Thursday, 28 February 2008

Avoiding big mistakes – Lessons from a leading investor

There are very few investors in the UK with the kind of education and training that Dr Hermann Hauser has received. He completed a PhD in Physics at the Cavendish laboratories in Cambridge, the home of several nobel prize winners and source of inspiration to many generations of researchers. (add link to HH and Cavendish)

Following this training Hermann went directly into creating his first start-up – Acorn computers, described at the time as the first ever home computer, now called PCs. In other words he combined his insights in Physics with entrepreneurship. But as he then described at his keynote speech on Enterprise Tuesday, there was much to learn about doing business. Since then Hermann has personally invested in around 60 businesses and as co-founder of Amadeus Capital – probably the leading technology venture capital fund – he has influenced and shaped a further 60 or so investments.

Hermann was candid enough to talk about some of the mistakes he has experienced so that future entrepreneurs can avoid these. Actually making them seems rather easy, getting it right seems much harder! And Hermann has a stronger track record in getting it right than getting it wrong. Phew!

Here are the lessons he learnt.

Inventory. In a business that sells direct to consumers, especially if it is product based, you just have to understand when things will sell and get the volume of inventory right. At Acorn, it took a number of years to scale up production to the levels that were being demanded, but just as production levels were resolved, competition came in with products, timed their entry better and this left Acorn with unsold computers. With cash tied up in inventory – the firm had to be sold on and exit was achieved through a takeover by Olivetti.

Strategy. When you are taking a product that is new to the market, it is somewhat easy to go down blind alleys in terms of market strategy. In the case of Acorn, the team did not spot the growth of set top boxes and later with another firm they focused for too long on “switches” rather than on the chip they had designed to solve the switch problem. Getting the strategy right, together with understanding the business model and how revenues will flow is probably one of the most common challenges faced by early stage companies in the technology sector.

Not believing in yourself. As part of a growth plan – one of the ways of achieving scalability is to merge with a larger organization that has market access. But – if you do not choose your partner carefully you might find that in reality you could have done it better yourself. So a lack of self-belief might lead to the thoughts of mergers or trade exits that might come too early.

Relying more on debt than equity. In high tech when there is a great need for cash, some entrepeneurs are reluctant to part with equity and prefer to borrow. The essential difference is that if and when times get hard, banks can demand their money back. Not understanding the risk profile and using the wrong type of money to grow the business can be expensive to the business. The example provided was of a firm called Harlequin that racked up £30m of debt, rather than take in equity and eventually the bank called in the money and the firm had to be sold off for £1.00. The lenders were Natwest. (was this an early example of NatWest in the so-called sub-prime marketplace?!)

Market size estimates. Entrepreneurial over-optimism is central to self-belief and risk taking. But – thinking in terms of global market size and assuming small percentage market share is dangerous. The mistake is in not understanding market segments, customer needs and not having conversations with potential buyers.

Estimates of time to market. Although markets and customers may well have been identified, it always takes longer to persuade customers to buy! They have internal reasons to better understand how your products or services fit, issues of integration, finding budgets, trusting the suppliers and a host of other factors, all of which can delay decisions and actual spend. The delays eat into the cash available to the firm and if combined with other risks in the business can be one of the most agonizing reasons for failure – so near yet so far!

Understanding the window of opportunity. Timing. Markets and customers respond to needs and you need to get your timing right. For example – no good bringing a Christmas product out in January, or trying to launch a product solution when there is no infrastructure available to support it (service back up and so forth). Markets shift rapidly and the entry of substitutes or competitors can close a window of opportunity quite quickly. The team needs to remain alert.

Technology failure. Taking an idea from a laboratory to the market requires, proof of concept, prototypes, understanding methods of production, ease of use and scalability. At any stage in this cycle of events the technology can fail. To avoid this you will need the right type of people around you and this is yet another judgment call, to understand the critical success factors.

Amount of money needed to get to market. There is a simple rule that for every $1 to invent it takes $3 to prove the product and $10 to take it to market. And not having enough money to go to market can kill a business quite early on. Underestimating the challenges, harsh market realities, skills and communication experience, trust building needed and operational effectiveness of getting to market can all contribute to runaway costs.

Overestimating the attractiveness of the new product. As founders of a business or at least as founders of the business idea – we can easily seduce ourselves of the merits of the product. In reality the product may not do “anything” for the customer. Another bland offering or just insufficient “wow” factor. If people are to buy – they will need the product to really solve a problem they have or have so much fun/enjoyment that they can be persuaded to buy.

Having the wrong people around you. Perhaps one of the most common errors in business and the hardest of all to get right. Much as been said about the importance of having the right people, but the challenges of finding the “right” people, recruiting them, rewarding, motivating, trusting and working together is not at all easy. Often we build relationships with the people around us and so there is a fine balance between being hard nosed about business decisions and thinking of people as a resource in the business with managing the emotional, moral and social aspects of working with people.

In summary – getting it wrong is easier than getting it right and so to avoid common pitfalls, try and get some experienced people around you. Read a lot and get training in the basics of business. Build your skills, knowledge and credibility.

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