[UK] This is a guest post by Doug Richard, the American-born but UK based entrepreneur and formerly of the BBC’s Dragon’s Den show. Doug is the Founder and Vice-Chairman of the Cambridge Angels and Chairman of the Conservative Party Small Business Task Force. Between 1996 and 2000 he was President and CEO of Micrografx, a US publicly quoted software company. Prior to that he also founded and subsequently sold two other companies: Visual Software and ITAL Computers. Doug is a long time proponent of startup culture in the UK and to that end has recently created the School for Startups. Their next event will be on November 18th at the Royal Institution.

I have been writing a series of articles recently entitled “The Price of Money” that grew out of my unease that people neither understood how great the cost of capital is nor the enormous difficulty involved in pricing capital. I was further dis-enchanted by the rhetoric amongst government ministers reciting mantras of entrepreneurship and access to capital as though their wholesale theft of the language of the Schumpterian community absolved them from actually doing anything effective in support of small business growth.

What tipped me into action was Jason Calacanis’ outrage recently that some Angel Investor networks were charging unwary entrepreneurs to pitch; the “pay-to-pitch” scandal. I was caught off guard by his naïveté. As I said in my first essays (The Price of Money: Sex, Lies & The Bottom Feeders of the Angel Community, The Price of Money Part 2: At Least You Can Eat Catfish, & The Price of Money Part 3: Angel Investing & One Night Stands. This article is Part 4), no one should be charging entrepreneurs merely for the right to pitch to them and then disguising the fee by claiming that they provide investment readiness support, or they help them write their business plan. That is a just a form of “tying”: forcing you to buy one product to get access to another and shifting the cost of one onto the price of the other.

And Jason is naive. At least he appears so. Because the chain of iniquities may start with the egregious behavior of the bottom feeders who swarm around the business support industry like so many curb-side window cleaners in Manhattan, or tourist guides outside the Taj Mahal; but it continues right up into the lofty thin air summits of the most successful venture firms whose behavior is primarily characterized by doing only those things they can get away with, and doing everything they can get away with.

This is not a rant about VCs though. It is a measured reflection on power and the inevitability of a bad deal when there is a tremendous difference in negotiating power. Money, after all, is in short supply. Or to be more accurate, it appears in short supply because the venture industry has grown up without any need for disclosure and thus has been able to limit the access of the people with the money (the limited partners) with the people who want the money (the entrepreneurs). And that will be the subject of another post.

But for today, accepting the reality that there are a relatively small number of VCs and a nearly unlimited number of entrepreneurial opportunities; then it is inevitable that the VC will have the upper hand in negotiation. And that some VCs will not feel constrained by any impulse when it comes to negotiation.

The heart of the matter is that you cannot know how expensive capital is if you don’t know the value of the business of which that capital is purchasing a part.

Furthermore, the only way to know the value of an investment is to get two investors bidding over it. Why is this so? Well, I presume everyone understands that valuing things gets different when the number of transactions one can benchmark against goes down. Take homes for example, the reality is, is that a home is only worth what the other guy will pay for it. And the only way to get a decent price on a home is to get two people bidding on it. The highest value will emerge. Moreover, the buyer and the seller are on essentially equal footing. If you can get a couple of interested buyers, they will each be forced to reveal the highest amount they are willing to pay and the competition forces that information out of them.

It is no different with VCs except that it is a requirement. That is, in the absence of a competition, unlike the residential home market where there is broadly even negotiating power, in the venture capital market; there is a huge power difference between the VC and the entrepreneur. Thus in the absence of competition, and in the absence of meaningful benchmarks, or transparency of prior transactions, the price can fluctuate wildly: almost indiscriminately. In fact, I have seen VCs make offers that assumed the company was worth nothing, nada, zippo, not a cold hard dime. And of course, it was perfectly evident that that wasn’t the case.

Whatever else you may take from this essay, take this: if you want a good deal get two VCs to bid. The corollary to that is no matter how annoyed they may get with you, do not tell VCs which other VCs you are in discussions with. Because they will frequently just call each other up and form a syndicate removing the opportunity to get bids. Oh, and they generally don’t like it when you do that. I have seen VCs stand up and walk away, calling me rude and other names when I politely declined to tell them who else might be giving me a term sheet. It is a discussion for another day how to manage such an issue. Today I remain firmly focused on one point. You cannot know the value of your company and thus how much you should sell a portion of it for unless two or more parties are competing for the money. In the absence of that, some VCs will take extraordinary advantage of you.

Which brings me neatly back to why I think Jason is slightly naive. As offensive as it is for skulking figures in the undergrowth to be charging entrepreneurs to pay to pitch; how much more offensive is it when a VC takes a 2 times liquidation preference or insists on reverse vesting of founders shares. In each case there is a genuine economic concern that the investor has a right to have protection against; but in each case the fair approach is rarely employed.

Liquidation Preferences or “I Used Cash, You Simply Gave Up Your Life, So I Get My Money FIRST!”

A liquidation preference if you are not aware is the means by which the order of payback is determined at the point of a liquidity event (ie when folks might get their money like going public, or selling the business etc). Now naively you might think that if a VC bought 30% of the company then, when the company sells, they should get 30% of the money. Well, maybe. Let’s use an example. If the VC invested 300,000 for 30% then the value of the company just prior to his investment was £700,000 (”the pre-money value”) and it was worth £1,000,000 (”the post-money”) just after the investment. Thus £300,000 neatly equals 30%. But let’s say that for unknown reasons the company is sold for £500,000. Then the VC get 30% of 500,000 or £150,000. The founder who hasn’t put in any money walks away £350,000 richer and the VC walks away £150,000 poorer. Not good.

The general view, and one I agree with, is that the cash investors should be able to get their cash back before the non-cash investors are entitled to receive money. Thus in this scenario, the VC would get his £300,000 out of the £500,000 and there would be £200,000 to distribute. And this is where things get complicated. One view is that the £200,000 should be split 30%/70%: the VC gets an additional £60,000 and the founder gets £140,000 in direct proportion with the share ownership (30:70). Another view is that the founder should get the entire £200,000 and in fact he would get all the money until he got £700,000 so that the VC and the founder’s ratios once again matched.

Not many VCs like that idea. In fact, they do much the opposite. They will assert that there is a dividend on the preference shares (say 10% per annum). They won’t take the cash but they will expect it to accrue. And they will in addition ask for more than a 1X liquidation preference. Let’s say 2X for giggles sake.

In that scenario, assuming the investment had been made one year earlier. Then the VC would get its £300,000 back; it would then get £30,000 for its accrued interest, and then it would get the remaining £170,000 because it would be entitled to 2 times its capital before the founder gets anything. So even if the company were sold for £1,000,000: the amount it had been valued at when the investment was made. One year later the VC would get £630,000 and the founder would get £370,000. Even though the founder owned 70% and the VC owned 30%.

Just shake me when you think this starts getting fair, Jason.

And I haven’t even gotten to reverse vesting. And I don’t think I can right now. I need to lie down. But I will say this. If you are going to get investment, it is your job to know what you are doing. And it would be my pleasure to teach you.

If you liked ampersands, the Government’s creative industries conference, C&binet Forum was a great place to be. The logo sat everywhere, from the signs for dinner to massive “&” sculpture in one of The Grove’s lobbies.

And, and, and…

…and the ampersand character fitted the complexity of the conference. Just when you thought you could define or dismiss C&binet in a sentence, you realised it was too complicated to be concise about. For instance…

• C&binet was dominated by the record industry’s anti-piracy agenda …& the energetic counter-arguments, not just from “internet libertarians” – as the old/big media representatives dismissively referred to objectors – but web music companies, heads of major marketing agencies and film-makers.

• There was depressing inevitability about the “three strikes” announcement on copyright
…& Open Rights Group and many other articulate delegates were on hand to cross-examine and challenge this view at every turn.

• The exclusivity of this invite-only event (places were limited to about 300) meant that many interesting voices were not in the main conference room …& because of Twitter, the organisers’ openness to the conversation and a diverse set of delegates connecting that conversations it was also massively open. A couple of thousand Tweets were made to the #cabinetforum hashtag and they were being read and discussed not just at the fringes of the event, but by the Government people and the moderators as well.

• Big media players and white middle aged men seemed to dominate the conference stage …& this fact was challenged from the first both on Twitter and openly on the floor by delegates such as Anita Onidine. If you want it spelled out: there were very few women panelists.

• As Government ministers and advisers were in the room, there was an embarrassing number of requests for state-funding or legal protection of business models …& there were people ready to rail against this “Mandy-make-it-better-attitude”, if you will and insist that industries find their own solutions and innovate to create new models and markets.

• It looked formal and mainstream and big players like Jean-Bernard Levy pronounced on industry issues from the stage… & alternative voices formed coalitions, for instance when Kathryn Corrick instigated an un-conference (called suitably Out of the Closet) which was acknowledged by the main conference, aggregating and amplifying the diverse voices and preventing any clumsy, wrong-headed consensus appearing to be the unanimous position of the creative industries.

Deafening protection rackets: Three strikes

The agenda of the conference and the news reporting around it were dominated by the announcement by Peter Mandelson of a clamp-down on illegal file-sharing.

What was disappointing about the proposed legislation and the announcement was the lack of emphasis on the need for innovative new business models for content. The idea of “three strikes” had already been scoffed at openly by delegates, and is seen by many as both infuriating and irrelevant. Some of the views I heard were that…

…people’s use of technology will make detection near impossible.

…the security services will scupper the legislation, as the last thing they want is mass-adoption of encryption technologies

…the emerging idea of web access as a human right (recently enacted in Finland which is usually ahead of the game) will put up another barrier to three strikes

Mandelson himself sad that he did not envisage “mass disconnections” of web access. He also stressed the urgency for the industry to speed-up its innovation in developing new business models and said that he would be prepared to knock heads together if needs be. All to the good, but this was a minor “&” to the main point of the “three strikes” stick that dominated the conversations on the floor and the headlines in the mainstream media.

All well and good. But the energy of the meetings and conferences that flow from C&binet Forum need to be on creating the new models. Neither carrot nor stick, but a way of ditching the donkey altogether and developing new modes of transport (someone put that metaphor out of its over-stretched misery, please).

Meanwhile, it was clear to me that for the music industry and other big content players to move forward they need to shake out a bunch of lazy-thought myths and misconceptions. It was shocking to see that leaders of major companies were still conflating file-sharing with piracy, for instance. But there was also much-repeated collection of narratives on stage about 15 year old boys being rumbled for file-sharing by their parents and “thieves downloading 20 albums a night”.

The outlook of web-based business – the imperative to understand the user’s needs – is just culturally absent here. It’s a case of ask not how customers can better comply with your business model but how can your business model better adapt to consumer needs. A more constructive equitable approach to licensing content for use online should be top of the list.

Opportunity: Advertising, producers, broadcasters and the great re-ordering of the media world

A panel led by Tim Bradshaw of the FT and a fringe event on Brand Content did give some glimpses of the future and the opportunities available for everyone in the media segment of the creative industries.

Perhaps these were the conversations and debates that should have taken precedence over the copyright and business model-protectionism. I would like to think that these sessions set the agenda for the continuation of the from C&binet Forum conversation.

As far as the media industry-to-be is concerned this will mean brands, indie producers, record labels and marketing agencies in the same room with a blank sheet and a brief to create new models, then ways to pilot and try them out [Editor's note: And maybe some technology people this time, huh?]. The business model gap still leaves significant opportunities for start ups and entrepreneurs to create new businesses also.

&…

An event like this could never really succeed in uniting the creative industries by itself. It did however spark many, many conversations that were connected in the physical conference and the wider conversation around it on the web. It did also give a glimpse of the mainstream media industry in the UK’s future self-reinvention and the character of the cross-platform, entrepreneurial, anti-protectionist people that will be at the heart of it.

There has been a lot of discussion on the web over the last week regarding the business angel network business model and in particular “pay to pitch”. While there are certainly elements of truth in some of these complaints, there is also a lot of misinformation and confusion over our actual role and business model.

Why should you care what I say? My background, while at University and despite an Economics degree and my friends heading off to the City, was as a boot strapped entrepreneur launching Deskpro.com and more recently Controlmyname.com so I know the challenges entrepreneurs face. I now spend the majority of my time as the Investment Manager for London Business Angels but also assist on the £5m venture capital fund London Seed Capital. I share an office with a £30m Enterprise Capital Fund and a £50m Regional Venture Capital Fund (both of whom we have co-invested with). Our parent group has £330m of early stage venture capital (sub £8m) under management, making us one of the largest early stage investors in the UK. I believe these set of experiences have given me a reasonable perspective across the early stage funding landscape.

LondonVC’s implicit argument appears to be that angel networks promise to introduce you to Venture Capital funds. [Editor's Note: I think most would disagree - the main argument was mainly that VCs don't usually source dealflow from Angel networks, and not from pay-to-pitch events].

In my experience this is not the case. I know of no angel network (we certainly don’t) that promises to introduce you to venture capitalists although perhaps others do. There is a reason we are called angel networks and not VC networks. Saying that, we regularly co-invest with early stage VCs; I did a quick review and these are some we have co-invested with in the past: Catapult Ventures, Create Ventures, GEIF, IQ Capital, Rainbow Seed Fund, AITUA, Creative Capital Fund, Seraphim Capital, Oxford ECF, South East Growth Fund, Octopus Ventures, NESTA, Bridges Ventures, IP Venture Fund, Esperante Ventures, Nova Capital and The Capital Fund – there are certainly more. It is important to remember that angels are generally investing in companies at stages that large VCs are rarely interested so of course the likes of Index, Balderton, DFJ, Accel are not going to be at angel network events; and if they are – it’s to see what might be coming to them in 12-24 months time. Chris Dixon has a great article on why entrepreneurs should be wary of taking seed money from big VCs ; in fact we get deal flow from some big VCs who like a company but it’s too early for them to invest into.

Moving on from “angel networks promise to introduce you to VCs but don’t” tangent to what I believe is the more pertinent issue, the “pay to pitch” issue as brought up by Jason Calacanis. There are a number of reasons why most Angel Networks charge to pitch as opposed to only taking success fees (which is where the majority of revenue comes from). Firstly though, there is an important distinction between an angel club and angel network. An angel club is one where all the members know each other and they setup the club themselves. They generally share the task of reviewing business plans or often will independently bring companies from their networks to the group. It is inappropriate for angel clubs of groups to charge companies anything. An angel network is a different beast. The members don’t know each other before they join, the network will generally have a professional, pay rolled “gatekeeper” and support staff, operate from an office, have a brand and marketing strategy and actively seek out new investors. They are very different types of organisations with very different cost structures. So, why do angel networks charge to pitch?

1. They provide more than simply a pitch:

We charge £850 (not £1250, as LondonVC wrote) for companies to present to our investor network; but included in this is a significant amount of work. We run a half day and full day training session, a day’s support from a pitching coach, a legal seminar, over a week’s worth of support reworking and editing executive summaries and the powerpoint presentation (and trust me they change an awful lot) and share a significant amount of IP developed over 25 years running the network. The cost of this, let alone the actual event itself costs us more than £850 x 6 companies that present and is a sunk cost.

2. To get the entrepreneur’s commitment

While we can argue on the level a company should pay to pitch; having it zero is very risky for angel networks. When you have 70+ investors all taking an afternoon/evening off to see 6 companies – you have a significant problem if one of the companies decides that something urgent has come up (and as every entrepreneur knows there are a lot of urgent things) and cancels. What if a VC/major client/potential employee says the only time they can meet is the same time you were meant to be presenting to an angel network; not an easy call for an entrepreneur. Having a sunk cost really does ensure entrepreneurs take the process as seriously as the angel network (and the network’s investors) do. I’ve seen a number of angel networks cancel events at the last minute because of problems here; and your angel network will not last long when this happens.

3. We can’t control entrepreneurs

We can put a lot of work into preparing a company for investment (sunk cost) but the deal might not happen for reasons the network manager can’t control. A typical example is an entrepreneur doubling their pre-agreed pre-money valuation. Some companies don’t put as much work into raising money from a network (it’s never easy I’m afraid) or follow up appropriately. We do our best to align both entrepreneurs and investors however we can’t force deals to happen. Can you think of any other professional industry with significant sunk costs that works on success fees only where the facilitator has limited control over the process of any deal which is heavily dependent on personalities?

4. Investors are loathe to pay fees

The obvious solution to the problem is to charge investors high memberships to cover costs. We charge our investors £295/year and are very strict on this. Most angel networks I know struggle to charge this or anything at all. It is unfortunately the case that a precedent has been set in the UK that investors won’t pay more substantial fees – but our experience is they simply don’t. The US is more fortunate in this regards where investors are prepared to pay higher fees – but this is the current reality we are faced with in the UK.

5. Cashflow

Angel networks don’t have the relatively comfortable management fees that venture capitalists do. If a VC does not do any deals for a year their LPs might get annoyed – but the employees are still going to get paid. Angel networks rely for the majority of their income on success fees – but having some guaranteed income (member subs, pitching fees, sponsors) ensures that they can at least function for a while – no angel network can sustain itself without actually doing deals unless it has public support (we don’t). Let’s be clear on this, no one has got rich on running an angel network, most are run as not for profits to comply with FSMA regulation. Being a VC is a significantly more comfortable existence and certainly more lucrative.

Given all the above, I think charging to pitch is appropriate and likely to stay – however there is certainly a lot of scope for the level of charging to be reviewed. Since I have started working at London Business Angels I have been able to bring the fee down from £1,250 to £850. This was largely due to bringing on two more sponsors, UKTI and Speechley Bircham – who join our other long standing supporters: Larks, RBS, NESTA, McDermott Will & Emery and Kingston Smith. Without them, the fees would have to be higher. If we were to find another sponsor – we will use that money to lower the fee because it solves problem #5.

We are also working on a number of other initiatives to make it easier (and less costly) for our entrepreneurs to raise money. We are raising our own mini co-investment EIS fund. My aim is that in a year or two, the pre-committed capital that goes into this fund will solve problem #5 so that we can price at a level that satisfies only reason #2/#3. I agree that we should charge as little to companies as possible.

It’s also worth saying that most angel networks don’t focus solely on web/tech/media and the types of companies talked about on Techcrunch. There are a few high profile web/media investors in the UK (of course they together are not capable of investing the £1bn of angel funding annually) but we also raise money for companies in other industries. Med-tech (medical tech) has been particularly popular this year; our largest £2m investment was into a clean-tech company.

I hope that explains my position on “pay to pitch”. I want to make it clear that, as with every industry, angel networks differ by quality. This is not however objective – I regularly hear from entrepreneurs who disliked one network and then the next day hear from one that had a great success with it; I am sure the situation is the same with us; although I believe the majority of companies (and even the ones that did not raise money) have felt our process was good value I have to accept that it is always going to be disappointing for those that don’t; but we are regularly told by companies that even if they don’t raise money they felt the intense education was worth the cost. All I can say is that we do our best to make deals happen.

I have explained our model in full here – and most networks are similar; however there are certainly other models all with different benefits/costs associated with them. I recently met the two entrepreneurs who have setup FindInvestGrow.com who are trying to help young student entrepreneurs raise small amounts of finance and have a really interesting model. New and innovative approaches are great for the industry – so if you think the model is broken – get up and fix it. Jason threatened angel networks by running free events – I truly welcome the challenge – the more people helping enabling this type of investment, the better.

If the founders of Google or PayPal had stuck to their original business plans, we’d likely never have heard of them. Instead, they made radical changes to their initial models, became household names, and delivered huge returns for their investors. How did they get from their Plan A to a business model that worked? Why did they succeed when most new technology ventures crash and burn?

Let’s face an uncomfortable fact: the typical startup process, largely driven by poorly conceived business plans based on untested assumptions, is seriously flawed. Most new ventures, even those with venture capital backing, share one common characteristic. They fail. But there is a better way to launch new ideas—without wasting years of your time and loads of investors’ money. This better way is about discovering a business model that really works: a Plan B which grows out of the original idea, builds on it, and once it’s in place, enables the business to grow rapidly and prosper.

Getting to Plan B in Your Business

How can you break through to a business model that will work for your business? First, you’ll need an idea to pursue. The best ideas resolve somebody’s pain, some customer problem you’ve identified for which you have a solution that might work. Google, for example, makes hard-to-find information instantly accessible. Alternatively, some good ideas take something in customers’ lives that’s pretty boring – think old-fashioned coffee shops, many of them now gone, supplanted by Starbucks – and create something so superior it provides true customer delight.

Next, you’ll need to identify some analogs, portions of which you can be borrow or adapt to help you understand the economics and various other facets of your proposed business and its business model. You’ll need antilogs, too. Analogs and antilogs don’t have to only be from your own industry, though. Sometimes the most valuable insights come from unusual sources, as was the case for Steve Jobs in turning Apple from an innovative but struggling PC-maker into a music industry phenomenon. Jobs copied ideas from Sony’s Walkman, Napster’s free but illegal downloads, and more.

Having identified both analogs and antilogs, you can quickly reach conclusions about some things that are known about your venture. But it is not what you know that will likely scupper your Plan A – it’s what you don’t know. The questions you cannot answer from historical precedent lead to your leaps of faith – beliefs you hold about the answers to your questions despite having no real evidence that these beliefs are actually true.

To address your leaps of faith, you’ll have to leap! Identify your leaps of faith early and devise ways to test hypotheses that will prove or refute them. By doing so, you are in a position to learn whether or not your Plan A will work before you waste too much time and money.

But what do you actually need to consider when developing your business model? Every model needs to quantitatively address five key elements:

• Revenue Model: Who will buy? How often? How soon? At what cost? How much money will you receive each time a customer buys? How often will they send you another check?

• Gross Margin Model: How much of your revenue will be left after you have paid the direct costs of what you have sold?

• Operating Model: Other than the cost of the goods or services you have sold, what else must you spend money on to keep the lights on?

• Working Capital Model: How early can you encourage your customers to pay? Do you have to tie up money in lots of inventory waiting for customers to buy? Can you pay your suppliers later, after the customer has paid?

• Investment Model: How much cash must you spend up front before enough customers give you enough business to cover your costs?

Uncovering the right analogs and antilogs, identifying your most important leaps of faith, and testing a series of hypotheses to inform all five elements of your business model doesn’t happen in a single ”eureka” moment. Getting to a viable Plan B is a journey that can take numerous iterations over months, perhaps years. For PayPal, what eventually worked was founder Max Levchin’s Plan G!

To guide this process, we suggest you build a dashboard – a systematic record that will focus your attention on the critical issues and more efficiently deploy your precious time and resources to removing the critical risks. It provides a way to respond to the real-life data you generate and make mid-course corrections when your data so indicates.

The Cold, Hard Facts

Most business plans assume that most everything is already known up front – not the case, as the PayPal example shows. As the famed American general in World War II, Douglas MacArthur, is reputed to have said, “No plan ever survives its first encounter with the enemy.”

The process articulated here is a healthy alternative to the straight-jacket of today’s business planning practices, to enable you to anticipate and move beyond a failing Plan A. It is a process designed for learning and discovering, rather than for pitching and selling. It’s a process that recognizes the cold, hard facts: most often, what ultimately works, is not the Plan A that was so persuasively articulated in the original plan. Instead, it’s Plan B.

We went to Seedcamp, and spent three grueling days analysing our product. On the Thursday of the week we didn’t pitch for investment, and in fact, we completely sacked the product. That sounds bad – but this was a great achievement. If you don’t understand why, read on.

Loc8 Solutions began as a startup that bootstrapped with contract work for iPhone and Android applications. We saw an opportunity to make a mobile app builder that allows anyone to make their own app just by designing the screens and selecting features. Think WordPress for mobile apps. No more £30,000 bills for getting an iPhone app from an agency, no specialist skills required, and more apps for everything you need. It won’t do games, but it’s perfect for information retrieval and media content apps.

Before we started coding, we had a lot of stuff to examine. Firstly, the market. Well the mobile app market is big and forecast for huge growth. Check. Everyone wants their own apps. Check. Nobody else lets you make apps so easily. Check. Imagine the excitement – we had found a big, fun concept, we had spoken to a few potential customers and they wanted it. But as we dived deeper into Seedcamp week, it became gradually clear that all was not well.

We realised that the mobile web could replace the type of apps we’re providing. We can bide our time with the release of new App Stores and leverage the current marketing hype around apps, but soon enough browsers with HTML5 will provide the key benefits of apps such as location and offline support. That scrapped the long-term potential of our idea.

Our customers, digital agencies, will seek a high quality product but they will absorb the greatest margin from the end client – as a business we must go direct to the end client. Scrap the product, this needs to be a service.

Also, a popular request from clients is for marketing advice along with the development of apps. Scrap everything, it turns out this is a specialist mobile app-shop with a consulting (ugh!) element.

Against all the excitement over the past few days, we had to accept that the product didn’t have any wings. It might make a great open source project, or could even be a good internal tool for Loc8 to cut costs on development, but it’s hard to see it going much further. Come Thursday we didn’t pitch for investment – we just presented our tumultuous story of the last three days, and explained the realistic opportunity at hand, which needs no investment. We got our product to fail in three days.

Afterwards one journalist asked “why are you so happy to be a failure?”, slightly set aback by the bluntness, I responded “I don’t think we’re failures, we just saved ourselves months of rewardless pain and effort”.

There’s an odd sentiment in the UK around the term “failure” which makes us feel like we should avoid it for fear of being labeled an idiot. This is wrong, for the following reasons:

1) If you are trying something, you will fail at some point – it’s not a reality to achieve a 100% success rate – and that’s not even the challenge. I believe you only really fail when you don’t get up and go again.

2) You need to be critical, don’t blind yourself with false hope or ignorance, and question everything. This leads to good decision making, and it will be needed over the lifetime of your project. Sometimes the best decision is to stop, and do something else.

We really wanted to build this product. For a long time we thought it was an incredible startup opportunity. But as we progressed, we had to face the reality that it wasn’t as we first thought. And we stopped.

In failing so quickly, we can now spend the time on other opportunities which may succeed. Eric Ries explains this process in more detail, and it’s an essential lesson for anyone doing startups to be able to learn.

I have watched with interest as the Apple backlash intensifies* (see below). It seems the App Store has broken the camel’s back. There is massive resonance here for both entrepreneurs and VCs.

This quote from Chris Messina is my favorite . He thinks that the Apple App Store is a “flash in the pan” because it is a proprietary platform and, hey, wait a minute, proprietary platforms are counter to consumers’ interests. That’s why Microsoft accrued haters. And why folks are starting to feel the same about Apple?

There are actually three intellectually fascinating points here:

1) Behavioral economists and entrepreneurs agree: Creating an emotionally resonant or “cool” product gets ‘em hooked.

Fashion makes people purchase irrationally. It didn’t take a genius to realise that having all your MP3s in an Apple AAC format was locking you in. Irrational. But people did it. And they’re only just beginning to realise it. Hence rants against everything from the app store to itunes.

It is amusing to watch how the worm has turned. But it will not come as a surprise to behavioral economists who have been telling us for some time how to pull the punters in:

“Our choices are often affected by random initial anchors …The choices and trades we make are not necessarily going to be an accurate reflection of the real pleasure or utility we derive from those products…”

This was written by Dan Ariely, who has essentially written a manifesto for entrepreneurs to focus on “user love”. Some entrepreneurs need no warnings against academic over-analysis. For example, the team at Qype (interest declared: one of our investments) made a product that people just love.

A behavioural economist would say this was constructing a compelling “initial anchor”. Whatever the dev team was thinking, they were trying to build something cool. Sweet. Nice. Something with emotional resonance. I meet some very “business school drilled” management teams, who have performed deep analysis to the nth degree, but they’d do well to stop their SWOTs and spend time just making a product for us all to fall in love with.

2) Apple shows entrepreneurs how to build competitive advantage.

Apple has helped entrepreneurs (and VCs) understand how investing systematically in previously intangible product features such as “cool” and “sweet” makes for a better business model. (For example Spotify’s made the decision to invest in them significantly easier when they started by demoing such a beautiful app).

At a simplistic level, Apple get punters to buy their products because on the “way in” it has invested a little more in R&D to make the iphone beautiful or, invested a little more in community marketing to get cool designers blogging about the mac book air etc. On the “way out” (i.e. at Best Buy or Dixons) this allows Apple to charge twice the price.

For any entrepreneur interested in how this affects their business I would strongly recommend Joel Spolsky. In this video he Argues (proves?) that Apple is winning by making their products acheingly beautiful. Now geeks are having to grok aesthetics because this is the thing that can triple your margin. Or your exit value.

3) Is the iphone app store an interim “moment” in the mobile web or does it have longevity?

The iPhone app store isn’t so different from the Mobile Operator’s “Walled Garden” of 4 years ago, like Vodafone live!. (A defunct model if ever there was one, but don’t get me started on this industry peddling an over-branded data pipe).

So is it a little surprising that the “Walled Garden Mark II” actually looks like it’s working. Didn’t consumers already vote with their feet against these proprietary platforms?

Well economists would argue no. Carlota Perez would suggest a “walled garden” was the classic “development phase” of a market: it was bound to fail but a necessary prerequisite to the successful appstore market:

“The action of these pioneering agents blazes the trail, giving rise to increasing externalities and conditionings – including production experience and the training of consumers- that make it easier to follow suit.”

However, to continue this logic, it could be that the Apple store is also just another pioneering agent which is a means to an end, not an end in itself. Messina argues that just like the walled gardens, the app store is also an interim development phase and the future is a mobile browser that’s yet to be finished. Phew.

So what does all this economic theory mean for entrepreneurs?

If you’re building a company with mobile apps (which is pretty smart) there are few issues. I have met companies developing apps just for the app store. Nothing else. Not the mobile Web at the same time. Is this smart?

I have met small companies spending $$s on multi versioning for different smart phones. Is this a better strategy? Are you writing for Android and Apple? Are you assuming “discovery” is covered with GetJar, and the App Store, or are you investing in direct promotion ?

Or are you forgetting the mobile strategy for the app until a dominant mobile browser emerges? What’s the right strategy?

Of course no-one knows. It could take 1 year to find out, or 5. The problem for both entrepreneurs and VCs is that timing is everything. If you’ve raised money today to execute on a mobile strategy you need to go where the market is now. But what if that market goes away or moves elsewhere? Surely Apple has it sewn up for another 5 years right?

Hmmm…And this, dear reader, is the eternal question. Timing. As John Maynard Keynes said: “The market can stay irrational longer than you can stay solvent”.

Looking forward to hearing your thoughts.

* Here are some interesting links with people getting annoyed with Apple: Apple annoying iPhone developers here. Apple the New Microsoft here. App stores just a flash in the pan? here Are app stores just another walled garden? here .

Inside the Radialsystem V in Berlin, one of the city’s “new spaces for the arts”, the second Music Hackday has begun. There’s a real buzz of excitement within this diverse collection of people, some traveling from as far away as Boston, Stockholm, London and Amsterdam, who have just 24 hours to conceptualize, build and present the best possible ‘music hack’.

This is a new type of event for the music industry. Sessions are focussed on talks about APIs and technology and the mood is refreshingly upbeat. You won’t find any long-winded panels about ‘Music 2.0’ or the death of the traditional music industry here: the participants are too busy swapping ideas, sharing code and building the future using blocks laid down by companies like SoundCloud, Songkick, 7digital, Last.fm and The Echonest. The hackers are also joined by music software companies such as Ableton and Native Instruments: hardware meets software meeting the web, all connected via music.

The results (listed in full here) are varied and innovative. Projects presented on the final day include a Berlin gig visualiser GigLook that takes events data from Last.fm and Eviscape.com and displays it along with pictures from Last.fm and Musicpictures.com.

The aptly named TracksOnAMap, a polished mashup of Google Maps and tracks uploaded to SoundCloud by users.

One of the event’s best physical hacks is a more artistic piece called Xylobot, a music robot consisting of an Arduino micro-controller, six servos, a toy xylophone and a lot of wood and glue:

Also created was a rather slick iPhone app made for Citysounds.fm – one of the excellent projects already developed during Music Hack Day London earlier this summer (fingers crossed that it makes it on to the App Store!):

Despite Berlin being smaller than London, the quality of hacking and passion for the subject has been particularly high. We’re seeing the beginnings of a whole movement seeking to change the traditional music industry and the way we consume music: in Europe alone we now have platforms like SoundCloud, Songkick, 7digital, Last.fm, Gigulate, Cloudspeakers and Spotify. Events like the Music Hackday are stepping up in frequency: there are instalments being planned in Amsterdam, Boston and Mumbai and there are tentative talks about Music Hackdays coming later in San Francisco, New York, Stockholm and Manchester.

The main aim of a Music Hackday is to showcase the forward-thinking companies opening up their APIs and connecting them with local coders, hackers and enthusiasts with a passion for music and building amazing new things. For our part, SoundCloud is really embracing this new way of doing business by totally opening up its platform, making it as easy for developers to build on top of its foundations as possible. In the last week, we’ve released PHP, Actionscript and C wrappers for the SoundCloud API (in addition to its existing Ruby Gem and iPhone/Cocoa wrappers). One of the keys to success for SoundCloud is an active developer community, using our API to build everything from desktop music uploaders and iPhone apps through to cool music players and integrations with other sites.

There is a serious point underlying this for everyone: many of the recent innovations in the music industry have happened from people outside of it. Talented and smart developers are taking full advantage of all the tools at their disposal to interact with music in the ways that they want to, not just the ways that the traditional music industry wants them to – so quite often that’s happening illegally. Popular sites such as Muxtape and Mixwit have been forced to shut down by the RIAA, while Seeqpod is the target of a major label’s lawsuit. Those who try to explore the legal route are plundered for expensive advances. Barriers are put up. But I sincerely hope that he industry is taking note and seeing what could happen if it was to embrace change.

Just like these pioneering digital music services, the labels should be providing resources, data and audio to developers. Let them play, develop and experiment, building (legitimate) new services along the way. Sure, maybe 8 out of 10 of these new services will fail. But this is nothing new to labels: they’ve faced exactly the same risk/reward ratio when it comes to investing in and signing new artists!

As a technology startup you will, at some point, decide you need some PR. You might not know what that really means, or how much it might cost, or even who could be able to do it, but you’ll want it.

Public Relations is one of those rare business services with no value aside from the amount people assign to it. Essentially, you’re paying for the relationship that someone you’ve never met has with someone else you’ve never met. That’s a tough thing to cost up.

You’re also often paying PR people to do nothing. Actually, you’re often paying them to tell you to do nothing. Confused? Say a video pops up on YouTube that you don’t want people to see. Do you tell everyone not to look? No, you don’t. But you’d be surprised how many times a PR person has had to convince their client not to issue a press release protesting innocence. (Note: “Company CEO denies dungeon orgy” is just as bad as admitting to enjoying them.)

In my four years as ex-journo-turned-PR-man, I’ve had all sorts of tech startups knock on my door in the mood for buying. These meetings can be long, tough and caffeinated. They can be fun, relaxed and alcoholic. They are always eye-opening. And thinking about those experiences, I did what every self-respecting PR person does best. I made a list.

START ME UP: FIVE PR PITCH SCENARIOS

1. The shaky startup

New to PR (and probably business, and possibly the inside of an office) a startup can forget the agency is a potential supplier and nervously pitches their idea. The presentation is well oiled, having been recently given to numerous investors and family members. When it’s the PR person’s chance to speak, they get three minutes before the questions start. “What’s a press release?” is a well-documented example. The product or service will have been thought up in someone’s garage (but then so was Google). The first month’s PR retainer will be paid on the founder’s (and only permanent employee’s) credit card.

2. The flying startup

Still a small business, the brains behind this commercial proposition already understands the media and the tactics they should employ to get seen. They know how a viral video, with the right promotion, will drive traffic to their site. They know the press they want to be in, and that a review programme is critical. They understand that they’ll need to be trained before they go on TV. The budget is still going to be small, but this company wants it all and wants it yesterday. They are seeing six agencies today, and the decision will be tonight. (The email arrives at 3am.)

3. The false startup

Some meetings are long, and an agency can get a feeling that it – to coin a phrase from Auto Trader – is having its tyres kicked. In the worst case you realise, well after the meeting has ended, that you’ve been had. With so many tech companies not understanding PR, inviting a series of agencies to spend a week getting their best people to generate ideas can be a great value exercise. Throughout the meeting, the agency will get the feeling that everything they say is close to genius, and come away thinking they have a new client. A month later, one of their ideas surprises them by appearing in a national paper.

4. The fresh startup

Have you ever dreamt of giving up your day job and going it alone? Guess what – some people have gone and done something about it. One of the best pitches you can give is to an experienced business person working for a small, newly-formed company. The agency gets a client with big-business processes with startup-style creativity. The startup gets a PR agency that cries with joy every time their idea to create a ridiculous viral video gets approved… In triplicate. (There is a downside – three years later the company will probably be acquired and end up with startup-style processes and big-business creativity.)

5. The head startup

We may not be partying like it’s 1999 but – as many startups will testify – there are investors out there for those with enough luck and tenacity to out-manoeuvre the crunch. At that point, PR will be top of the shopping list. Armed with a blank cheque from their VC backer and the gummy-eyed confusion that follows an eight-hour flight from San Francisco, a pitch to a company with capital will be quick, to the point and results focused. PR takes time to implement, people to execute and a miracle to effectively measure. The agency has a week and is clearly on its own. Start praying.

So after all that, what’s my advice? It’s important not to worry too much about which category you fall into. Firstly, the list above is not exhaustive. Secondly, a good PR agency will guide you through the process, tactics and ideas you’ll need to get noticed. Whether you’re sitting there wondering what a press release is, or waving a blank cheque in the air and ready to drop £50k getting your message heard, make sure you cover the bases and do your homework. Ask around, check references, and approach agencies that demonstrate an understanding of companies in your space.

Most important of all, send your proposed media spokespeople to the meeting well informed. They will need a solid idea of your target audience, your overarching business goal (Sales? Brand recognition? Staying out of prison?) and the keywords being optimised for search on your homepage. These three things alone should be enough to form a killer PR strategy.

The final ingredient for a successful PR campaign is chemistry. Treat the meeting like a date. Did conversation flow? Were the jokes funny? Are there similarities in tastes or aspirations? If so, take things further. If not, let the agency down gently (but honestly) and move on. You’re a young business, with your whole life ahead of you. With so many different types of agency out there, your perfect match could be just around the corner.

For my first startup eCourier.co.uk (founded in 2004), getting top senior talent was a long & painful process punctuated by expensive ads and extortionate recruitment consultants. Hiring a CFO cost us around £25k. Hiring a CEO (when I was moving on) cost at least twice that. And even after making the investment, results were far from assured.

For the CFO vacancy, a quirky ad in the FT got us a ton of great candidates… however when push came to shove our short-list saw us as too risky a proposition, especially when compared with what the market was offering in risk-free salary. I enlised my co-founder & CTO and we wined, dined and begged our top 3 CFO candidates… all without success. One seduced by the real-estate boom went to Colliers CRE, another consulted his father who told him it was too risky (he ended up joining 3i!) and the last one said we needed more £ and joined Multimap, which was swiftly bought by Microsoft (he was right on the £ btw). We ended up hiring a recommendation from within our network.

To fill the CEO position (when I was leaving) our board hired a headhunter on a retained search (on insistence of the VC) in order to ensure a hire. From the 5 candidates shortlisted, only 1 wanted the job. Unsurprisingly he got it… on his terms.

We had a relatively high profile business (slew of awards & press), sales in the millions (had been growing at 20-30% per month for first 3 years) AND £2m+ VC investment in the bank… and yet recruiting senior managers was still a challenge. Was it us, or were things even harder for those that were not in as fortunate a position?

Fast forward 2 years… Given my previous experience I was a little apprehensive when Shutl needed a full-time CTO. On paper we were undoubtedly a riskier concern: tiny team, no (finished) product, no clients, no investors, etc… we also did not have the means to pursue either of the former recruitment strategies. This proved to be a blessing in disguise.

We hired a CTO in July and it took 3 months. The process was painful but only because we had to choose from a number of fantastically over-qualified candidates, all of whom wanted the job. Our only expenditure was a £20 TechCrunch Europe CrunchBoard ad.

So what had changed?

Admittedly this was a different (and more exciting) business (well, I would say that). However, this was also a very different market… and there were new tools available to access the market without use of an intermediary.

I wrote the spec, posted the CrunchBoard ad, sent out a link to ads on facebook, linkedin, plaxo & twitter. TechFluff videoblogger Hermione Way and a couple of others possessing 2.0 fan-clubs reposted. I also joined just about every relevant LinkedIn group (and a dozen not so relevant) and posted the job there, as well as emailing out to a couple of entrepreneur lists. Within 2 weeks we had 260 applications. Obviously there was a fair amount of chaff, but not nearly as much as had anticipated.

Not unexpectedly I was also bombarded by recruitment consultants. I treated them all equally and told them: if they had someone that fitted the profile, send me a CV and we would consider, but only subject to my (not their) terms- a copy of which I provided them. I told them that they could not advertise the role themselves and I was not prepared to speak to any of them let alone meet them. Not one dared to propose a retained search.

We filtered CVs and interviewed around 50 NDA’d applicants. This was time-consuming but gave me a great feel for the market- what was out there and what it cost. This also helped me to refine the requirement. It also narrowed the field to 12 who received a disclosure pack (business plan, SDD, code, model etc). After a week to digest, we then sent out an RFP. The responses required some real time & effort and separated out the really serious candidates.

Once reduced down to the final 5 we needed to narrow the field further and asked them where they would come out on tension between salary & options. 2 of our top 3 came out at less than 50% of the salary we had originally been considering (with higher equity packages). At this point we could almost have gone with a reverse auction.

After dilligencing references provided & found (thank you LinkedIn!) and not insignificant umming and erring, we made a very tough decision. Our final few candidates had been CTOs respectively of a well known mobile phone operator, local directory site & top 3 ratings agency. All of them were in their jobs. It was a tough decision because ordinarily I would have been ecstatic with any one of them.

And the candidate that got the job… well, he was someone I had been at university with 8+ years ago (and hadn’t spoken to since). He is based in the US, and saw the posting on LinkedIn. He certainly wouldn’t have come up from any ad/recruiter. His proposal was far and away the best and to avoid nepotism had our Chairman (Simon Murdoch) & tech advisors (Jay Bregman & Glenn Shoosmith) heavily involved in the process. We made the appointment last month and could not be happier.

I admit that a CTO is a different hire from CEO & CFO, however in a tech business no less important. Had I been in the market for either of them I am confident that the same investment and process would have yielded very similar results.

What I take from this experience is:

1. The recruitment industry (in its current form) has been dealt a deathblow blow by social media. Provided content is good and you make a bit of an effort, your audience will find you without a recruiter or expensive ad. To add value a recruiter or ad must be cheap enough & targeted enough to save you the time involved with making good content & effort.

2. There cannot be a better time than now to startup. Repeating what I told Oli Barret yesterday.

“Talent, the most critical factor to a start-up’s success, is the cheapest and most abundant it has ever been.”

3. I probably could have improved my ROI exponentially by not forking out £20 for a CB ad – but at least that created the link which could be passed around by social media.

The humble termsheet has been the subject of a fair amount of debate and comment over the past few weeks. VC Chris Dixon got the ball rolling with his post on the ideal termsheet, then Fred Wilson weighed in and finally the mighty Michael Arrington, no less, on TechCrunch, following up the story that TheFunded.com had released a standard termsheet for use in series A rounds. As Arrington said, the aim of the TheFunded.com’s “plain” termsheet is to reduce legal fees on a VC round “which average $50,000 or more per venture round”. In the interests of full and frank disclosure, we’re lawyers – and here’s our take.

In our experience, it isn’t the termsheet which drives the time and cost of doing the deal. As a result, the standardisation of termsheets is a red herring. The truth, like so many things in life, is a bit more complicated.

We’d love it if the entire universe of VCs, angels and other assorted tech investors could agree on a standard set of terms for first round investment. It would mean no more reviewing for elephant traps, no unworkable mechanics or terms which work in one market, but not another. Chris Dixon says it should all come down to price – valuation and amount, as he puts it, and all the other “standard” stuff.

It’s a very attractive argument. But there are a couple of challenges: firstly, investors often compete with each other for deals, and secondly, investors and start-ups want to secure the best deal they can. These factors alone (and there are plenty of other variables, like country specific terms) frequently drive different deal terms between the investor and the start-up. Or, to put it another way: one size does not fit all.

As Fred Wilson said in the comments thread to his post: “There are some reasons why we might not want to share our standard set of terms. That becomes the baseline for negotiation and we just give from there. I don’t like negotiating very much and would love it if everyone started with their bottom line. But that’s not the way life works.”

So, while any lawyer who routinely does these deals frequently sees same terms or a variation on a theme in the deal documents, the termsheet is not itself the expensive piece of the puzzle. This is why law firms are able to give away term sheets for free, or even have bespoke term sheet generators on their websites – because this is not where the time is spent or the fees earned.

We advise our clients that if they want to secure the best deal possible they need to obtain more than one termsheet. This gives the founders a sense of the “market” for investment in the start-up and the parameters of the likely terms of investment in their company, which is not simply a matter of valuation and amount. It also gives the start up some leverage to negotiate the best possible deal.

Once the best deal has been secured, it is our experience that, when advising a founder on an investment, our time is principally spent making that deal actually happen. For first time investee companies, there is usually a steep learning curve and so some time is spent explaining to the client what different terms mean (regardless of whether they are standard or not) and discussing what the impact of those terms might be, in relation to other terms in other documents.

A significant proportion of time is spent on any disclosure exercise which might be necessary. The more nascent the company, the easier this is as there is less that can be disclosed. Sadly though, gone are the days when two geeks and a couple of weeks produced a web app that could attract significant funding. Most investment in these chastened times is going to companies which have made it out of the bedroom/garage and which have already got employees, customers and business contracts. Some of them, stretching the definition of “start-up”, will have been running for a number of years. Inevitably, time is spent cleaning up things which have been put on the back burner until the funding is imminent.

We would love to see more tailored warranties. Often, untailored warranties drive a disproportionate disclosure exercise when taking into account the developmental stage of the company and the level of risk being taken on by the investor. But even when tailored warranties are provided, the disclosure process is always a bespoke exercise.

Finally, room always has to be given for the quirks and complications which are thrown up by almost every deal: the former employee with 2% of the equity who must be bought out; the last minute indemnity given for a late-breaking, potentially deal-breaking, liability; a final switcheroo in the angel investor line-up – these are all things we’ve dealt with in the final stages of a transaction, none of which would be made any easier by starting off with standard terms.

So good luck to all those who want to standardise how deals are done, but until VCs and venture-backed companies are also standardised, we’re not convinced that the saving is all it is cracked up to be. In the meantime, if you’re a start up looking to raise funding, try to get more than one offer and make sure you pick the best one!

You know the story. A group of friends come up with an amazing product idea, lock themselves away, code like demons, eat pizza, drink coffee and several months later come out with a prototype. The prototype is good enough to convince some investors, they raise money, build the full product, launch it, users love it, product gets traction, acquirers circle and then founders exit to a large pay-off. They then give media interviews which gets summarised into something that sounds like the above story.

What is wrong with this picture? Well, for a start it is not an accurate summary of any of the start-ups I’ve either been part of or observed over the past 10 years. The main problem is that it puts success down to the quality of the original idea and completely glosses over the most important factor: achieving a product that customers want enough to pay for. And even though most entrepreneurs know from bitter experience that the above story happens only very rarely (if at all), it retains a grip on how we think about growing our businesses.

Six months ago we decided to launch a premium prediction game. Our market analysis showed that the biggest opportunity was US fantasy sports. The only problem was our fantasy sports knowledge was limited and we were 3,000 miles from our target customers. So, instead of trusting ourselves to build something we thought users wanted, we looked for a way to build something we could be sure they wanted.

In doing so we discovered Customer Development, a product development methodology formulated by veteran entrepreneur Steve Blank.

Based on the premise that start-ups tend to fail through lack of customers rather than lack of technology or product features, customer development is a systematic way of identifying who the customer is, what it is they need and whether that need is sufficient to build a business on. One of my co-founders describes it as ‘an algorithm for building products users want and are willing to pay for’.

The first phase of the process is customer discovery, which is identifying who the people are with the problem. This is harder than it sounds as they must not only have the problem, they must realize they have a problem and be willing to invest time and money in a solution to that problem. These are your early adopters. They are willing to overlook shortcomings in your product and believe that you will make it better with time.

In the consumer space we used surveys and customer interviews to see if our target users identify with our hypotheses. If your initial interviewees don’t identify with the problem then you either have identified an issue people don’t care about enough or you are speaking to the wrong group of people. You need to continue to iterate problem hypotheses and customer groups to get to a problem that a particular set of potential customers identify strongly with. In our interviews we found that fantasy sports players were passionate about fantasy sports but many felt the season long commitment was too demanding and also early season injuries could end the game far too early.

In testing hypotheses we found the best method was to drive interviewees to an online questionnaire using Facebook and Google ads. The pay-off for the user was to help us make a product they would love and be entered into a prize draw. We then telephone interviewed a sample of the respondents. In building your survey it is key to making sure each question proves or disproves a hypothesis about the problem or the potential customer. Be very careful of leading questions (like one I received from a fellow entrepreneur which asked “If all my friends were on [niche social network] would I want to be on it as well?”). Finally, friends don’t count as respondents. By some quirk in the human psyche we would rather see our friends waste their time and money, rather than to tell them the truth!

Lastly, you need to identify with the interviewees what is the minimum feature set that they would require to use the product. To identify this, show a very basic mock-up to the interviewees and go through each feature to find out which ones they feel the product must have. For example, with Fanduel, we thought player images would be important but most potential users didn’t care. Live scoring however was vital.

At the end of the customer discovery process you should have a set of externally verified hypotheses, a target customer group and the minimum feature set. This is a checkpoint and you only pass on to the next stage if you have a defined customer group that said they would use the product with the defined feature set and it is within your capability to develop that feature set. Note that customer interviews and surveys don’t prove there is demand (interviewees are generally over-optimistic particularly on their willingness to pay) but they can disprove it, saving you from building something that no one wants.

The second phase is customer validation. Here you push out the first version of the product and attempt to gain paying customers. It is fine to offer free trials or discounts but it is vital in this stage you get to payment otherwise the customer has never had to decide whether product is valuable to them. For apps that are supported by advertising, your customer is the person who hands over the cash. That is the advertiser, so the criteria still holds.

Once you have got a statistically significant user base (which will vary by product) the next step is to survey them to see what they think. Sean Ellis and KISS Metrics put together a fantastic survey for start-ups which is free to use. The crucial question in the survey is “How would you feel if you could no longer use [product]?” Sean has benchmarked the results of that survey and found that if less than 40% of respondents say “Very disappointed” then your product doesn’t yet have sufficient traction to scale. Until you hit 40% you need to focus on the product proposition, targeting and quality.

Once you have achieved sufficient traction with your customers then you need to focus on optimizing your customer acquisition funnels and build out your business plan. Only once you have completed that should you consider spending serious money on marketing and customer acquisition.

The above process may sound quite linear but in fact it is highly iterative. Your vision, target customers, perceived benefits and product are all likely to change a number of times as you go through it. One of the biggest challenges of the process is trying to sell a vision to investors, customers and employees at the same time as constantly challenging and adjusting it in response to customer feedback.

Customer Development certainly lacks the drama of the overnight pizza to Porsche success story, and doing it properly takes time. However, in return you maximise your chance of finding customers who will give you their money before you run out of yours.

Further reading

Steve Blank has written up Customer Development in a book called The Four Steps to the Epiphany. I would recommend it to all entrepreneurs. It is exceptionally insightful however it is a tough read (even the author described it as ‘turgid’) and it tends to focus more on enterprise software. Jon Bischke has put together a comprehensive list of customer development resources. Also, Sean Ellis writes an excellent blog on customer development which is well worth reading.

This is a guest post by Nicolas Holzapfel of stealth mode startup Yoomoot. Throughout the summer we’re running guest posts we like – exclusive to TechCrunch Europe – written by people on the tech scene in Europe. If you’d like to contribute get in touch.

Widget developer JS-Kit recently proclaimed the “death of comments”. How so? By way of its innovative comment management system Echo, that’s how. This would-be executioner pulls together disparate comments across the Web about a particular article and places them amid the conventional comments below the article. If it takes off, popular sites like TechCrunch could end up with hundreds if not thousands of additional comments. And therein lies the problem. How many of us can be bothered to read through more than the first few dozen or so comments on an article?

Not more than a handful I’m sure; a handful that won’t be made any bigger by Echo’s invading army of snippets from Twitter, FriendFeed, Facebook, Digg and Delicious. It may be nice for the article’s author to conveniently track every last mention of his or her article, but for the reader it just means hundreds more comments to not-read.

That’s not to say that Echo doesn’t benefit readers at all. Seeing new comments appear without having to refresh the page is handy, but not game-changing. Being able to post images and videos, log-in via OpenID and conveniently share our content across our different networks are all nice touches, though really these are just basics we’ve come to expect everywhere, not the stuff of epic comment mass-murder which Echo trumpets.

In reality an aspiration to be the death of comments is doomed to failure because it ignores the fact that comments, where they become at all numerous, have long been doing just fine at killing themselves by way of drowning in their own popularity.

Lots of comments amounts to an enormous long list of entirely unstructured text. There are no dividers or subheadings, no logical progression of arguments or groupings of opinion and no distinction between unique, intelligent insights and throwaway expressions of approval and opposition. Because nobody can be bothered to read through such a mess before they add their own comment, there isn’t even the structure of a coherent conversation. Instead, there is endless, pointless repetition; conversations emerge, peter out and then re-emerge 50 comments later with new participants who haven’t noticed that the same issues were discussed 50 comments ago. And these are the more productive comment threads. Much more often comments are unreplied-to and unacknowledged: futile, audience-less clamours and lonely questions without a hope of ever being answered.

By massively increasing the volume of comments and taking them from many different social networks, Echo will only exacerbate this problem: completing the transformation of comments into a disjointed stream of mutually-ignoring cries into the void, each destined for a brief flicker of prominence before vanishing without trace under the weight of a thousand tweets.

I don’t say any of this because I dislike comments but because I’m disappointed with how comments are handled. To my mind, the Internet should be the world’s parliament. It should be a massive conversation, a democratizing collective debate which abolishes the distinction between authors and readers – the active opinion-producer and the passive opinion-consumer. Unfortunately that’s not going to happen if all that the readers author is a garbled, unstructured mess that nobody reads.

Some people believe that comments on popular articles will always be like this because many-to-many conversations are impossible. They believe that if we want coherence we must content ourselves with either conversations in small groups (few-to-few) or one-way conversations whereby a throng of admirers hang on the words of an admired expert (one-to-many).

I disagree.

I believe that the Internet offers the potential for coherent many-to-many conversations for the first time in the history of humanity. As MG Siegler points out, today’s “commenting structure [has] been in place basically since blogging began”. What is needed is an evolutionary shift which is suitably adapted to the Internet’s unique potential and pitfalls. We need something that allows massive numbers of comments to be navigated quickly and easily so that coherent mass conversations can emerge.

We don’t need amplified echoes of what already exists.

In 1901 a Swedish immigrant to America called Johan Nordstrom founded the Nordstrom department store. In 1975, by now a national chain, a Nordstrom customer walked into one of their stores to return a set of tyres he’d bought. The salesperson gladly took back the set of car tyres and gave the customer a refund. Nothing weird about that, right? Except Nordstrom has never sold tyres.

Many of you may have heard this story before; it’s one of many legendary tales of great customer service from Nordstrom and best of all it’s true.

According to a chap called Efraim Turban “Customer service is a series of activities designed to enhance the level of customer satisfaction – that is, the feeling that a product or service has met the customer expectation.”

Like us all I have copious tales of despair dealing with corporate giants. I’d say the worst offenders used to be banks, but in today’s world of mobile everything, the mobile network operators have definitely claimed that crown. They whine about infrastructure costs while continuing to fleece consumers with roaming and data charges; and all while delivering a deeply inconsistent customer service experience which can drive grown men of good demeanour to the edge of sanity. I’m one of those grown men.

This got me thinking. As the internet envelopes our world, one of the biggest challenges facing online brands will be to avoid becoming the customer service dogs of the next decade.

With the expectation of “free” which the internet engenders, there’s an inherent danger of a cultural ethos in business in which non-paying “users” don’t have the right to a personal customer service experience.

This would be naïve on two counts: firstly today’s free user is tomorrow’s paying customer, but secondly we ARE paying. The personal data I give (even if out of self interest) to MyFace when I join a group, FPost when I send an email or Chatter when I update my status, is MY data. We trade this in return –hopefully– for value; and ACME Inc get, consequently, to push us advertising.

There are many better places to read about the relationship between giving up personal data in return for delivering value (my friend JMacs blog is as good as anywhere to start) because what I am interested in are the Nordstrom car-tyre returns of the online
world.

If this is all very obvious, then when was the last time you heard someone say “Awesome! ACME.com gave me such incredible service, I clicked the link and they called me back instantly”. It’s rarer than you think. That’s because at scale, it’s really hard. For excellent customer service to survive as a start-up grows into an incumbent, it has to be –and then remain– a deeply rooted driving goal of the organisation.

37 Signals have a fanatical following; but they’re almost equally infamous for a slew of “we know better than our user” style diatribes. Jeff Bezos in contrast says quite simply “Amazon wouldn’t exist if we didn’t obsess about the customer above all else”.

So which online brands are glowing examples of amazing customer service?

I have recently known very happy customers who’ve used Twitter and received prompt, sometimes exceptional, service from brands. @ahousley a friend of mine tweeted in frustration @easyjet (a large UK budget airline) when his girlfriend accidently booked four seats instead of two on the same flight after a double-click incident on the purchase button. @easyjet sorted it out: fast and without fuss.

If Alex had used “normal” channels, he’d have had to dig thru the website to find a buried telephone number, wait on hold for eons (probably on a premium rate telephone line) and then be told the tickets were binding and non-refundable. I suspect we are experiencing a temporary ‘Golden Age’ of customer service via Twitter. Enjoy it while it lasts, because sadly it’s not going to scale.

Kevin Roberts, CEO of Saatchi & Saatchi claims “Brands are running out of juice.” He’s concluded that “love” is what is needed to rescue brands. He asks “What builds loyalty that goes beyond reason?” Customer service – which includes any interaction with your customer – is a huge part of this. Roberts coined the term “Lovemark” as a step beyond the concept of a simply having “a brand.” I love this idea, of a Lovemark; of irrational loyalty.

What are your Lovemarks? Mine include Virgin Atlantic, my Blackberry and Pret (a sandwich store in the UK). In all cases, I’ve at some point experienced a sub par product* but I’ve always received amazing customer service. I’ve become an irrationally loyal customer. Online that’s probably true for me with Kayak.com, but probably not Facebook.

* Virgin Atlantic on 3 flights the entertainment system didnt work, my Blackberry Bold keeps hanging and Pret? well actually Prets food has always been fantastic

Emotions being as they are, this can work in reverse. I was so frustrated with Microsoft Vista on my new laptop last year, I found myself typing “I hate vista” into Google. As a general search it gave 3,310,000 results; being a nice chap I thought I’d do an explicit search instead. Let’s have some fun…

(Bing in brackets) It’s all rather haphazard of course…no scientific logic was harmed during this experiment and apparently I’m rather alone on my love of Virgin Atlantic.

** BTW not to escape, “I hate Rummble” produced only one result, a tweet [rightly] complaining about the friend connect process –we’re fixing it this week– but “I love Rummble” was equally scant; so I guess we’ve got some serious work to do to.

Traditional business avoids confrontation “What ever we say people will always complain” said an executive to me recently “[Twitter] would be a minefield…” he said. This is akin to letting the bully in the playground simply carry on bullying. Brands must stand up to their customers and be human, apologising where necessary and engage (note, I didn’t say argue) when the claims are unfair. Patience and a measured response are key.

Be careful though, engagement without substance is almost worse. I was recently forwared this reply to an extended query about Facebook privacy: “Thanks for the suggestion. We will certainly keep it in mind as we continue to improve the site. Thanks for contacting Facebook,” I am Robot. Well, actually, allegedly the customer support guy was “Craig”; the point is, he didn’t actually answer the question which was asked.

As anyone in business knows, there are many tombs written on the subject of customer service, along with blogs, podcasts, qualifications, training camps, methodologies and of course the inevitable slew of government supported “standards” with customer friendly titles. In the UK these include “TICSS” and “ISO 10002:2004”.

Much to my frustration, none of these outline why customer service agents who hold ALL my personal details #FAIL on an epic scale when they refuse to give me THEIR full name, extension number or a direct email address. Don’t scream data protection, WTF should I trust you’re not a stalking axe murderer if you don’t trust I’m not? IMHO (lets keep the acronym theme going) these accreditations are all a load of crap. I’m with Johan (remember him?). Good customer service is really rather simple.

Until very recently Nordstrom staff when joining were given only one thing: a card with just 75 words written on it, the core of which said:

“Our number one goal is to provide outstanding customer service. Nordstrom Rules: Rule #1: Use good judgment in all situations. There will be no additional rules.”

As modern health & safety madness and litigation has got worse, that same card is now accompanied with an employee handbook, but this simple guidance when combined with employee empowerment remains hugely powerful.

When building your start-up, make sure the zeal today with which you reply to tweets and emails, good or bad, continues tomorrow and into next year. As you grow, there’s no question it is going to be hard. Look at the ACME Inc’s of today; Facebook has a considerable customer service challenge. I got to 25 clicks to find a customer contact form and stopped counting. With no telephone number and “contact facebook” ranked no.1 in Facebook Help’s own search terms, one could argue they’re failing currently that challenge.

Services such as UserVoice, GetSatisfaction and even Twitter, are certainly helping empower the user to provide feedback easily, but you have to go further. My humble advice to your company is find Mr Nordstroms 75 word mantra online, replace “Nordstrom” with your own company name and stick on your office wall, today. Then stick it on the back of the toilet door. Then before you become the size of FaceSpace, work out how you’re
going to live up to it when you’ve got ten or one hundred times the number of users you have today.

I’m a customer. I don’t care whether I’m paying for the service or not; however unreasonable that sounds. Just serve me well. If I AM paying for your service, then I expect to be treated like a God. I’m your customer and I’m the reason your company exists! Johan Nordström understood that.

At the end of my last published article I said I’d write next time on the subject “It’s about the data, stupid.” Well, in terms of delivering valuable functionality to users, that statement remains true; but in terms of your brand and business, it is most definitely all about the customer, always.

I can’t find my phone. What are my options for locating it?

1. Look for it
2. Ask others if they’ve seen it
3. Phone it

I would probably apply those strategies in that order as each fails. Of course, what I really want is for my phone to magically appear in my hand whenever I need it. That would be nice.

Search on the internet today is somewhere between a technology-driven stage 1 (Google, and minor variations like Wolfram Alpha and Bing) and a people-driven stage 2 (Digg, StumbleUpon, Twitter, Amazon recommendations). One might stretch the metaphor to argue that RSS, Google Alerts and the like are forms of stage 3; I’m not sure I would agree.

Technology markets typically display the following characteristics.

- Incumbents are displaced by products that are an order of magnitude better, not just 20% better.
- Product evolution is about adding value by getting closer to the user

The Internet has evolved. It has become more personal, less about static home pages and more about communication and collaboration (behaviour rather than data). This is what we would expect: The Internet is moving closer to us.

But what most people think of search has not changed significantly:

For the first 10 years, the web was primarily just a bunch of pages, and Google was an excellent tool for searching primary data.

Then we started doing mashups and social networks; these are essentially derived and dynamic forms of data and it’s not that we search differently, per se, but that we simply don’t think about search in these arenas in quite the same way. How many links away from me are you in a social network? Who is listening to the same music as me on Last.fm? What relevant experience do we have within our business? What houses are for sale on my street?

Inevitably, search will move closer to these problems, because these problems are closer to us.

Context is King

The end game for search is recognizing a context where an answer should be presented rather than sought. There are a few candidates in this field.

The semantic web garners a lot of attention (or at least it did once!). It attempts to wrap content in more meaning by enriching it with relevant keywords (I know this is a simplification, but really, who cares?). It is a rather an old fashioned view of the web because it solves an old fashioned problem — find relevant pages. It’s not that there is no room for innovation in this arena it’s jut that Google does this so well, you’re only ever go to be picking at their leftovers. Start-ups entering the search arena should be focussed on a different set of use cases.

There is a lot of talk about real time search but I think it is confused. Nothing is real time, particularly the typical examples that are given like Twitter (go talk to guys that build financial trading systems about “real-time”!).

Further, it is a rather unattractive property. I want data to arrive at the right time and real time is a narrow set of those cases (your house is on fire!). But we don’t understand what right time means so we’ll shove it at you whether you like it or not, so that when you actually need the data, it will have disappeared down the drain with the rest of the contents of the firehose.

Which returns me to my opening gambit. I want my phone to appear in my hand when I need it. How do we know when I need my phone? We start with behavioural triggers (he put his hand to his ear!) and continue to layer in those activities that provide meaning such as task-lists (I must order my groceries) or conversations (they are discussing the price of tomatoes).

Put that way it sounds a lot like the future of search belongs to collaboration: ‘What am I working on with you?’ is a the kind of behavioural question we could hang a new form of search off. What do we have to do to complete this project? That’s a context begging for unsolicited answers.

The future of search is not about better text fields and faster, smarter indexing; the future of search is about you and me.

I spent the whole afternoon and evening yesterday evaluating a list of about 50 UK startups that will compete for the title of “European Tech Media Company of the Year” in a high-profile October event in London. Not that I haven’t been involved in similar processes before but the point that I want to highlight hereby is the absolute mental maze that we, the evaluators, got ourselves in for at least a good five hours. Amongst us were some of the highest profile investors, lawyers and execs in the entrepreneurial world.

The mind-boggling issue was to be presented with a list consisting of a mixture of early stage startups alongside companies trading for a large number of years as well as companies turning over about £100m per annum. To everyone’s amusement, a good number of companies dated back to 2000 – yes, almost ten years ago – and still no one in the room had a clue as to what was going on with their businesses because sales figures had not shown up in their applications, so they still looked to all appearances like pre-revenue or bootstrapped up to their eyebrows. So are we to still call them “startups” because they are either still unfunded, or showing very little footprint in their market? Which leads me to ask:

When is a startup no longer a startup?

We can apply several measuring indicators:

(a) A startup can no longer be called a startup when their brand and footprint in the market is recognisable, they sell in several countries and – even if you don’t know if they are cashflow positive or even sell anything at all (Twitter); their brand has entered into popular culture and the Queen of the United Kingddom, no less, may even have a subscription to it (would you follow the Queen on Twitter if she wrote her own tweets? I bet you would even if you abhor the monarchy).

(b) A startup can still be a startup even when they get Angel money. Pre-revenue or with little sales to account for, half of their professional management are still in “startup training” and cannot be accountable for their sins entrepreneurial early days sins. Nowadays, by the time a VC gets involved, things are very different from “starting up”. Company founders are challenged to deliver businesses for a Series A investment round that pretty much means they have not only started the engines up but they left home and Mama a long time ago. You cannot call a company a startup when they have proper clients, have a PAYE payroll going, pay national insurance contributions, corporate taxes, rent office premises that cost over £25,000 a year and operate like a proper small limited company. It may trade in a risky market – in banking we call them “emerging” – just so that the asset managers don’t get freaked out – but operationally they have the same dynamics and responsibilities of a SME.

Back at the World Bank we used to invest in project financing, a term that ended up meaning something very close to venture capital. Ask the EBRD (European Bank for Reconstruction and Development) what happened to the Vienna-Budapest toll road project. Hundreds of millions awarded to 3 engineering companies to build a toll road between the two cities for the glory and the benefit of all drivers in the region. What happened? So, the toll road opens and nobody uses it. Not because it is badly built or the re-payment model has not worked before in other markets – toll roads are mega successful in the UK – but because in Vienna, back in 1995, nobody cared about driving to Budapest. And in Hungary Eastern European drivers could not afford toll roads. Doh!

This is exactly like investing a series A on a company – Spotify – seemingly poised to rule the world at Star Trek-style valuations even though they have only been trading since June 2009 (ahem, nothing like wiping out the Swedish/Luxemburg past, OK….).

VCs, and challenge me if you want, invest in companies these days, not startups. They invest post-revenue and in markets where the company operates with a high amount of “it’s a sure-thing” ingredients. If you doubt this, do you honestly think for one crazy minute that Spotify would have raised that amount of wonga if there had not been a Pandora years before, rocking every consumer’s music dreams? Wake up and smell the decaf risk, kids.

VCs can argue that “major” risks can jeopardise their investment. For instance, the CEO and the rest of the team – bright young things who are rarely as focused as Steve Jobs – can go mad and mismanage the company. Or the marketing strategy can fail to generate more sales. These are realities that represent the day to day of SMEs and big multinationals. It is called running a business in the real world. The size of the company is irrelevant. Ask any CEO who’s been sacked – Porsche, anyone? (2009) – or big FTSE company with a disastrous marketing campaign, like BT and their riduculous “Surf the Net, Surf the BT Cellnet” ad campaign (2000). Risk – market, human capital, credit crises, is business.

Leaving that heated argument aside, I can propose a safer line of thinking: that of the passing of time. Is a startup really a startup after 2 years of trading? Because this is the point where many run out of money or patience waiting for (a) angels (b) miracles (c) the market (d) a regular, salaried job back in the industry.

Could we now start talking about startups with some kind of proper definition?

What does one call an entrepreneur with a business plan looking for money? A hopeless romantic?

Latest figures show UK ecommerce sales continue to buck the financial doom-and-gloom. There was an overall 14% increase in the year to April 2009. E-commerce certainly looks like the Noah’s Ark of retail during the recession: those companies that have a strong online consumer proposition get a ticket to ride out the storm, and those that don’t, may drown.

There is a lot of he growth in the clothing, footwear and accessories category in particular. According to Forrester, in those categories online sales represented 2-4% in 2003, and now represent over 10% and in some cases, over 15% of the total category.

Where the sale of more ‘generic’ products such as books, DVDs and travel can be seen as something of a first wave of ecommerce, understanding how consumers want to buy high-touch, cosmetic products online such as expensive jewellery, fitted garments and for us, eyewear, could represent something of a second wave of e-commerce.

For companies involved in this second wave of ecommerce, it is not as simple as relying on the old cornerstones of price, range, convenience to attract customers. Our peer group face significant consumer purchase barriers to do with try-on, fit, and product education, that one-by-one, need to be identified and addressed, through continued technological innovation and great customer service, in order to pursued customers to make purchase decisions in our favour over the high street.

A number of interesting businesses ride this new wave of e-commerce innovation shotgun with us:

Blue Nile, is an online jeweller that offers a completely new level of service online, changing diamond shoppers’ habits. They offer enormous amounts of information on the diamonds that they sell, specialist experts on-call, and a massive focus on education to teach you about what you should think about when buying a diamond – far more than you could get in a high street store. The technology on their site allows you to see what different carat diamonds would look like on your finger. This matched with the traditional advantages of shopping online – a massive selection, reasonable pricing and convenience, has meant their business has been a runaway success.

Everyone knows ASOS, which has developed some really strong online celebrity and brand engagement. Suggestions for product ranges and tips from other consumers’ purchases, beautifully shot imagery and the ability to zoom in to inspect every detail complete the picture for the ASOS shopper of high-touch products.

At Glasses Direct [interest declared] we help our customers find their ideal glasses with our Virtual Mirror, which allows people to virtually try on glasses while they’re browsing. We want people to use the resulting images to get other people’s opinions on their looks. ‘Do I look good in this’ becomes a question you can ask your community, not just one shopping companion or the store assistant. Retailers like us are looking at ground-breaking ways to visualise products online, especially when the products face higher than average barriers to sale.

And then there’s Zappos, who use customer service to create a ‘personal emotional connection’ with their customers – something that helps it overcome barriers to buying shoes online, drives loyalty and therefore repeat purchase, and helps them sell over a $1b of shoes every year online.

The second wave of ecommerce isn’t about necessarily unique or high technologies, but how we, as retailers of the fitted or fashion product, can fashion practical online solutions to each of our own consumer bases’ needs. I believe that in years to come it is likely that every retailer will be able to offer price, range and convenience like Amazon, and so the real competition will be around the customer experience and the customer service. We’re just ahead of the curve by prioritising these now. This is why, as I said in a blog post after a visit to the company, Zappos, who calls itself ‘a service company that happens to sell shoes’, it will probably in time, replace Amazon as the e-commerce ‘gold standard’.

Now that the first group of second wave companies has proved that the public, investors and the city all buy in to the prospects of companies dealing thin the high-touch, entrepreneurs should be scrutinising the high street for possibilities. Most of the obvious e-commerce first wave opportunities may well have been seized, but there are many second wave opportunities still out there. Look around and anything that says ‘tailor made’ on, is not sacred to the high street anymore.

TechCrunch Europe posted an open letter by Robin Klein of The Accelerator Group to the Chancellor of the Exchequer Alistair Darling and Lord Dryson Minster for Science and Innovation about what to do with purported stimulus funds. BVCA wants the money to go to large VC funds whereas Robin Klein wants to see the money channelled to supporting very early stage companies (amounts less than £100k).

Robin’s logic and reasoning is sound and I agree with them. But it is not a good use of the money for two reasons.

Tech (web) Focused
The idea is far too technology (read web) focused. There are lots of opportunities throughout the UK for entrepreneurs to create businesses; many, indeed most, outside the world of the web. Why shouldn’t someone starting a lawn-mowing business have access to early stage funding as a technology developer? Both create value. We in the technology sector tend to be myopic about start-ups, small businesses and entrepreneurs. Richard Branson can hardly be accused of creating a technology business and yet he is by most measures the UK’s most successful entrepreneur.

Yes, technology creates long term value and wealth, but the vast majority of wealth is created by companies outside of the technology sector using technology and not developing it. It is created by a lawn-moving business using twitter to alert their customers that their lawn is done and having a website where clients can go and book a visit using something like BookingBug to provide the functionality. The lawn-mowing business is creating value through better customer service and consequently generates wealth. Would a business angle or early seed stage fund invest in such a company? What about if it is located in the hinterlands of Wales?

Relying on Judgement
The mechanism for distributing funding relies on someone making a judgement call as to what is potentially a good opportunity. The act of making a judgement takes time and as many commentators pointed out in response to the open letter, time is very precious at the early stages of a business. Waiting more than a month for a response is a massive drag on very early stage businesses. Small business need responses fast.

More problematic is that a person can only make the judgement based on their experience and expertise. Many great opportunities will be bypassed as the judges’ focus on what they know. Now however is a time to fund companies that are moving into new areas and new ways. It is a time to let 1000 flowers bloom. In the end the only real judgement that matters is that of the market. It would be better to create a situation where those companies can be judged by the market rather than a limited individual. The market is crowd-sourced investment decisions.

Proposal
In place of co-investing or creating lots of seed funds, I propose that the UK government create a scheme of income-contingent loans. Under the scheme an entrepreneur can take out a loan that covers his previous salary up to a maximum of £50k to £60k. The loan is paid monthly like salary and is re-paid by the individual (not the company) through the tax system (similar to student loans). Other characteristics of the scheme are:

* The scheme would provide loans for up to 3 people per business in the first year, followed by another 2 new employees in the second year
* The loans are tied to the individual and are re-paid by the individual based on the individuals income
* An individual can only take out a loan under this scheme once every 5 years

An income-contingent loan scheme provides funding irrespective of industry or goods and services. It addresses the funding gap that is a barrier to entry for all entrepreneurs and has a lower administrative burden. The loan scheme can be administrated through the existing Government banks and through an online loan application system which are widely geographically diverse, scalable and most importantly can return a fast decision.

One big objection is the potential for fraud. Nothing involving money is without the potential for fraud and venture funding is not immune (witness Tiger Telematics). By putting the liability to re-pay the loan onto the individual reduces the avenues for fraud using this scheme. The other limitations are also designed to reduce the attractiveness of fraudulent behaviour.

Conclusion
Granted, the loan scheme is unlikely to produce the next Google but I would rather see the loan scheme generate 100,000 businesses all employing an average of 10 people. That would be far more valuable to the UK economy as a whole than 1 Google.

Ideally, you would run both an income-contingent loan scheme and co-invest in early stage investments. However, given the realities the loan scheme is more valuable. The co-investment scheme should follow. By the time the co-investment scheme is up and running many of the first lot of companies that have benefitted from the loan scheme will be ready for their first round of funding.

What the UK needs is a large and sustainable investment ecosystem that covers seed, early, and expansion stage. For the last 50 years, various UK governments have experimented with a mixture of programs and initiatives. I suggest we build future initiatives based on the past’s success, not by repeating the many mistakes that have been made.

1) Seed Phase – Seed new companies by bringing back a modified SMART Award
By far the most successful program that the UK has ever run in terms of giving early stage money was the £45k SMART Award program. The program required founders to invest £15k in their company and, if qualifying conditions were met, they received a £45k grant. This program invested in both startups and product ideas of established companies. The former worked well, the latter not. Later on, the program’s responsibility was given over to the regions and the brand was abolished.

I would suggest revitalizing the SMART program with the following criteria: £15k own investment, £45 grant by government, provided following criteria are met:

- Company younger than 18 months
- Company less than five employees
- This is grant money, not equity investment, not a loan

The grant should be centrally administered. There should be no regional focus. All government loan or equity investment programs at this stage that I am aware of don’t work well. I would therefore make this a grant. This program’s aim is to help early stage companies get off the ground that then grow to employ many people. I would rate a success any company receiving money that lasts for longer than three years and that employs more than ten people at this stage.

2) Early Phase – Seed new VC Firms by creating seed funds in cooperation with established VC firms
The key problem in Europe’s investment ecosystem is the slow birth of new VC fund management companies. Looking around, I largely see fund managers that have been around since before 2000. These fund managers have progressively raised larger and larger funds, moving later and later stage. What any healthy investment ecosystem needs is a continuous supply of new VC companies ‘bubbling up’ from the bottom. These new VC fund managers naturally start out with smaller funds, investing smaller amounts of money per company. Eventually, they will mature, raise larger funds, and move later stage themselves. In order to get VCs to invest early stage, you need young VC firms. So I suggest we create a system that results in a continuous ‘supply’ of new, small VC firms, which invest early stage.

I would suggest expanding and making permanent a program to ’seed’ Seed VC Funds in cooperation with established VC management companies.

Specifically, I suggest doing the following:

- Offer a seed fund to all VC fund management companies that have closed a VC fund larger than £75 within the last year (maybe two years initially) and do this continually.
- The seed fund should have a size of £10-20m
- These funds should be equity investment vehicles, not loan or grants.
- They should have no co-investment limitations
- The funds should be fixed term funds of 12 years
- Ask the VC firm to invest half of the money (at least say £5m), the remainder should be from government
- Ask the VC firm to have the fund managed/run by somebody who is NOT a General Partners at the VC firm’s main fund. This should be somebody from the middle management of the VC firm.

The principle is to establish a program that enables the next generation of managers at VC firms to run ‘their’ own shop. Over time, I estimate that some 30%-50% of these emerging seed fund managers to be successful. This means they will start raising the next fund, eventually separating from the ‘mother ship’, setting up their own VC firm, and thus growing the ecosystem of VC fund managers. The reason why I would establish these funds in collaboration with established VC funds are manifold. In short they are: By sharing the cost of people, offices, etc, the seed fund can work with a smaller amount of money than would be necessary, if it operated on its own. The operations would share deal flow. The seed fund managers could ’soak up’ lessons learned from the more established fund. By aligning the vintage date of the main, larger funds, with the smaller seed fund, the seed fund can have the larger funds invest in follow-on rounds. This means that the seed fund invests in early companies, not so much in small companies. By only offering the seed funds to VC firms with recently closed funds, the government can choose fund managers easily, as closing a new fund means that the VC firm is good at what they do. I would rate as a success that the seed fund returns a positive return over the fund’s life time, and the spin-off the of the seed fund into a new VC firm.

3) Expansion Phase – Ensure that the government remains an active LP/ fund of funds investor
In a time when many LPs have problem honoring the capital calls of their GPs, I strongly suggest the government not waiver. In addition, I would suggest that the government aggressively support European institutions as an LP investor. All of this is already happening, don’t take the foot of the gas pedal!

Summary
Grants at Seed Phase. Collaborative equity investment at Early Phase. Cash as a fund of funds investor at Expansion Phase.

Investing £100,000 in 10,000 start-ups sounds good, but investing it via equity is hard. By making it a grant program, you remove many of the problems associated with the cost of making an investment work at this size. I further suggest investing larger sums of money intelligently in collaboration with existing VCs, and to continue investing even larger sums as an LP at expansion stage.

All of the above has been shown to work. There is real data and real evidence for this. SMART Awards worked in the UK. The support of new VC funds worked all over Europe and specifically in Israel. The European Investment Fund is a heavy LP investor in many VC funds, some of which have done extremely well.

I suggest we do what works first. We can improve from there.

Alistair Darling, Lord Drayson – an Open Letter

Dear Lord Drayson,

Put £100,000 into 10,000 startups – not £10m into 100!

There has been a lot of chatter about the Government’s apparent initiative to make £1bn available for innovative early-stage companies.

Apparently, Lord Drayson, the Minister of Science and Innovation in the Department for Universities and Skills is driving this. The BVCA is keen to promote the idea through its influential contacts that this money should be channeled via the large established VC funds.

From where we sit, putting lots more money into the large funds achieves the exact opposite of what I understand the desired the objectives to be.

What is urgently needed in the UK – in order to promote entrepreneurship and encourage innovation – is funding at the very earliest stages.

One of the major drivers for Silicon Valley’s success has been the readily available, quickly raised seed capital. Its not uncommon, even in today’s funding climate to find start-ups funded with $500K in a matter of weeks by angel syndicates led by an agile tech VC.

There is more than enough capital available once companies have proven their technologies, validated the market need and have real momentum. This capital is NOT venture, it is development or growth capital.

The so-called funding gap has never been adequately filled and the growth in size of the leading funds has forced them to move up the food chain and to back relatively fewer pure start-ups.

We have all been wringing our hands at this gap for many years and in the current environment the gap is noticeably widening.

Seed funds are extremely difficult to make work effectively on the classic 2/20 model since it is important that seed funds invest in a large and diverse portfolio (in order to find the winners) while at the same time need to provide a lot of hand-holding to these companies (implying a larger organisation – more partners).

The BVCA’s position is interesting in that it looks at the whole issue from the ‘industry’s perspective’ – you can’t blame them for that – its their job. It’s certainly not being looked at from the entrepreneurs perspective!

We at TAG have had terrific support from some of the large tech VCs but their ability to do many seed fundings is very limited. We need healthy and growing seed capital partners to join us in our quest to find and nurture the next world beaters.

One of the most important and effective vehicles for promoting entrepreneurship in the tech arena in recent years has been Seedcamp [Interest declared: TAG has been an investor in companies promoted by Seedcamp - Editor] – the flood of applicants and the rising quality of these applicants attest to the strength of innovation emanating from Europe.

They are deserving of far greater financial backing.

Robin Klein

Partner, The Accelerator Group (TAG)

PS: TAG is an early stage technology investor with 43 investments currently in its portfolio. We invest actively mainly in the UK but also across Europe and in the US.

[Photo credit]

As I am in the midst of raising another round of funding for fav.or.it I wanted to cover some of my thoughts on the government’s recent announcement of further funding for business that is meant to help SME’s survive through the credit crunch. The question is: is there real substance to any of this, or is it just a lot of hot air?

ENTERPRISE FINANCE GUARANTEE SCHEME

This is just a fancy new name for what you probably know as the SFLG (Small Firm Loan Guarantee) – this is a scheme in which the government guarantees 75% of a loan with the rest covered by the banks.

A year ago this allowed loans of up to £100,000 – which was then increased to £250,000. It was something you fell back on if the bank turned you down for a normal loan (in fact it was a requirement that you first applied for a normal loan). I have previously raised a SFLG (over 2 years ago) and found the process reasonably painless except for the fact they take a debenture against your Intellectual Property.

The problem though is that since the beginning of the credit crunch the Banks have not been lending. I inquired to a friendly senior figure in HBOS about 4 months ago and was told not to even bother. I also contacted a few other people in the know within SEEDA and the answer was the same, no lending.

So when I heard about the new initiatives I was curious to find why anything would have changed. Well the statement from the UK GOV declares ‘This scheme will support up to £1.3bn of new lending by banks.’ However, there is one BIG problem, the banks still do not want to lend. I heard today from someone who was at a senior meeting of the “Big Four” banks (that we as tax payers now own) that they declared that in no way was there any going be any lending via SFLG.

My Advice: Ask your bank manager, but when he laughs at you don’t be surprised.

CAPITAL FOR ENTERPRISE FUND

This used to be a fund created by the government that was bid for by various private venture funds who would then invest it. The scheme was originally setup to fill ‘the equity gap’ that being investment between £250,000 and £2million – an area that traditionally is not covered by Angels or VC’s. The fund is re-invested by companies such as Seraphim Captial and Oxford Technology. Both of these in general only deal only with companies that are already generating good revenue.

The confusing part is that the new announcement seems to have converted this equity based funding model into a ‘debt to equity fund’ this may be due to the fact that not enough of the fund has been spent, and or they see it better used to convert bad debt.

My Advice: If you are already generating cash then talk to them, but if you are in that position then the VC’s (such as Balderton) are already in the prowl for good deals.

REGIONAL DEVELOPMENT AGENCIES

The last minor announcement was that a further £25m was going to be invested through the RDA’s. This in theory is the best news for startups as RDA’s such as SEEDA are slightly better at distributing money out via other agencies. One which I have dealt with at length is Finance South East – they have a range of funding models from equity based matching funds (up to £250,000), debt based accelerators (up to £100,000) and also a few other small funds for very early stage ventures.

My Advice: For startups at pre-revenue stage there are a number of good options, but be prepared for a 4-5 month process + a lot of paperwork.

NESTA

Lastly let me just make a scathing attack on NESTA who in theory cover ‘Science, Technology and the Arts’ but in fact would rather not touch Technology with a 9 foot investment stick. I was clearly told that “We do not invest in anything web 2.0 at the moment.” – So feel free to go waste time talking to them, but I would warn against it.

My Advice: Tell them to stick it where the sun don’t shine.

Other Resources

• Region Development Agencies – What They Do
• Assess your eligibility for government guaranteed lending schemes
• Enterprise Capital Funds

If anyone wants contacts into SEEDA, FSE or advice on other government schemes then get in touch via Twitter.

OpenStreetMap started four years ago in the UK as a project to create a free and editable world map. What began as a few geogeeks wandering the streets with their GPS’s has turned into a global movement with over 75,000 registered contributors. The database has improved rapidly in quality and comprehensiveness, as have the tools and services around it. OSM is becoming a viable datasource for complex projects.

The project’s stats are another demonstration of the awesome power of a motivated online mob. The passion of some of the volunteers is shocking; there’s even a student attempting to go his entire time at uni using only OSM maps. The result is that the OSM now compares favourably versus some professionally gathered geodata. Most impressive has been the takeup in Germany: 300 volunteers mapped 99.8% of Hamburg (German), and there is now a German-language OpenStreetMap book.

OSM has spawned numerous related projects, the most prominent of which is OpenCycleMap which takes the base OSM data and renders it slightly differently, giving emphasis to features relevant to cyclists. OCM was recently commended by the British Cartographic Society and is an example of the technical innovation that free access to the underlying geographic data allows. Similarly several groups are working on using OSM for open source routing applications.

As the biggest commercial geodata providers Tele Atlas and NAVTEQ have been acquired, the intensity of their competition in (and focus on) major markets has increased. As a result in many parts of the developing world OSM is now the most comprehensive online mapping available, for example see this comparison of online maps of Baghdad or compare for yourself: Mashad in Iran (OSM, Google) or Kinshasa in the Dem. Rep. of Congo (OSM, Google). This summer’s annual State of the Map Conference had representatives from most major European countries and five continents.

Tellingly, while most of the audience at the conference was the usual hard core of geo-enthusiasts, many businesses were represented (including Google and Ordnance Survey) and there were a few VCs in attendance. Which brings us to the next phase in the OSM’s growth: commercial utilization. Companies have been using OSM data in proof of concept implementations for some time. Recently though the examples have become more prolific and more public: see flickr’s use of OSM. Some businesses are starting to rely on OSM for parts of their product offering, for example Wikitravel uses OSM derived maps in their printed travel guides.

New start-ups like CloudeMade in the UK and Geofabrik in Germany are being founded and funded around the business model of providing services around OSM (see TechCrunch coverage of CloudMade funding). The exact revenues of these companies is unclear (and likely still negligible) but the general concept of providing consulting and value-added services around a free (and complex) asset is well entrenched. This year’s acquisition of MySQL by Sun is only the most recent successful (and European) example. One certainty is that the recent explosion of interest in online cartography has lead to the development of an increasingly sophisticated “open source geo stack” that will pressure traditional GIS software companies.

The big players are increasingly trying to use crowd sourcing methods to improve their proprietary databases – see Tele Atlas’s use of Tomtom data or Google’s MapMaker, while savvy (and smaller) businesses are realising that there is much to be gained by working together with the OSM community. Smaller digital mapping services like Autopoietic Systems, Tann Limited (ASTL) and Holland’s Automotive Navigation Data (AND) have donated significant amounts of data OSM.

OpenStreetMap and the tools around it still have a very geeky feel, making it
easy to be dismissive. Nevertheless, there is no disputing the rapid growth,
improvement, and emergence of a surrounding ecosystem of ventures make this a
project likely to a have global impact for both internet users and businesses.

Full disclosure: the author is a member of the OpenStreetMap Foundation.

If Silicon Valley checked into hospital, it would be diagnosed with severe bi-polar disorder. In mid-September, with the bad economic evidence mounting and the markets in freefall, its mood swung from vaunted optimism to extreme despair. Sequoia summed up the change in mood, titling their recent presentation “RIP Good Times”.

So, as we officially head into Bad Times, the first question is, will we see a period of mass extinction similar to the one that occurred after the dotcom bubble? Unlikely. Firstly, the dotcom bubble gave rise to thousands of companies with heroic growth assumptions and high cost bases, serving markets that didn’t yet exist. In contrast, while many web 2.0 companies are still propositions looking for a business model, they often run at less than 10% of the cost of an equivalent dotcom business. Secondly, in retrospect we see the market peak in early 2000 and then the gradual slide as if it were inevitable. However, right up until 9/11 there was a feeling that the market might pick up again and the good times return. This resulted in many companies failing to adjust quickly enough to the new reality which caused many to enter, what Sequoia described as, a ‘death spiral’. Given the speed at which start-ups have cut costs this time around it looks like that mistake is not being repeated.

In fact, Bad Times can be very good for start-ups. In the last tech downturn we saw the birth of Last.fm (founded in 2002), Skype (2003) and MySpace (2004), along with a plethora of other successful web 2.0 start-ups. Tighter times mean less competition, not only for staff but also for users. This is highly significant as pay-roll and cost of user acquisition are the two biggest costs for any start-up. More importantly, a tougher environment forces start-ups to ruthlessly focus on only those opportunities where they can bring value.

On entering a downturn it is often hard to see if the economy will ever recover. I remember in 2002 wondering if there was any future in the web economy (and at least one of my developer friends retrained as a cocktail waiter!). However while expectations of growth got wildly inflated by 2000, the underlying trends continued. People continued to migrate to the internet and also massively increased the amount of time they spent on it. In a downturn, the allure of the web as both cheap entertainment and as a utility gets stronger. And while it may be hard today to picture the wider economy coming out of recession, the most likely scenario is that it will, and indeed within the next two or possibly three years. What will the world look like for start-ups when it does?

Very. Well. Positioned. To understand why, consider Start-up Economics 101. Big companies struggle with innovation, even at the best of times. During the past 10 years in the technology and media industries the smart money has been on start-ups out-innovating more established companies. Whether it is Google besting AltaVista in search, Flickr out-performing Yahoo in Photos or YouTube whipping Google in Video, it was the start-up that came out top.

However in downturns, innovation in big companies is pretty much closed down as the focus moves to cutting costs and eliminating any product lines that arenít showing immediate profits. Last week we saw AOL shutter XDrive, AOL Pictures, MyMobile, BlueString and AOL Video Uploads. Innovation at AOL, like most big companies, isn’t seeing much love these days. However the media sector, like the technology and mobile sectors, is seeing deep structural changes. Consumers are moving rapidly from print and broadcast to digital media. And consumers are being swiftly followed by advertisers. Over the next 2-3 years innovation within the media sector will happen in start-ups, not big media companies. That means when the market returns, media companies will have to acquire if they wish to remain relevant and grow.

Of course many things will stay tough over the next couple of years, with finance in particular remaining tight. However start-ups that can work through that constraint and focus on opportunities where they can create value will be excellently positioned when the economy picks up again. Now is a great time to be an entrepreneur.

Search for a product you may be interested in and you’re given a list of related products. What I like about this is on the same screen you’re given a clearly displayed rating on every listed item. It’s convenient and saves time. If you’d like to go deeper when researching, or if you wish read those staple reviews the company is built upon. You simply select a result and you’re presented with a clear list of reviews, a guide price and a product image. The format is clean and the information is plentiful.

I spent this morning in my local town center drinking too many cups of coffee, and looking at various electronic indulgences. This is where the application shines. The ability to research the product whilst you’re in the store is an in-expendable tool. Another nifty feature of the app is the ability to purchase products though the merchants signed onto the site. More convenient, and you can now compare prices to find the best credit crunch beating deal.

For what it is Reevoo isn’t anything groundbreaking, even delivered through the iPhone. But the service is good, the app is useful and you will discover that Reevoo is a tool you want to use. Price comparison services are also about to become a great deal more important in the coming recession. Alas.

(By Grant Bell, TCUK’s current intern)

So how does FineTuna work? Well, remember that drunken picture of you and that person you don’t know? Upload that image file and FineTuna will present you with a unique URL. This is where the service comes into its own, as you are then presented with the ability to comment on parts of the images. Maybe not the most practical example of what you can do with the service, but the feature set is definitely there to help you along the way.

Not content? Well FineTuna offers up a very handy FireFox add-on. Install and right click on an image, or even an entire browser screenshot. Upload to FineTuna and get the same services as before.

Now there are as many image sharing services on the web as there are fish in the sea. But FinaTuna is one I could actually see myself using. It’s simple, intuitive and an absolute delight to use.

(By Grant Bell, TCUK’s current intern)

The pointlessness of most Facebook applications knows no bounds but at least here’s one that appears to be the the first application that enables people to send each other alcohol.

GetThemIn is, currently a Facebook app which lets you send drinks vouchers to friends. Once installed you select your poison, the friend you wish to intoxicate and then pay. You can alert your chosen friend through a text messaging service provided. But there’s a simple way the makers have addressed the issue of teenagers sending eachother bottles of White Lightning. Your friend has to redeem the code through the app, get sent a coupon via snail mail, then take that coupon to a participating store, which is obviously going to check the age of the recipient. Over 1,500 participating stores in the UK, including Threshers, The Local, Wine Rack and Haddows. GetThemIn is the brainchild of Jay Feeney, entrepreneur with promotional experience in product and event management for bars and clubs in Scotland.

There are some issues however, apart from this being an app with less than instant gratification. I would have liked to have seen the inclusion of PayPal as a payment method. The app currently only supports Google Checkout. Although it does support almost all major credit and debits cards, GetThemIn is the type of app you would use at a whim and you don’t want to have to be signing up to a new online payment service like Checkout.

Virtual gifts have been popular on Facebook and are being lauded as a future business model, but at least this is a little more ‘real,’ however so take that at face value is to miss the power that virtual goods will have in the future. And I fail to see how this app is anything other than a marketing gimmick from the participating stores. There doesn’t seem to be any real advantage over buying from an online supermarket and just changing the delivery address, or are we missing something here?

GetThemIn aims to be an app for social sites in the US, Canada, Australia and Ireland and aims to expand to Bebo, Friendster, Hi5, MySpace, Orkut and LinkedIn, though I don’t quite see the how Bebo (largely teens) or LinkedIn (largely business) would let this app on their platform.