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RESEARCH TRIANGLE…An entrepreneur came to venture capitalist Frederick J. Beste, III, late in the 1980s and complained his 50-50 startup partner no longer showed up early, stayed late or came in on weekends.
Beste himself is a partner in Mid-Atlantic Venture Funds. Mid-Atlantic has invested in “a handful” of North Carolina companies in addition to its Mid-Atlantic region investments. NC investments include Trinity Convergence and TapRoot Systems. Durham-based Intersouth Partners co-invested in both deals and Kitty Hawk Capital, Charlotte, also invested in Trinity.
North Carolina entrepreneurs and venture capitalists are probably more familiar with his Reston, VA based partner, Tom Smith, Beste says. But anyone starting a company should be familiar with his article citing 25 entrepreneurial death traps.
Beste says the entrepreneur who asked him for advice about an under-committed partner sparked composition of his list. After talking to him, Beste grabbed a piece of cardboard off the floor of his car, turned it over and began writing them down.
Since then, Beste has cited the paper in numerous talks to venture conferences and groups, although it’s been a decade since he last spoke at an RTP conference.
“I’ve written a number of papers, but this one may be the most important,” Beste tells LTW. “I never deliver it without entrepreneurs coming up to me and saying they wished they had heard it a year ago.”
Catalog of errors
The 25 death traps he cites are a catalog of entrepreneurial errors. However, they’re far from uncommon. “Those mistakes are natural, human mistakes, and unless you find out about them beforehand, they’re traps,” Beste says.
Unfortunately, the traps can break a company’s legs or kill it just as surely now as when he wrote them, Beste says.
The saddest failures he has witnessed, he notes, “are the conceivably predictable, lethal ones that could have and should have been avoided.”
We’ll only take a look at the first ten of his 25 company killers. You can find the rest online at the Venture Capital Institute’s Web site (see link following this article).
The first relates to the entrepreneur who asked advice about his less committed partner. Beste calls it the 50-50 partner trap.
It is natural and normal to start a company with friends and decide to share everything 50-50. With more than two people, this particular trap expands to become The Three Musketeers (or four or five Musketeers) trap, Beste writes.
“It’s human, be the Three Musketeers, all for one and one for all. Hello? Where’s the leader?” says Beste. In a company, someone has to take the role of chief executive officer and everyone else has to treat him as such,” Beste warns.
Garheng Kong, a partner at Intersouth, tells LTW, “We run into that all the time. Founders who have worked together, all want to be equal and take the same salaries. But it doesn’t work like that. There are not four equal jobs. There are different roles, all compensated differently.
“You disagree sometimes and then you have to agree on something. That’s when structure and organization comes into play. The CEO, right or wrong, ultimately makes the decision,” Kong says.
Your friend is gross
Next, on his list, is the “one or two customer over-reliance trap.” It may give your startup a heckuva roll if its making $4 million selling to one marquee customer, but the drop is just as steep if that customer is lost. The vagaries of doing business are such that you can’t rely on one or two customers as permanent, Beste notes.
Perhaps the trap we’ve seen most often as a journalist covering startups in North Carolina: “Mousetrap teams.”
That, Beste writes, means “a handful of brilliant scientists or engineers disappear into a basement and emerge six months later with an absolutely gee-whiz prototype.” In short, he adds, they “have invented a better-mousetrap. The world, though, to their great frustration and confusion,” does not beat a path to their door.”
If no one on that team ever commercialized a product before, that really should not be surprising, says Beste. “Doing this (commercializing a product) well is every bit as difficult and specialized as coming up with the product itself.” Having one member of the team with this talent, preferably the CEO, “absolutely critical,” he says.
Intersouth’s Kong adds, “My phrase for it, ‘finding the world’s first cure for a hangnail.’ Who cares?”
Beste quotes Bill Stolze’s book, “StartUp,” which says, “there is no startup strategy more likely to fail than one predicated on being the lowest price competitor.” Beste adds, “gross margin is your best friend. It can absorb all manner of adversity.”
Kong adds, “A startups’ advantage is in the technology and the margin. Try to compete on pricing and distribution early, you will certainly lose.”
Know the market
Insufficient startup capital dooms many, says Beste. “History shows that 90 percent of the time, first year sales and gross margin do not reach projections for whatever perverse reasons. Don’t start a company if you cannot come up with more capital than you think you’ll need.”
Entrepreneurs need to be optimistic, adds Kong, “But the reality is that it doesn’t quite work out. It’s a truism.”
Beste also warns entrepreneurs they need to know their market. Deadly traps crush the running legs of companies that ignore such matters as the downside or industry norms, leading to over optimism. “Counting on industry-unrealistic performance has drained many an initial capitalization,” he says.
Beste suggests, “With minimal effort, you can learn via trade journals, annual reports, annual statement studies, whether your industry is closer to a 30 percent or a 55 percent gross margin, or its top performers earn 4 to 18 percent pretax.”
“Lack of focus,” is trap nine. “Sort through your opportunities before you start,” Beste cautions.
Kong says entrepreneurs often do have an inside scoop on their industry, but then fail to look at the larger industry picture. “You need that inside scoop on top of overall market research,” he says.
“Bringing on the vulture,” trap ten, notes that “while all money is green it is not equal.”
Beste notes that there are real vulture capitalists out there who are “obstructive, controlling, heavy-handed and mistrustful.” On the other hand, there are “real gems, experienced, connected, and supportive.”
How do you tell a jerk from a gem before the fact, he asks? He suggests two things: ask service providers, lawyers, accountants, bankers. “They know who the bad guys are.”
Also, he says, ask for as long a list of CEOs of companies the VC backed and “grill them mercilessly.”
“Not all investors are created equal,” says Kong. “Doing due diligence on management partners is critical. One bad investor or board member can really ruin it for you. They can hold out on a transaction, cause management to chase down rabbit holes. Talk to those CEOs.”
(We’ll take a look at 11-25 in a future column).
25 Death Traps: www.vcinstitute.org/materials/deathtraps.html
Intersouth Partners: www.Intersouth.com