Dr. Earl R. Smith II

By Dr. Earl R. Smith II

Barely one out of ten start-ups survives the first five years. Of the remaining less than twenty percent make it to the tenth year. Understanding the process of starting a business is best something other than a purely intellectual exercise. In an important sense it is one of the biggest challenges facing any entrepreneur. I limit my work with new companies precisely because such fundamental understandings are often lacking. The process of gaining the required insight can often take years - and may, in some cases, never be gained.

After years of working with dozens of entrepreneurs - and starting half a dozen of my own companies - I have developed a screening process which has proven very helpful in identifying those entrepreneurs and start-ups which are most likely to succeed. This has allowed me to concentrate my efforts on the relatively few which have very good chances of succeeding. Here is a quick review of some of the items on my list:

Focus: This is always my first screen when getting to know a start-up team. I look for an imbalance in their understandings of the challenges which they face and pay particular attention to the prioritization of goals and metrics which they have decided on. My attention focuses on the presence or lack of the tendency to develop and implement plans to accomplish the single most important goal during the start-up phase - turning potential clients into paying accounts.

Within the military there is a useful saying - ‘In war, amateurs talk strategy while professionals talk logistics.’ I often encounter CEO-wannabees whose vision of the world and their business seems to be based on a radical overestimation of the importance of their business and a radical underestimation of the indifference of the world towards that business. They spend all their time talking about the strategic importance of what they are doing and almost no time focused on tactical implementation. The logistics of turning potential clients into actual ones is what they should be focusing on. Success in this area demonstrates both the ability of the team to develop and keep clients and the inherent benefits of the company’s value proposition.

Customers and markets: This leads me to my second screen. Here my rule is ‘amateurs have markets and professionals have customers’. I have lost count of the number of times that someone has made a presentation which included a statement like - ‘it’s a twenty bullion dollar business and if we get only 1% of it … ’. My response is always, ‘well come back when you have .000001% of it and we’ll talk.’

The primary objective in any start-up is to get clients from among the population of potential clients and have them pay for whatever the company is offering. If they can’t do that, then the CEO is not running a company - it’s a senior-class project. The fact that they did a Google search and uncovered some estimate of their market is irrelevant. The fact that they have companies - clients - who are running business better established and more successful than theirs and are willing to actually pay for their product or service - is an affirmation of the attractiveness of the company’s value proposition and the strength of the management team. In fact, it is the only measure that really matters.

Anti-humanism: I am always on the lookout for refugees from life who are parading as entrepreneurs. Most often these people have not been able to make it in larger organizations - mostly because they don’t deal with other people very well - and have a strongly anti-social tendency.

There are several characteristics of these people that are worth mentioning. The first is that their commitments are generally worthless. They tend find the fact that there are other people on the planet an irritation and inconvenience. They consider commitments to them are disposable. Second they don’t tend to build real teams. I might find a loosely organized gaggle around a CEO but nothing even approaching an effectively operating team. I have encountered ‘entrepreneurs’ who have assembled very impressive teams and advisory boards which are completely non-functional. When you boil it all down you find a single individual bearing most - if not all - of the burden of getting the company off the ground.

The trick to understanding this phenomenon is that, within the ‘entrepreneur’s’ mind, the company is an intellectual exercise which is inconvenienced by the fact that other humans actually exist - inconvenienced by the fact they might actually have to rely on them to solve the complex challenges that every start-up faces.

Finally, start-ups run by these people tend to be free standing - meaning that they do not seek out and build stable working relationships with better established and more successful companies. If partnerships are established at all they tend to be informal arrangements which are mostly unproductive.

Communication patterns: I pay attention to the patterns of communication which an entrepreneur uses - particularly during my initial interviews with them. Most of the problem types aren’t able to recognize the depth or complexity of issues which their company is facing - or they want to avoid those depths and complexities altogether. If I find myself constantly saying - ‘well, before we move onto that issue, let’s finish our discussion on the last one’ - it is a pretty good indication that this person is approaching our conversation as an intellectual exercise.

Also, I have found over years of working with and studying entrepreneurs - successful ones, that is - that the really good ones are compulsively extensive communicators. They discuss important issues and opportunities with everybody they trust and see as potentially contributing to the possibility of success. The important goal is focusing all available resources on meeting the fundamental challenges that a new company faces - the foremost of which is the establishment of a growing customer base.

Attitudes towards risk: Here is one of the biggest myths about entrepreneurs - that they are risk takers. This ‘red herring’ is generally promulgated by academics and writers who have never been through the process of successfully launching a business. My first study of entrepreneurs was done while I was an MBA student at the Sloan School of MIT about three decades ago. We were studying the Route 128 entrepreneurs - a particularly successful group. What we found was that successful entrepreneurs are incredibly good at estimating and aggressively mitigating risk - in fact they were, if anything, risk averse!

One of the ways we discovered this was the ‘ring-toss game’. It is a deceptively simple game. You get a bunch of rings and attempt to toss them onto a peg. If you are successful you get points - if you miss you get none. The farther you stand back from the ring the more points you get - that is, if you are successful. What we found was that successful entrepreneurs focused on maximizing the results by gradually pressing the distance - always maintaining a high level of success and moving back a bit at a time to increase their returns. The ‘faux’ entrepreneurs generally went to the other side of the room and ‘let it fly’.

The unavoidable fact is that any start-up is a high-risk undertaking. The successful entrepreneurs were the one who aggressively mitigated those risks through the implementation of focused tactical plans and made the most effective use of available resources - including advisors. They were highly focused on milestones and doing what was necessary to reach them. Overall, the process of successfully managing every start-up involves beginning in a high-risk situation - but succeeds by reducing those risks to manageable levels as rapidly as possible.

The backdoor syndrome: If an entrepreneur spends very much time in our early meetings telling me about the exit strategy, I generally avoid entering into any engagement with the company. People tend to start companies for one of two reasons. The first - and the best one - is that they really want to be in the business. Their passion and experience in a particular field leads them to discover a market opportunity - a niche - that their company can fill. For these people, questions about an ‘exit strategy’ are secondary. Their real agenda is to build a business which will take advantage of an attractive opportunity - and to build a team and value proposition which will form the core of a growing company with an expanding customer base.

The second reason can be generally described as ‘getting rich’. These people tend to see their company as a pathway to their real goal - financial independence. As a result, they focus heavily on the ‘exit strategy’ from the very beginning.

The perverse result of these two strategies is that those in the first group will probably have a higher chance of achieving the goals of the second group. There are a number of reasons for this. First, their company will be seen as less instrumental - and potential customers will sense that. They will recognize the COE and the company as being in it for the ‘long haul’ - a reliable long-term partner in any engagement or contract. Second, the culture of the company will also be far less instrumental. This will allow a CEO to build a team which is made of people dedicated to the long term rather than being focused on a ‘liquidity event’. Finally, the vision of the company will not be static but will tend to grow and evolve as market pressures dictate. The second group tends to have a relatively static vision which runs from the founding to the ‘liquidity event’.

I was recently describing this part of my screening process to a friend. Her comment was “I know both types of men.” Well, I’ll leave you to figure out what she meant and why it is relevant.

Picking the winners: With ten to one against odds in the start-up world as the dominate factor - and with the twenty percent rule for survival during years five through ten - you might appreciate why I’ve developed my screening process. I have come across venture capitalists, acquisition specialists and angel investors who have a similar approach. For them, as well as for me, the issue becomes picking the winners out of a pile of probable losers.

But the screening can have value for the CEO of a start-up as well. By looking at a new company through these lenses, a CEO can more accurately assess and improve the probabilities of success.

Dr. Smith is a proven senior executive, successful entrepreneur, published author and public speaker. He serves on boards of directors and advisory boards or as a strategic advisor to CEOs. Dr. Smith specializes in leadership development and advising management on leadership styles which make them more effective leaders. He also works as an executive and/or life coach in the areas of personal growth and spirituality.

This entry was posted on Wednesday, August 13th, 2008 at 8:46 pm and is filed under Advisory. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.