Wednesday, January 28, 2004

Starting Your Own Company

Summary: Eric talks about the decision process for starting a new software product company.

Since I began writing this column, I have received e-mail every day from entrepreneurs who are starting a new software company. All those comments and questions have motivated me to write an article about the process of creating a new, small ISV.

Note that this article is about "bootstrapped" companies, not "funded" companies. Starting a company with money from investors is a completely different topic that I am not addressing here.

In addition, this article is written for the would-be founder, whom I assume is a geek, primarily trained in software development, just like myself.

The core question you are facing is this: Should you "take the plunge" or just keep your job?

A full treatment of this topic would fill a book. For the sake of space constraints, I'm going to be linking to sources for additional information and limiting the discussion to the four topics that I think are most important:

• Know Thyself
• Have a Failure Plan
• Choose Your Product
• Make the Numbers Add Up

Know Thyself

Successful entrepreneurs are people who know their own strengths and weaknesses. This rule is absolute. All exceptions are flukes. You have to adopt a lifestyle of constant learning, and this means you have to understand the areas in which you most need to learn. If you truly dislike introspection, or if you are uncomfortable facing your own weaknesses, just keep your job.

What is your personality type?

One way to increase your self-awareness is to take a standard personality test. There are several such tests, but my favorite is the Myers-Briggs Type Indicator (MBTI).

The MBTI requires you to answer a bunch of questions about yourself. Upon scoring the test, the result will be four letters long:

• The first letter will be E (extravert) or I (introvert) and describes how you "recharge your batteries."
  • E's draw energy from being around other people.
  • I's draw energy from solitude.
• The second letter will be N (intuitive) or S (sensing) and describes how you think about things.
  • N's tend to be "big picture" thinkers.
  • S's tend to be better at details.
• The third letter will be T (thinking) or F (feeling) and describes how you make decisions.
  • T's tend to make decisions with their head.
  • F's tend to make decisions with their heart.
• The fourth letter will be J (judging) or P (perceiving) and describes how you run your life.
  • J's prefer orderliness and routine.
  • P's prefer to keep their options open.

For example, my personality type is ENTJ.

Note that there are only 16 different possible results. This means that regardless of all the wonderful things that make you a unique person in the universe, the MBTI will place you squarely inside one of 16 pigeonholes. Key point: These kinds of tests are really helpful, but don't take them too seriously.

Note that this is not a test to determine whether or not you are qualified to run a company. It is true that certain personality types are somewhat more common among entrepreneurs. However, each of the 16 types is well represented in the world's entrepreneurial ranks. These tools are valuable simply because they help you know understand how you are wired, and regardless of how that wiring runs, the increased understanding will be a tremendous asset.

A complete explanation of the MBTI is well beyond the scope of this article. You can find lots of information on the Internet. Note that the official MBTI is a copyrighted test. You'll have to pay a bit of money to take the real thing. Clones exist, but it is often better to take the official test from a professional who can explain what the results mean.

How versatile are you?

Almost without exception, entrepreneurs have to wear a lot of hats. The "To-Do" list for starting a small ISV is long and varied. You've got code to write, coffee to buy, lawyers to call, checks to mail, and trash cans to empty. One day you are trying to figure out why your product won't install properly under Windows "Longhorn." The next day you have to get the payroll taxes paid. After seven years, the sheer diversity of all these tasks still surprises me sometimes.

The crazy thing is that you have to do it all. If you don't do it, nobody else will. This takes a lot of versatility, and it explains why entrepreneurs are usually generalists, not specialists. We are the type of people who tend to be just a little bit good at everything, rather than very good at just one thing.

Has anyone ever called you a jack of all trades? If so, that bodes well for your entrepreneurial career. On the other hand, if you know yourself to be more of a specialist, you may want to keep that in mind as you consider your decision to start a company.

Over the years I have noticed that I don't see too many entrepreneurs with a Ph.D. Getting a doctoral degree is perhaps the ultimate example of focusing on just one thing. Very few truly versatile people have the determination to finish a Ph.D. I don't.

However, I must point out that these kinds of rules are riddled with exceptions. One of my good friends is a true generalist. He is good at basically everything he does. Anyone who knows him would call him a jack of all trades, but strangely enough, a Ph.D. hangs on his wall.

Don't take anybody's guidelines too seriously. Just try to figure out how you are wired. Ask yourself. Ask your friends. If you discover that versatility is not your strength, you can still choose to be an entrepreneur. But if you are simply unwilling to do all those things necessary to make a fledgling company work, then keep your job.

How effectively do you communicate?

When you start running your own company, you will probably have good days and bad days. If your bad days are anything like mine, somebody will eventually catch you whining about "how great the company would be if we could just get rid of all the customers and the employees." :-)

Alas, there is no way around it: Becoming an entrepreneur requires you to interact with people. Any deficiencies in your communication skills are going to be exposed.

Entire books have been written on the subject of communication skills. I couldn't begin to cover the subject thoroughly here, but I do want to emphasize the importance of this issue and offer three guidelines that have served me well:

1. Shut up and listen. Good communication is not 50% listening and 50% talking. It's more like 80% listening and 20% talking.
2. When communicating by e-mail, read your message before you hit send. Look for typos and for ways that your e-mail might be misunderstood. This is a simple technique, and I am amazed how few people do it.
3. Remember that e-mail is a terrible medium for communicating emotion. The recipient can't see your facial expression or hear your vocal intonation. Any negative emotion you express is likely to be received several times stronger than you intended. Keep this in mind when you are communicating by e-mail, and never write an e-mail message when you are upset.

Have a Failure Plan

The tenor of my last article really encouraged a posture of risk-taking. I'm not backing off on that stance, but in the interest of balance, I'd like to clarify a thing or two about the other side of the coin.

Like I said in that piece, the goal is to avoid making any fatal mistakes. But I purposely left the word "fatal" undefined. The implication of this metaphor is the death of your business, but the real issue is how much impact the business failure will have on your personal life. You have to decide for yourself how much you are willing to lose. You need a failure plan.

Business failure is a real possibility. Overcoming fear of failure is not a secret trick that will magically make you succeed. In starting a new company, there are lots of things you can do to increase your odds of success, but in the end, your odds are still not very good. :-)

The important thing is to avoid any failure that is too much for you to handle. The ideal business failure is one that leaves you with the ability to learn from what went wrong and try again. Ask yourself how big of a risk is appropriate for you. Ask your significant other. The answers can vary widely based on your personal situation.

One of the most common decision points will come up if you own your own home. Every entrepreneur will eventually be presented with the opportunity to pledge his home as security for a debt or contract. Although I concede that this could be the right decision for some, I have never done it and I don't recommend it. For me, that is too much risk to accept.

Regardless of your particular posture toward risk, the important thing is to understand every risk you are taking. Ask yourself: If this risk goes badly, will I be able to handle it? If the answer is no, don't take the risk. If that means you can't start a company, then don't do it. Keep your job.

Overcoming fear of failure does not mean making a bet that could really mess up your life.

Choose Your Product

What product do you want to build and sell?

If you are contemplating the decision to start your own small ISV, then I suspect you already have your idea. But it's probably not too late to give some additional thought to this issue.

Blatant tangent: Ideas are worthless

Although you may not believe it right now, ideas are essentially worthless. You are emotionally invested in your idea. You've spent lots of time convincing yourself and others that the business will work. You are devoted to your idea and you do not want to give it up.

But like it or not, your idea alone is not valuable. In the business world, ideas are worthless. Real value comes from good execution.

The reason is that value is generated only in the presence of a risk/reward ratio. An idea by itself involves no risk, so it will lead to no reward. In contrast, execution involves risk, which is why it leads to reward.

Back to the topic: Do your marketing homework

No matter how much you like a particular product idea it would be foolhardy to launch your new company without doing some basic marketing research. At the minimum, you need to ask yourself one very important question:

      What kind of competition do you want to have?

If you think the answer is none, think again. Having no competition at all can be one of the fastest ways to kill a business. You need competition, and you need it to be the right kind of competition.

When starting a new venture, every business-planning book will tell you to ask yourself if the market is big enough. True, this is an important question. You need to know if the potential customers can possibly yield enough revenue to pay the expenses you anticipate.

But as bootstrapped small ISV, you also need to ask yourself if the market is small enough. Small companies should stay out of markets that are big enough to be interesting to big competitors.

I recently heard of a serial entrepreneur who understands this concept very well. Each time he starts a company, he evaluates the market opportunity and refuses to pursue it if the market size is more than 50 million US dollars per year. This may seem counterintuitive, but the reasoning is actually quite sound. You can't beat big companies. The best way to win a fight is to not be there.

For more on this topic see my weblog article, "Choose Your Competition."

Verticals

The software market is maturing, and this means that companies stronger than yours occupy most of the mainstream market positions. You may have to look for opportunities in places you hadn't considered. You might want to look for opportunities in "vertical" markets.

In marketing we use the terms "horizontal" and "vertical" to describe two different kinds of products and market segments:

• A horizontal product has very broad appeal. It can be applied across a wide variety of businesses. Microsoft Excel is a horizontal product. Almost everybody in every possible field uses Excel.
• A vertical product is one that is specifically designed for a single market segment or niche. Dental office management software is a vertical product. Nobody outside dentistry uses it.

In the '80s and '90s, small ISVs could realistically enter a horizontal product market. But today, as the software industry has matured, it is far more difficult to compete with the big companies for the attention of mainstream customers. Horizontal product markets are filled with the wrong kind of competition for you.

The competitors you want are in the vertical markets. These markets are safe from the big companies like Microsoft. Remember, even though you are reading this on the MSDN website, I am not a Microsoft employee. Even Microsoft employees are not allowed to speak for the company, so my opinion of their future means nothing at all. Having said all that, I believe Microsoft will never begin entering vertical markets. These market segments are simply too small to be interesting for a company that size.

Now you may be asking: but if the market is too small for Microsoft, doesn't that mean it's too small for me? Almost certainly not. Granted, some markets are simply too small to run any sort of company (in other words, they're actually not markets at all). But most of the vertical market niches are much bigger than you think.

Obviously, entering a vertical market will require you to know something about that particular industry. For instance, these guys claim to be the "industry leaders in bowling software," so I suspect they know a thing or two about bowling.

It's only fair to point out that entering a vertical market is rather difficult for those of us who don't know anything except software. This is why I ended up running a developer tools company. However, my own experience is a really lousy example to follow.

Do as I say, not as I do

Think twice before you get into the developer tools market. Strictly speaking, this market should be considered a vertical. This market is quite small by mainstream standards. The world spends more on beer every day than it spends on version control tools in a year.

Microsoft and its ilk don't do developer tools because the potential revenue is so exciting. Rather, they play in these markets because doing so is strategic support for their platform. I haven't done the research to verify this, but I suspect that the developer tools market is probably one of the smallest market segments in which Microsoft is involved.

In other words, the developer tools market offers the worst of both worlds. It is a small market, and is occupied by big, powerful competitors.

Developers really like the idea of building developer tools. After all, we get the chance to build something we really know. We get to use our own products. I can't deny that this has been a good business for us here at SourceGear.

But do think twice before you get involved in the business of dev tools. Over time, the competitive risks are substantial.

Make the Numbers Add Up

No company should be created without spending some time figuring out how to make money. Self-awareness and a failure plan and good marketing strategy won't help you if your company never makes money.

Do I need to write a business plan?

This is one of the most common questions asked by new entrepreneurs. The answer: Yes and no.

When people speak of a business plan, they are usually talking about a document that is used to convince an investor to fund the company. These documents are written for show. They're filled with fancy graphics and "wordsmithed" mission statements and highly optimistic revenue projections.

In the end, you spend hundreds of hours writing the perfect business plan, and the investor spends hundreds of milliseconds reading it. Do yourself a favor: Spend those hours working in your company instead of working on your company.

Starting a bootstrapped small ISV doesn't require you to convince anyone but yourself. This means you don't need to write a business plan, but you do need to think carefully about every issue that would normally be included in one. If writing an actual business plan document is the only way you can force yourself to go through all the necessary steps, then do it. But you can probably cover all the bases without actually writing the document.

Getting a book on how to write a business plan isn't a bad idea at all. One book I really like is called The Silicon Valley Way by Elton B. Sherwin, Jr. Note that I do not like the title of this book, since I don't like the way things are generally done in Silicon Valley, nor do I like the book's general orientation toward funded companies and IPOs and other get-rich-quick schemes (end of sermon). However, the book is still excellent. It contains 44 questions to ask yourself about any new venture. Answer them all.

Build a cash spreadsheet

At some point, the critical exercise of business planning is financial projections. This can sound tedious, boring, and difficult, but your chances of failure go way up if you skip this step.

It's not hard. Create a spreadsheet with months in the columns. The rows will be your predicted revenues and expenses. Like I said in Finance for Geeks, Cash is King. The whole reason you are doing these financial projections is to figure out if you will ever run out of cash. When you run out of cash, your business will probably fail.

Somewhere you need a cell that contains your starting cash balance. This is the amount of cash your company will have on its very first day. We call this "seed capital." Let's assume for the moment that this number is zero. At the bottom of every month's column, you need to calculate the cash balance you will have at the end of that month. Basically, take the previous cash balance, add your cash revenues, subtract your cash expenses, and that's your answer.

Your cash spreadsheet should look something like this:

Fill out your entire spreadsheet, estimating your revenues and all your expenses for each month.

• Be as specific and as detailed as you can be. Try to think of every expense you might encounter.
• If you don't know how much an expense will be, ask somebody who knows. When in doubt, overestimate it.
• Take the projections out for at least 12 months, preferably longer.

After you have estimated all your revenues and expenses, do the following three things:

1. When you projected your revenues, how much time did you assume it would take for you to build your 1.0 release? Whatever it was, double it, and adjust all your revenue projections accordingly. Building that first release will take you a lot longer than you think.
2. Divide all your revenue projections by two.
3. Multiply all your expense projections by two.

There, that's much better. These three adjustments should counteract much of that unrealistic optimism and excitement you've got. There is a proper place for these sentiments. Your spreadsheet is not that place. :-)

Seriously, be honest with yourself. I've seen people keep two separate spreadsheets while they are looking for investors. One contains "the numbers we can convince an investor to believe." The other spreadsheet contains "the numbers that we actually believe." This is one of the great advantages of bootstrapping a company: you only need one spreadsheet. Make sure it contains numbers you believe to be realistic.

Now, look at the bottom line. If any of the predicted cash balances are negative, you've got a big problem. Of course, since we left a big fat zero in the starting cash balance cell, your cash is probably negative for the very first month. Congratulations--your business died before it even got started.

Finding seed capital

The harsh truth is that you need that cell to be non-zero. Lots of companies have been started with very little capital, but very few can get going with none at all. This brings us to the most common question I get when people e-mail me: "How do I get enough money to get started?"

The first meta-answer to this question is to observe that there are no easy answers. If all of the possible answers are unacceptable to you, then consider the possibility that it's not the right time for you to start a company.

Lots of stuff has been written on the subject of finding that first seed capital. I disagree with some of the conventional wisdom. Nonetheless, I'll give an overview of the usual answers:

• Borrow against your home. As mentioned above, I hate this idea. If you do it anyway and end up losing your house, I promise I won't say, "I told you so," but I'll definitely be thinking it.
• Borrow from friends and family. I'm not fond of this idea either. Eventually, we all realize that the only thing that really matters in our lives is the people. Most of us should be working harder to make our relationships healthier, not finding new ways to place them at risk.
• Have a working spouse. This is strictly a personal decision. If it works for you and your spouse, that's great. Lots of entrepreneurs use this approach to give themselves the flexibility to take bigger risks. The truth is that it's a lot easier to go from two incomes to one than it is to go from one income to none.
• Borrow from your credit cards. Of all the usual pieces of advice, this one may be the least bad. If your business fails, you could be paying off the debt for years. But this particular consequence may be more tolerable than some of the others.

Like I said, there are no easy answers. Ideally, you would start your company using cash you've already got. But that's not often possible.

As unappealing as these options are, you will want your initial cash investment to be as small as possible. For an ISV, this can be really tough. It's going to take several months at least to build the 1.0 release of whatever your product is. It is quite likely that your spreadsheet doesn't show product revenue for 6-12 months even though it shows expenses in the very first month. Life is so unfair. :-)

My favorite solution to this problem is to start out as a consulting company and evolve into an ISV later. SourceGear was built this way. The concept is simple:

• In your first 40 hours per week, build custom software or websites for other companies. Charge them enough money to pay your expenses.
• In your other 40 hours per week, work on building your product.

After the product is released and its revenues start to grow, you can gradually stop taking contracting gigs.

If this sounds like a lot of hard work, you are absolutely right. If that sounds unappealing, keep your job.

Eric Sink is the non-legendary founder of SourceGear, a developer tools ISV located in Illinois. Eric enjoys woodworking, and the real reason he refuses to borrow against his home is that he finally got his woodshop setup just right. His weblog is at http://software.ericsink.com/.

This article originally appeared on the MSDN website.