Note: this post was written a few weeks ago, I just forgot to publish it.

Credit crisis, schmedit smeisis, I decided to just not care about it. Life is hard, it may have become harder, but that doesn’t meant that we shouldn’t just get on with it (a little harder) too. One of the issues today is whether it’s a good time to start a business and/or be in the early stages of a business. Because you’re in the money-begging phase and it seems like that’s in short supply right about now. I also decided to not care about that either. “Begging” for money is a psychological game: you present arguments and based on those you either get money or you don’t. If you don’t, you improve your arguments.

One tool to do that is to reduce assumptions to the absolute minimum. An article from my studies that always stayed with me, is entitled “Critical assumption planning – a practical tool for managing business development risk” and the diagram below is taken from it.

What is the point? An assumption is a guess that you make about a topic. I assume that (so many) people will buy my product, or I assume that building this machine for my company will take so many years, or I assume that my medical product will be approved by the relevant regulatory parties. Etc. etc. Each of these guesses, if wrong, can be fatal to your project, you know that and your investors know that. So how do you turn guesses into “truth,” or rather, into a perceived* truth (*: the fact is that nothing can be predicted 100%)?

Somewhat simple: triangulation. Triangulation means that you don’t trust single sources, least of all yourself, but rather place your faith in the power of many. To give you an example, for my current (non-tech) venture, I’ve divided our assumptions into 5 parts:

1. Who our consumer is
2. What the size of our market is
3. Who our competitors are
4. What our value proposition should be
5. And how this should work financially

Each of these are important things to work out and represent different challenges in doing so.

For our customers, I could send out a survey, but how can I be certain that the questions are the right ones and that it reaches the right audience? Instead, I chose for surveys and face-to-face interviews, and, guess what, some of my survey-questions were phrased* wrongly (*: the biggest danger in designing surveys). For our market, I have import-data for our industry from the government, which is itself based on estimates and doesn’t take into account different classes of products. So I have to sanity-check those figures with experts in that industry. And so on…

In the end, you should have the ingredients for a picture of your business-proposition, one you can work out into a number of pages or slides and present to potential investors and partners. And one that can act as the blueprint for what your business should look like. And if someone questions your assumptions, you can tick off, point by point, each of the reasons why you think you are right. That should be a nice feeling!

Does this method of planning apply to all types of ventures? It could be argued that it’s most relevant to projects where the price of failure is expensive, e.g. real-estate. Starting something online may be much cheaper and quicker (perhaps), but I wouldn’t say that the price of failure is cheap. If you want to start something that you want to live off, that your co-founders and employees want to live off, then I’d say that the price of failure is pretty expensive for you and them too, and that having done your homework beforehand is a good thing!

Feedback on my own assumptions in this post are, as always, welcome!

Vincent

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Premise: I’m in the midst of preparing a presentation for my thesis defence—practice-session this Friday, and final one on September 5th. My thesis is on how high-tech startups can bridge the equity gap, and I’m still busy every day interacting with potential employers. Love it when my hobby and my “job” work out in synergy!

So what do venture capitalists and employers have in common? Investing in startups and hiring employees can be tremendously fun for sure. You’re funding bright ideas and getting fresh blood into the company. But there is also a significant information asymmetry between the “Investor” and the “Investee.” Both VCs and employees use similar means to overcome that, I think.

The VC investment process

Startups have the problem that they lack a track-record and collateral. So they can’t just walk into a bank. And VCs need to find ways to deal with that. Well, technically, most VCs don’t even bother. Statistically speaking, over 80% of VC investments focus on buy-outs, i.e. established SMEs that are just changing ownership. It’s pretty easy to see whether a project is good or bad in that case, you just have the people-risk to deal with. That attitude is not surprising either, since a VC-fund is typically restricted to about 5-10 years worth of investments, while some really high-tech startups (e.g. in medicine) can take 10-15 years to get out of the red figures. For purposes of this post (and my thesis), I use venture capital as an umbrella term for entrepreneurial finance, which covers a whole ecosystem of investors.

How VCs manage risk is typically through:

• Intense scrutiny beforehand—they analyse the business plan, the team, and possibly exchange information with other venture capitalists;
• And intense monitoring & control during—using staged investments, spreading the risk by syndicating with other venture capitalists, taking seats on the board of directors, and by using compensation arrangements, including stock options.

You can probably see a pattern here already. Since VCs, or rather startups, don’t have the luxury of having a house or similar as collateral, nor having forecastable (just imagined) income-streams, VCs have to rely on judging quality on qualities that do exist: the business-plan, the team, and industry/market-insight. And they minimise their risk-exposure over time, by investing in chunks and making sure that priorities between them and the founders are aligned through contractual and other means.

One important thing worth mentioning is that the best way to minimise risk is to spread it across a portfolio of investments. Again, VCs tend to have this luxury, even if smaller investors (e.g. business angels and friends) do not.

The hiring process

The parallels must be obvious. Employers too have to rely on softer qualities, like CVs, grades, work-history, and all of it hopefully accurate. How employers manage risk is typically like this:

• Erecting high barriers to entry—relevant work-experience, good grades, etc.
• Prolonging the application process—erecting multiple hurdles, which applicants must pass.
• Using monitoring & control tools during the employment-period

And, also spreading the risk across multiple applicants! Again, I think, the term “employers” should be qualified: there are large companies, with well-established risk-reducing (or quality-enhancing) procedures, and smaller/younger ones, with less of a history and less resources to dedicate to this.

I do think that startups can find pretty creative ways to deal with it. The primary one, which I have found here in Europe, is working with interns. I think this works pretty well for a certain segment of employees, as long as it’s combined with a proper motivational structure! The other one which I like, is encouraging entrepreneurism from the start. There is no net to catch you if you fail in a startup, and by having applicants show that they have this attitude even before they are hired, you ensure a certain alignment of priorities. Note: I think this perhaps works better for business-applicants, correct me if I’m wrong! I think it was Seth Godin that once wrote that the best way to hire a person is to just put them straight to work and see how they do. That’s your application process right there!

You can employ techniques from VC-investing after hiring someone as well: using a staged approach (which is typically an internship and/or trial-period), monitoring (in a nice way, I hope), and motivational tools. I think the one major difference between VCs and employers is that there is less “psychic distance” between the latter and their employees. VCs, while being considered active investors, can still get away with weekly or monthly contacts. Employees are exposed to the company every day, requiring a more human relationship. Just my opinion!

Regarding motivation, I like the idea of empowering employees, which I wrote about on my old blog before, and I’m also wondering in general about the effectiveness of stock-options vs. other motivational means. Certainly, considering the recent exit-unfriendly climate, people have become more sceptical about stocks. At the same time, I personally think that people work a little harder if they are working for themselves. Again, correct me if I’m wrong!

What are some creative ways to hire employees, do you think or have you experienced?

Vincent

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