Experience showed that even though it was possible to hire engineers trained at the local universities, it proved extremely difficult to attract top-quality senior managers with the right experience. Such people, if willing to take the job, often wanted to commute weekly from New York or Boston. Some were willing to move, but for others moving families was not an option. We’ve had the same experience with executives offering to commute from San Diego to San Francisco. The consequence was that many senior managers who joined became commuters, staying near the company during the week and returning home on weekends. This is not a satisfactory long-term arrangement. It cuts the time that people can productively devote to their jobs, and being separated from their families adds an emotional burden that is best avoided. In virtually all our experiences, these arrangements are an invitation for a short tenure.

Of course, California is not the only place to build technology companies, and there are sometimes good reasons to choose other locations. Many other cities offer attractive locations. For example, when a promising opportunity surfaced in a small town in New England, the founders and senior management decided to move the small start-up team to Atlanta, Georgia, because its products addressed the manufacturing industry that was concentrated there. The move placed the company close to its customers and other software companies serving the industry, and attracting high-quality people was not an issue.

Because technology development is widely dispersed, you cannot be dogmatic about the location of talent. Although concentration of resources in young companies is desirable, you can at times make arrangements to work with product development in one location and the CEO and other organizational elements in another location. For example, with many Israeli companies the technology continues to be developed in Israel, but executive and other functions move to places like California, Boston, or New York.

Location may affect the value of the company if it is the target of an acquisition. Acquirers evaluate the entire business, with the greatest emphasis on the team. If the team is widely distributed, acquirers will have significant concerns as to whether they can integrate employees effectively into their company.

Finally, when you choose a location, be guided by the principle that even though you should not spend money on lavish quarters, there should be enough space for a projected two or three years of operation. Your quarters should be attractive. Shabby quarters repel potential recruits and customers.

Financial Management

Most ambitious companies seek capital investment at some point, either to fund the venture before the point of revenue and profitability or to accelerate their growth. This means that you’re using financial resources from investors to reach the next stage of investment or profitability. Entrepreneurs of fast-growing companies are always preparing for the next funding rounds, with new investors in each round, from seed to A to B and beyond. The challenge is to reach the next round of funding having achieved the metrics that are attractive to new investors. Therefore, it becomes essential to conserve cash to give the team the time and resources to achieve these metrics. As a result, the two most important metrics for all ventures are their burn rate (the monthly rate of use of available cash) and runway (the number of months of available cash remaining).

One school of thought argues that profitability is not a major objective, at least in the early years. We disagree. Of course, investing in growth is a key necessity, but you should strive for financial viability and then balance internal investments accordingly. Viability means that the business generates the cash to build its near-term future, and reaching that objective should be a constant target of your attention. Stay lean! Rent or lease rather than buy assets. Permanent employees are the backbone of the organization, but people needed for limited periods are best hired as contractors. Or you can pay for results. To give the venture the cash runway needed to succeed, avoid fixed costs as much as possible. The cardinal sin of any venture is to run out of cash.

Building the Organization

Starting the company means going from the camaraderie of the planning stage to the stress of the operating stage. This shift is difficult, because the early members of the team now find themselves in an environment where their activities are monitored for effectiveness and their CEO and visionary leader becomes their real boss.

You must define an organizational structure from the start (subject to change with circumstance). It is not possible to hold people accountable if their responsibilities are not clearly defined. This means that you need to define reporting lines, along with responsibilities and timelines—a transition that is always painful. The starting team feels like a family, but with the addition of new people it soon becomes clear that chaos will be the result of poorly defined roles. We have seen young companies with as many as thirty people who claim to report to the CEO. What this really means is that either no one is being managed or the CEO has improbable supernatural skills of management. More than seven or eight reports is usually too many.

We’ve also seen organizations with ambiguous or overlapping roles, or roles that are divided to satisfy the egos of some team members. This issue will almost certainly result in team friction as well as product and milestone delays.

Part of the wisdom of organization is to make sure that critical activities such as product development and marketing are closely coordinated and that the CEO focuses on the issues that are driving the company forward. He should not worry about office layout or administrative matters but instead needs competent people to manage them.

Product Management

After you launch your business, the first glow of planning the future is over, and now hopes must be translated into products that meet your financial goals: reaching profitability. That’s because profitability spells independence from the constant fear of running out of money.

That successful translation is what distinguishes winners from losers. Poorly run organizations start with product dreams but flounder in product delivery. The reason, seen over and over again, is a failure of product management, the objective of which is to deliver successful products at the right time to the right market. Because terms are commonly used without proper definition, table 7-1 clarifies the various roles. Such discipline must be put in place right from the start, and the difference between doing it well and doing it badly separates successful companies from failed ones.

The process of getting products to market starts with defining what to make and how to make it (product management). Product marketing defines how to sell it, and project management defines how to execute the project. Unless all three roles are assigned and managers are responsible for working together, winning products will not see daylight. Either customers won’t want it, or it will be too expensive, or it will never be finished within a time frame when customers are willing to buy it.

Following this disciplined approach to product development does not mean that you outlaw creativity and prevent prototyping of new ideas. Rather, it means that you make significant product investments within a disciplined framework.

Early Customers and Early Revenues

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The difference between customers saying they will buy a product and having them write a check for the product is night and day.

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From writing the business plan to actually bringing the product into the market can take years. Being in the market reveals new conditions that may require significant changes in tactics or even strategy. As we said in chapter 1, frequent pivoting is never a good choice, but when faced with changes that threaten the company’s survival, you need to have the flexibility and talent to adapt.

A thoughtful business plan identifies customers and channels to market. It also identifies the beachhead market (or base camp), the first place to target with your first product or service. Now is the time to enter the market, even though there is the risk of making premature commitments or tipping off potential competitors. You have no choice. If market conditions have changed so much that the early business plan assumptions are proven wrong, then you need to make changes—sooner rather than later, when you’ve spent a great deal of money developing the wrong product.

Avoid the trap of becoming a custom product vendor by delivering to only one or two big customers with unique requirements. For example, in a start-up with a manufacturing management software product, the idea was to develop generic software for midsize customers who wanted a solution that was simple to implement and use. But the company found that the market price was too low to justify the marketing costs, and management decided to seek larger customers and sell its software with bigger price tags. Toyota USA was the first identified customer, and the strategy sounded great—except that the solution Toyota wanted was suited to car manufacturing and no other manufacturers. Our company developed a custom solution for Toyota not usable by most other customers.

This was a sobering lesson in failure of product management. As the company used this implementation as a reference site, it discovered that every large company required something unique and that the cost of developing solutions for each of them exceeded the revenues they generated. Eventually, as revenues grew, losses increased as development costs spiraled upward.

For similar reasons, many investors avoid ventures that seek to serve government as their primary customer. Such ventures also tend to become too dependent on a single customer, and the government often moves very slowly. It can mandate levels of revenue and profitability, often not in a direction that allows for rapid growth and scale. It is wiser to build your base of customers step by step rather than depend on a single customer long term.

New, attractive markets don’t grow overnight, or as fast as start-ups might like. It takes ingenuity to survive in slowly developing markets. For example, when SanDisk developed the flash memory technology, their anticipated high-volume market was consumer digital cameras. This market was late in emerging, and in the interim, founder and first CEO Eli Harari noted, “We turned over every possible market corner to find customers of any size for our product. Our investors were extremely anxious to see early proof of the value of our product vision.”¹ It takes conviction, financial discipline, and extraordinary talent to transition through such slow build-up periods, but it can be rewarding.

Beware of Beguiling Corporate Partnerships

Inevitably, ambitious business ideas will involve relationships with big companies. In the case of international operations, such relationships can be critical for operating in certain countries. Our advice is to not shy away from corporate relationships—which can be unavoidable and valuable—but rather to learn to manage them.

There was a time when incumbents could ignore young upstart companies because of the incumbents’ confidence that their positions were not vulnerable. For example, the old AT&T monopoly did not have to worry about start-ups impacting its business. But this situation has changed. Technologies change rapidly, and every company is vigilant. Many of them maintain what they call “business development departments,” with the mission to assess competitive threats and recommend relationships and acquisitions of young companies that could threaten or expand their own business footprint.

As you develop an excellent management team with great ideas, it’s likely you will attract the attention of some of the major companies. The lure might be to share product development, establish distribution relationships, or receive direct investment, with access to company information or technology.

We can’t say strongly enough that you must be cautious when this bait is dangled. Big companies sometimes exploit young ones by making vague commitments. The new venture puts up cash, time, and management energy, and the corporation promises future benefits such as market access or a major revenue contract that may never appear. The benefit for the major company is to learn about the new technology or even potentially to compete—but often they intend no firm financial commitment. This kind of relationship can rapidly deplete your resources and move you away from your primary market and product.

Consider our experience with a start-up that was marketing a radically new chemical metallization technology for building products (such as cell phones) with much higher component density on the printed circuit board. It seemed that contract manufacturers that made products for major vendors, such as Apple, would be eager to exploit this technology. In fact, the contract manufacturers showed strong interest in getting an endless series of samples that demonstrated the value of the technology, but they were never willing to commit to funding the work done. Whenever the question of payment came up, the answer was always that trials were ongoing and that a contract would be funded when tests were completed to satisfaction. When finally the samples indicated great promise and the contract manufacturer was approached for investment, it made a ridiculously small offer, thinking that it held the keys to the only path to success for the emerging venture. It is hard for young companies to be tough in such situations. Who knows whether you’re neglecting a great opportunity by refusing to do some free work?

The short answer is that with limited resources to invest in market development, the key job of management is to decide which companies are actual potential customers and which are in the learning mode. If the value proposition is compelling, costs should be borne by the big company. Only the naive subsidize the learning experience of multibillion-dollar corporations.

Some corporate relationships can be extremely valuable, but only when the venture has leverage. SanDisk, for instance, established a business relationship with Toshiba Corporation in Japan and a number of other large companies for manufacturing access and licensing of technology. Here SanDisk benefited in two ways: first, by gaining revenues from licensing its technology to other companies (with restrictions) and, second, by gaining access to manufacturing facilities under agreeable terms. But these relationships worked because multiple partners could be played off against each other and because SanDisk had broad patents that stood the test of time and defeated legal attempts to bypass them.

Leave Room for Serendipity

The world changes rapidly, and the best plans in the world may prove impractical. On the other hand, new, even superior opportunities may arise as fast as old ones disappear.

Level One Communications, founded in 1987, was based on breakthrough chip technology for transmitting data at megabits-per-second on ordinary existing copper phone lines at a time when high-speed data communications required coaxial cables. The company was founded by Robert Pepper, a brilliant manager and technologist who became an outstanding CEO. The value proposition was that the infrastructure for transmitting high-speed digital data over copper phone lines was much cheaper than using coaxial cables.

What was missing was a market entry point, because Level One offered a chip technology and not a complete communications product. Therefore, the company worked with several customers to implement its technology into their network products. A contract with IBM implemented the Level One solution in local area networks, but it met with disappointment because of the slow acceptance by industry customers. In fact, IBM canceled a chip development contract that was the only source of revenue for the company. This is not surprising for new markets, as noted earlier. But there was a happy ending, thanks to brilliant execution and the recognition of the right technology.

When, in 1990, Level One was about to run out of money, a new Ethernet industry standard emerged for 10 megabits-per-second data traffic on ordinary copper telephone lines. The company was ready with the best technology (and funding from Warburg Pincus) to exploit this massive new market that transformed the world. Level One focused its development and marketing efforts on producing and selling novel chips that eventually found their way into most of the computers produced in the world. This explosive growth occurred because the equipment industry adopted copper wire lines for local area distribution after a standard was set. Being patient paid off. Level One emerged as an industry leader in the Ethernet chip business and related products, had a public offering, and in 1999 was acquired by Intel for $2.2 billion.

As we have progressed through the book, we have focused on planning and establishing the foundations of a new business. Navigating through such difficult waters presents no shortage of challenges, and ventures unable to get through this difficult phase need not worry about a future that will never come. However, many do get into the build-up phase and then their progress is limited by common mistakes—many of which are avoidable. In the next chapter we list those common mistakes.