@andrewchen

Small profitable companies versus VC-backed startups
I recently had an interesting conversation with a friend centered around a key question that’s come up a couple times before:

How transferable are the skills you learn from building a small, profitable company versus doing a VC-backable startup?

This question came up because part of his life plan was that he wanted to do a “real” shoot-the-moon type startup at some point in his career, but before doing that, he wanted to work on a small profitable company so that he could learn more about the process. We had a discussion around the key assumptions around a plan like that, which centered around the question above.

In general, it’s my belief that most of the knowledge isn’t that transferable, and you are better off just trying to do the VC-backable startup from scratch, rather than deferring that experience. In the worst case, if you fail, you still learn a lot about VC-backable startups and what it takes to succeed. Compare this to building a small, profitable company, where even if you succeed or fail, you may not learn what you wanted to learn.

And of course, it’s a perfectly healthy thing to NOT to want to build a VC-backable company, ever. That is a great idea too But for those who want to have that experience but are deferring it, I would encourage you to try sooner, not later.

VC-backable startups have weird constraints
Ultimately, the core of my beliefs stem from the fact that VC-backable startups have to deal with a number of weird constraints:

• they should grow really fast – people sometimes say ideally hitting $50M in revenue in <5 years
• they should be defensible – ideally having real technology that isn’t easily duplicated
• obviously, you want a great, experienced team – ideally experienced operators or cutting edge technologists
• it’s very centered on SF Bay area and less so on a few other areas (Boston/Seattle/NY/SoCal/Austin)
• early stage is focused on proving things out to get each new round of funding, not on profitability (which is a nice to have)
• etc.

Again, most of the above are nice to haves and they are always on some investor checklist somewhere, and are followed loosely/casually in most cases. Similarly, to get in the game, there are significant “community” effects that kick in too – it’s good to have the right angel investors, because they can help connect you with the right VCs. But angel investors are just random people (albeit random successful people), and they sometimes don’t like to give money to strange people from other cities. So they like to invest locally, and only through people they already know.

So the point on all of the above is, VC-backable companies have all sorts of weird constraints on what you have to be able to do.

Understanding these constraints, and working with them, requires a different mindset than if you are just targeting for profitability.

There’s different constraints on Lifestyle companies, aka Small/profitable companies, aka Passive income companies, aka whatever you want to call them
I think most of the constraints above are pretty silly if the only goal is to build a self-sustaining company that can get profitable and kick off passive income. In those cases, you really don’t need all the constraints above, which really take you down a different path.

In those cases, you could really execute your company anywhere – you don’t have to be in the Bay Area. Rapid growth is both unnecessary, and possibly not desired if new users are creating costs! Instead, you might prefer to charge users upfront, so that you can be sure that you can stay cashflow positive. Similarly, it’s fine to just work with your buddies, or family, or whatever you want – there’s less of a need for them to scale the business quickly, nor will their experience level play a role in whether investors fund the company.

What both the two styles of company do share, however, is that you still need to be able to build a product, and build a business for cheap, even if you are going after different goals.

But even with product development, when you are going for a smaller, self-sustaining company, it’s more OK to target niche markets or build high-quality products for slow-growth businesses. You probably don’t want to build for a new market, since that can take a lot of time and capital to get right.

How much do you really learn?
To net this discussion out, my point is that the two styles of companies are different in as many ways as they are similar. Instead of “walk before you run” it’s more like “learn to sail versus learn to bike.” Learning to sail does not increase your chances of success at cycling, and vice versa, as well.

So for all the engineers out there who are thinking about doing small web projects before trying to take over the world – go for the latter

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My experience in venture capital
As I’ve blogged about before (though quite a while ago), I spent some time at Mohr Davidow Ventures as Entrepreneur-in-Residence – for more about what that job is, read here and here. A couple years before that, I had spent some time at MDV in their Seattle office, towards the end of the dot com bubble, as an analyst/intern. Both experiences were a ton of fun, and I justified the ~3 years in venture capital where I could have been starting companies as an education that would help me later on.

Now, a couple years later, I thought I would reflect a little bit on where the VC experience helped and hurt me relative to actually trying to build a startup. The net of it is that the time was mostly helpful, and a big chunk of knowledge transferred over, but it was mostly high-level stuff. A lot of running a startup involves mastering nitty gritty details, and the VC experience did nothing to help there

For the lazy/impatient, here are some key things I’d say where it can help:

• It helps with traditional investor/entrepreneur information asymmetries
• Lots of tactical holes still exist
• Investors can often oversimplify startup issues, or overmatch on patterns
• Helps with understanding of investor motivations, which can otherwise appear mysterious

Let’s dive into each of these issues below.

It helps with traditional investor/entrepreneur information asymmetries
Some of the stickiest situation for entrepreneurs are cases where they infrequently encounter a situation, which generates information asymmetries where an investor often knows much more. These asymmetries often involve events like fundraising, selling a company, recruiting executives, etc. In the positive case, investors can be helpful and coach startups through these times, which is great. In the negative case, it provides an opportunity for investors to engage take advantage of naive entrepreneurs, which is not so great. This is why sites likes VentureHacks and TheFunded are useful, because they help even the playing field.

Part of the problem for me, however, is that only the General Partners at VC firms end up actually doing deals. All the associates, EIRs, etc often participate, and you see the final deal terms, but rarely get to see all the back-and-forths that end up with the deal getting done. This creates familiarity with the process, but not the battle-tested experience of having gone through lots of nitty gritty negotiations. But even then, you hear about, and know what the levers are, so everything is less mysterious.

(But like I said, VentureHacks and TheFunded are great, and I only wish there were sites with that level of candor about this obscure industry)

Lots of tactical holes still exist
One area where a venture capital background didn’t help at all was dealing with all the tactical details of getting a company off the ground. In particular, the biggest hole by far is hiring and managing people, which gets abstracted at the financial level. Someone in VC-land can talk abstractly about strong teams, but you don’t have to go through the process of interviewing dozens of people to find the right person.

I’ve written up some of my thoughts here on this topic, in a post called “Building the initial team for seed stage startups” where I talk about a couple points I’ve come to believe:

• Hiring T-shaped people versus specialists
• Try to get doers
• More candidate flow solves a lot of problems
• Interview for the actual work you’ll be doing, not skillset trivia
• Raw intelligence is just one factor – don’t overestimate it

There are also some even deeper questions that are unanswered by VC experience, such as how you actually build out a suitable recruiting pipeline? Or how do you interview people where you don’t have the skillset to comment about their competence one way or the other?

I would say hiring is probably one of the most difficult areas to master, and although there are other block and tackle issues – accounting, leasing an office, operations, etc – getting the right people is just a very hard topic. It’s not a surprise that so many startups struggle with it.

Investors can often oversimplify startup issues, or overmatch on patterns
Venture investors often spread their time across a whole number of industries – you look at their websites, and they’ll say they invest in everything from consumer internet to clean tech to life sciences. MDV was no different, and we were responsive to companies across a large number of markets. One VC explained to me early on that you have to respond to what entrepreneurs are producing, and if you get too “top-down” about a particular industry, it gets easy to overinvest in a bunch of mediocre companies rather than trying intently to just focus on finding the best single team and opportunity you can.

Mike Moritz has talked about this before:

Moritz waxed philosophical by comparing venture capital investing to bird spotting. “I rarely think about big themes. The business is like bird spotting. I don’t try to pick out the flock. Each one is different and I try to find an interestingly complected bird in a flock rather than try to make an observation about an entire flock.” For that reason, while other firms may avoid companies because they perceive a certain investment sector as being overplayed or already mature, Moritz said Sequoia is “careful not to redline neighborhoods”.

Continuing with the ornithological analogy, Moritz pointed to Cisco and said, “There’s a lot to be said for investing in the ugly duckling.” When Don Valentine led Sequoia Capital’s investment in Cisco, many others had passed on the husband and wife founding team of Len Bosack and Sandy Lerner.

One of the difficulties for me personally in seeing a wide variety of companies all the time was that it was impossible to not start to pattern match and draw conclusions about the companies that were probably false. You end up in the proverbial “mile wide, inch deep” level of knowledge about that industry, which makes it all too easy to make generalizations. Similarly, there is a drive to simplify your understanding of a company, since you have to socialize it and talk to other venture partners about particular spaces and companies, which also causes oversimplfication.

Contrast this to startup life, where you end up devoting yourself to one company (which may encapsulate many ideas, as you iterate) for the period of years. You end up diving very deep into situations, and learning about all the different details tradeoffs that cause products to be successful versus not.

Helps with understanding of investor motivations, which can otherwise appear mysterious
Finally, one area where having a venture background helped a lot was understanding investor motivations in general. Entrepreneurs ask a lot of great questions, like, “Why don’t investors want to invest in my idea X which will be highly profitable?” or “Why does hot consumer internet startup X lose tons of money but is valued so much?” The answers to these questions drive a lot of investor behavior, which can be mysterious if you don’t know what’s going on.

The interesting part is understanding why VCs are structured the way they do, why they have a 1 in 10 portfolio strategy, and how they think about their Limited Partners. They have a boss too, of course

The major point here is that building medium-sized, profitable companies that aren’t growing quickly is not really part of the venture capital model. Knowing that can help with all sorts of things, such as massaging your business plan into something “sexy” that investors will respond to. Similarly, it will help get everyone aligned on major decisions, such as financing events, exits, exec team building, etc.

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Welcome to part two of a series of articles from Gambit, a microtransactions platform – you can read the first post here. In the last article, we discussed the average revenues earned from various demographics, and this article touches on implications in product strategy. The author, Susan Su (@susanfsu), is a writer, marketer, and Stanford alum who’s currently at Gambit Payments. Please comment with any questions, and enjoy! –Andrew

Ignore Cougars, Follow the Money: 3 social gaming tips for monetizing younger users
by Susan Su, Gambit Payments

Lately, we’ve all heard a lot about the middle-aged housewife. She’s an adult, she’s got disposable income and a couple of credit cards, probably even a PayPal account. In her leisure time, she sits at home and plays social games with her Facebook friends, possibly instead of going out to a movie. She buys virtual goods with real money while you fill your Olympic-sized swimming pool with gold coins.

This is a great bedtime story to fall asleep to, but would you feel so relaxed if you knew you were leaving millions of dollars on the table?

Age is only one factor
In a previous post, we looked at user age as a factor in a game’s overall revenue. We took a bird’s eye view of average revenue per paying user (ARPPU) by age and transaction volume, and saw that older users – the middle-aged housewife (or husband) – brought in ARPPUs that were 2 or 3 times as much as ARPPUs for younger users. Because of low transaction volumes, however, older users represented little more than a tiny speck of total revenues across the developers in the dataset. It became clear that age data – and even ARPPUs – meant little without the context of volume.

On the other end of the ARPPU spectrum, younger users delivered ARPPUs that were fairly unsexy and unvarying, ranging from $2.58 for 16 and 17 year olds to $3.07 for users aged 20 to 29. However, users aged 14 to 29 together make up 91.5% of the total userbase for the virtual goods industry.

$2.58x…millions
A $2.58 ARPPU doesn’t look so bad when you’re selling to millions of users. The massive transaction volumes associated with teens and 20-somethings aligns directly with this group’s share of total revenue across a sample of nearly 2 million virtual goods users. How massive? Over 93%. That is, users in their teens and twenties bring in over 93% of all revenue seen across all games, for all developers in the sample. Even though ARPPUs are consistently modest, transaction volume – and with it, total revenues – are jaw-dropping.

Younger users are cheap, plentiful, and worth your attention.

Given these figures, what’s a developer to do?

For starters, don’t ignore your younger users. It’s true that there will always be transaction and ARPPU variation based on the game you’re building, what you’re interested in, and what resources you have available, but it’s clear that younger users are still the major players across the board. There are hordes of them, and they’re eager to engage in lots of transactions.

Get Them Young: 3 tips to monetize younger users

1. Think volume. Look for the users who are transacting the most, and then make sure you understand exactly who they are (and how they might be changing). For example, today your revenue may be driven by a massive group of teenagers, but what will happen when those teens become 20-somethings? In this series, we explored this question by age, but you’ll also want to think about geography, language, and gender. ‘Think volume’ means:

• Mind your game. If your product is subpar, you shouldn’t expect amazing volumes or revenues, no matter how much you…
• Focus on growing traffic through virality. How can you make your game even more social, more addictive, and more spreadable?
• Get users to complete. Users are 3 times as likely to make additonal payments if they’ve completed at least one offer.

2. Hold on to your users. People of all ages get tired of games easily. The last thing you need is a poor user experience to push users over the edge and straight into the database of a competitor. Do certain offers just rankle your userbase (leading to poor conversions, bountiful complaints, and churn)? While your payments solution’s algorithms will help you find the best offers for your users, there are always going to be a couple that just don’t perform. ‘Hold on to your users’ means:

• Pick out and remove underperforming offers, either individually or by offer category, and address customer complaints. For example, ‘adult’ offers may not work well if your game’s users are primarily 13-17 year olds.
• Diversify your product(s). How can you enrich a single game to be more complex and engaging? How can you offer more complementary games so when a user defects, she defects to another game in your suite?

3. Keep your eye on empty spaces. Yes, Facebook is huge. Yes, Zynga is dominating. But, growth potential is everywhere still. As more users of all ages sign up for their first Facebook accounts, more people pour into the virtual economy. As Facebook grows in locales outside the U.S., so do the games and apps that inhabit its ecosystem. As users get tired of specific games, they’ll start looking for other places to spend their time and money. They’ll probably invite their friends, too. ‘Keep your eye on empty spaces’ means:

• Don’t make a play just because someone else is making bank off of it (for now). Today’s leaders got there because they kept their eyes on empty spaces and filled them, quickly.
• Look for under-monetized user groups. How well is your game doing with young males? Can you work in a way for more of these users to complete their first offer (and open the door to additional payments)?

These should be your main considerations:

Growth
What does the growth trajectory look like for young users? How many of these users are already playing games, and how many more aren’t? The online casual games industry is still young and has plenty of room for growth.

Facebook boasts 300 million active users, with almost a third of these in the U.S. Since the entire population of the United States is just over 300 million, that means approximately half of all U.S. internet users, or a third of the entire U.S. population, are on Facebook.* Facebook counts 70% of users as having ‘engaged with a Platform application,’ meaning that most users have loaded an app of some sort at some point in their Facebook time. Judging by the impressive monthly active uniques the biggest developers are enjoying (51MM for Zynga’s Farmville alone), it seems that games have already taken off on the network. With all this, is there still room to grow?

Yes. Here’s why:

• Facebook has saturated the U.S. market, but that doesn’t mean every Facebook user is playing a game. Yet.
• The U.S. isn’t the only country in the world, either. In terms of Facebook traffic growth rates, the U.S. doesn’t even make it into the top 10. As other economies (real and virtual) catch up, markets around the world should start looking more and more promising for developers looking to monetize.
• People get tired of games. One developer’s churn is another developer’s new user.

As mentioned above, younger users contribute the lion’s share of total revenue for virtual transactions – for now. However, Facebook reports that the 35 and up group is their fastest growing demographic, so will we see this shift reflected in game usage and monetization too? Probably. But until the older users reach critical mass on the network, would you rather be competing hard for the same handful of housewives or slyly going for the many younger users at lower ARPPUs and massively higher transaction volumes?

Changing ARPPUs
Do ARPPUs change as users get older? Will your 15 year old user be worth more after she turns 18, gets a better job, and starts opting for direct payment over offers? We know that the typical 18 year old makes you more money than the typical 15 year old, so from this we might guess that it will pay off to hold onto that user as she ages.

Age	ARPPU
15	$2.65
18	$2.92
22	$2.82
25	$2.99
29	$3.33

Older users
Should you try to grow your older userbase? As just mentioned, Facebook’s fastest-growing demographic is the 35 and up set. While actively trying to acquire these users (over others) may divert your resources in ways you can’t afford, it’s likely that your game will indirectly absorb the benefits of Facebook’s demographic growth anyway. If everyone else is focusing on winning the middle-aged housewife segment, would you be better off stealthily (and expertly) acquiring the forgotten younger users? Try it. Measure it. Report back.

Conclusions
In parting, don’t buy into a ‘must do’ (eg. housewives) just because it’s popular today. Popularity doesn’t mean it’s wrong, but it does probably mean that lots of other developers are out there thinking the same thing as you. Instead, look at the data and focus your work where the greatest opportunity currently blossoms. Right now, that’s users who are in their teens and mid-20s.

If you’ve been targeting and you’re seeing interesting results, please share in the comments. What’s worked for you, and what would you do if you were a new developer just entering the marketing today?

For specific questions on data or resources, you can contact Susan here or follow her on Twitter at @susanfsu.

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*http://checkfacebook.com/ has great stats and visualizations on Facebook traffic and growth.