Free Association

Six Degrees? How about one?

Weird Six Degrees feeling  for me this morning seeing Brad Feld (Colorado) post on his blog about Josh Kopelman (Philadelphia). In the mid-90's I worked for the CTO of Infonautics - a company Josh Kopelman founded. Josh went on to start several other Internet companies, including Half.com, which was underway (albeit in stealth mode) when I left Infonautics in 1999 to start my company, Finali. Brad Feld was one of the VC investors in Finali. As a matter of fact, although we don't know each other well Josh and I exchanged a couple of emails when Finali and Half.com were founded within weeks of one another in 1999.

Weird to see your disconnected past come together like that. Six degrees? How about one?

Idea generation

Getting ideas for a new business is a never-ending obsession for entrepreneurs. I always have a few going in my head - and I suspect other entrepreneurs do the same. If I'm building a business I don't have time to follow through on new ideas; but when I'm in between businesses I track, research, noodle, and flesh out new ideas that show promise. By promise I mean that the idea passes my good idea test. That is: a) is it hard to do - so that others can't easily copy it, b) does it solve a real problem that people (lots of them) have, and c) is it patented, or able to be patented? This simple sniff test is a good idea parser. If the idea fails this simple sniff test, I throw it away and keep working. It's not worth the time to flesh out an idea that starts with this handicap.

But how do you find ideas? For me it's a bit serendipitous. I read alot - especially tech publications like Wired, and Business 2.0 (now part of CNN, and not nearly as cool)- but also lots of blogs and podcasts. These are ripe playgrounds of ideas.

For instance, I got an idea (which I am still noodling) from a PodTech podcast some months ago. It was an offhanded comment by one of the guests that started me down a path I'm still on. And today, I found an interesting blog post by Mark Cuban (formerly of Broadcast.com, and now the owner of the Dallas Mavericks). This post is full of interesting ideas that could become businesses. There are ideas everywhere.

Walled Garden Analogy

A friend of mine questioned me about my views on walled gardens. She was confused about the difference between this and other more open business models. So I thought an analogy would help. After thinking about it a minute I came up with this:

How likely would you be to buy a PC, if the only software that worked on it came from Microsoft? It would be useful - Word, Powerpoint, Excel, Windows XP, and even Internet Explorer - but you'd never have Quicken, Quickbooks, TurboTax (ok, I've been thinking about my taxes a little too much - highway robbery I tell you), Photoshop, iTunes, and forget about Firefox, Adobe Acrobat, and Sling Player and on, and on.

This is the situation when you buy most mobile phones today. Only applications sanctioned by the carrier (Verizon, Cingular, etc) are available (think Verizon "Get it Now" - oy!). Smartphones like the Treo 700W are better, in that they can load anything for Windows Mobile - which is good - but the vast majority of handsets are closed, walled gardens, not open platforms for running lots of different, and highly useful third party applications.

That's what's wrong with a walled garden approach - and why opening up is such a huge opportunity for wireless carriers.

Wireless Carriers Stifle Innovation

I have been looking at a business model in the wireless industry, utilizing Location Based Services (LBS) to provide a value added service for consumers. During my research, one of the main obstacles to innovation in this industry is the lack of open protocols and third-party vendor support by the wireless carriers. Everyone knows that Walled Gardens stifle innovation - and in the end are more harmful to the company that creates the garden than to anyone else. Said another way - not only do walled gardens (that is closed technology and user spaces; think AOL) harm innovation, and therefore harm users, but also are ultimately destructive to the shareholder value of the gardener. This has been proven repeatedly, but does not stop the CFO's at these companies from continuing down this death spiral of short-term thinking. There is of late, thankfully, some sign of change in the wireless industry...it's about time they saw the light.

Today I found a fascinating podcast in IT Conversations regarding obstructions in the mobile industry, specifically around LBS. While the tone of the discussion is more or less civil, near the end the frustration of the innovators starts to bleed into the conversation. The innovators are clearly frustrated with the walled gardens the wireless carriers have become, and these innovators stand by and witness the high value of open API's (think Google Maps) and the ease with which Web innovators can produce so-called "Mashups". When will wireless carriers start to see that openness in their value-added services is the only path that makes any sense? Probably only after one of them opens up, and starts to kick the ass of all the others.

The first carrier to aggressively open up could reap tremendous value from the innovations that result. To do otherwise is simply idiotic. It will happen eventually - and then they all scramble to get back the subscribers who leave for the promised land of functionality that will result from carrier openness.

I blogged satirically here on the wireless carriers and their idiotic, and ultimately pointless attempts at a death grip on video content - another stupid and counter-innovation walled garden screw-up. The long list of wireless carrier stupidity, stifled innovation, and worse - missed opportunity for the US wireless industry is long, getting longer, and not soon to end I fear. FUBAR.

What is Free Association?

Free Association is a term from Sigmund Freud's Psychodynamic theory and is a technique used in psychology. While this blog is not about psychology per se, I believe that a concept similar to Free Association is useful to entrepreneurs in idea generation. In general free association in this context is similar to brainstorming, wherein a small group of people - founders - can use this technique to find a product or service around which a business can be built. This blog - while devoted to many topics - is about my serendipitous encounters with entrepreneurial free association during my business idea generation journey.

Odd word of the day

I love France. It is a beautiful country that I've visited several times - but the French people are not - ahem - the world's hardest workers. They were risking falling into economic waste with their (now repealed) movement to shorten their already short work week. How ironic then that the word we use for creating a new business, and that we value as much as anything in a free country - I'm talking about "entrepreneurialism" here - that this word would be of French derivation. Then again, most of English is of French derivation. Still, it's ironic.

Find a Jerry Maguire moment

While torturing myself on my spinner (that's an exercise bike for cycle-phobes) today, I was watching Jerry Maguire. If you've seen that film you know that Jerry is a sports agent who wakes up in the middle of the night in a cold sweat, ashamed of his career. He gets an inspiration and writes a 25 page "mission statement" about his profession. Of course, this gets him fired - a forced sort of entrepreneurialism - but he's venturing even if that is not what he intended.

It made me think of entrepreneurialism and passion. If you're trying to find a busniess that you think will work, have a Jerry Maguire moment. You'll hear all the business idea creation metaphors: solve a problem, find the pain, follow the money, etc. But I like the Jerry Maguire moment. Follow your passion. Write it down. Risk everything. For sure solve a problem, find the pain and follow the money - but also find the passion. Start-ups are too hard to do something you're not passionate about.

Perhaps if you're fortunate it will end in someone, "Showing you the money".

An Entrepreneurs definition of "founder"

When I am working on a new business idea I often do so with other people involved. Usually the number of people involved is two - just me and the other person. Occasionally there are three people total, but never more if I can help it. The reason seems obvious to me, but I realized yesterday that other people do not think this way. For me, the reason is about limiting the number of founders. A lot of people seem to define that term differently, but for me it's pretty specific. Thought I'd share my view and my reasoning, and see if others agree or disagree.

I'm no lawyer, and so this is an entrepreneurs view of a legal arrangement. So take that free advice for what it is. Here's my view: There are a group of people who have decided to sit down and come up with a business. These people are the founders. When I say founder, I mean something VERY specific and with huge ownership implications. Founders are those that split the pre-money shares of the company, before any employees exist. The investors take all the post-money shares. (pre-money/post-money are actually valuation metrics and not stock class definitions, but it's an easy way to think about the shares).

That means that, once funded, a business has two classes of shareholder: investors (preferred stock) and founders (common stock) with different rights for each class - which is really important, but beyond the scope of this discussion, and covered well in Brad Feld's blog series on Term Sheets, Letters of Intent, as well as other interesting thoughts on entrepreneurship.

There are many differences between stock classes, but suffice to say for this level discussion that at a liquidity event (sale or IPO for instance) preferred shares get paid first, and then other mechanisms kick in to distribute the value of the remaining spoils - this pass with the investors sharing the take with other stock classes in some arrangement - all pre-negotiated at the initial funding - which is why raising capital takes so along (among other reasons).

Any other shares that are given out to people involved in the company (e.g. employees) are given in the form of stock options (usually called Incentive Stock Options, or ISOs). These are also common stock, rather than preferred, but are not actually shares but rather options to buy shares at some time in the future for a pre-set price, called the strike price.

The option strike price changes depending on when the options are issued - the earlier they are issued the lower the price. This strike price warrants an entire post of it's own, but suffice to say that the investors set the strike price - and ramp it for tax law reasons as the company nears an IPO - so that late joining employees options are no where near as valuable as earlier issued options. In any case, Founder shares are not options, but rather actual shares with a value of close to zero. An example. Two entrepreneurs create a fundable business, find investors, and raise $3M. The investors and the entrepreneurs (well sort of, it's really up to the investors) agree that the pre-money value of the company is $3M and the post-money valuation for the company is $6M - this is the classic 3-3-6 pre/post money valuation metric (pre-money value of $3M + $3M raised = post-money value of $6M).

The investor(s) and entrepreneur(s) create 6M shares and split the shares - 3 million shares of common stock for the entrepreneurs and 3 million shares of preferred stock for the investors. As you can see, founders and investors basically have a right, in a sense, to print money in the form of stock shares. While these shares have no liquid dollar value at the time, in the future they could be highly valuable. There are also profound tax benefits to owning founder shares. Because you as an entrepreneur buy them at a price near zero (something like 1/10th of a penny per share) you can pay this amount at the time, own the shares outright, hold them for however long it takes to find a liquidity event for the company (usually sale or IPO) and pay the lowest capital gains tax rate possible. You also have to alert the IRS that you might do this in the future by filing what is called an 83b election - setting up this advantageous tax situation for you should your company find high liquidity in the future.

This is critical.

Without the 83b election, the shares could be taxed at some value in the future, when you have no real ability to sell the shares. That means you're getting taxed on what could potentially be a multi-million dollar asset, that in reality has no liquid dollar value. Not good.

Next,  founders and investors create an employee stock option pool (ISO Pool), and all future shares come from this pool. So as you can see, having a legitimate claim to founder shares is quite valuable, legally very specific, and there's a limited number of them that you don't want to share with too many people if you're serious about leveraging your business idea into wealth.

So this is why I limit the number of people I am involved with while a business idea is forming. Sharing the idea, once formed (and that timing is KEY!), with others is a "must" in my view - although views differ on this and some entrepreneurs guard their ideas like some rare coin. Early brainstorming, where lots of ideas get thrown out, means that anyone involved at that point might feel entitled to some of the founder shares - no matter how ridiculous you think that is. Again, NOT GOOD.

So I don't like surprise visitors to early idea discussions until we've focused in on a specific idea. At that point, depending on the nature of the idea and it's patentable intellectual propery and competitive barriers, I like to talk about the business a lot and get feedback - as that makes the product/service much better. The only exception to that is if there isn't a lot of patentable Intellectual Property. Talking about it then could allow other, better funded competitors to take their fatter wallets and beat you to market. In this case I'd keep the company in "stealth" mode until we had a launchable beta product and hit the market with gusto. So it just depends on the nature of the idea and the competition.

So here's my general approach. It's not something to be paranoid about - but in general I ask my partners to limit our discussions on the idea to the founding group until we settle in on an idea, start to write a plan, and/or build a prototype, seek funding, etc.

At that point, any outside suggestions are just that - suggestions. We can take those ideas and add them to the mix, or we can not. Many entrepreneurs ethically try and reward anybody who significantly helps with the thinking at this point by offering that person compensation in the form of equity in the company. This can be done either in the form of friends and family stock - essentially founders shares that are gifted to this person at the funding of the company, or stock options by hiring them as an employee in the newly funded company - or both depending on the magnitude of their current and potential contribution level. In my experience (others may differ on this) there usually is no legal agreement to go into business as founders. It's simply a handshake thing, with people you like and respect, who are ethical.

The safest way to decide about whom you should discuss your business idea with is to just ask the other founders if they agree that it's ok to discuss the new business idea with others outside the founder group.

Orthogonal Thinking

Having sold my last business, and having just left the acquiring company after 14 months of integration activities, I am deep into the process of finding a new idea for my next business. I have created dozens of business plans in the last 15 years - walking away from most of them - but actually started several businesses along the way. So the process of business idea creation, moving to research, and finally to business plan is a very well-worn track in my mind. Still, the process is constantly evolving for me, hopefully for the better.

This time around I've found a very useful tool for aggregating all the "stuff" that accumulates as you work - things like lists, tasks, research, links, people, files, images, and of course the plan itself. It's called BackPack, from 37 Signals (love the story of how Jason came up with that name - naming businesses is always a chore for me). BackPack is simple and quite useful - especially for this task. The writeboards are perfect for sharing and collaborating on the plan itself with any partners who are working on the idea with you - as is usually the case for me (for some reason I rarely work alone on an idea).

But back to "Orthogonal Thinking". Orthogonal is usually a mathematics term having to do with right angles, but I tend to use it in everyday speech - a habit I picked up from a small group of math geeks in grad school - to mean that something is tangential to the current conversational direction. Example - "...well this idea is orthogonal to where we've been going, but I think it's interesting..." You get the idea.

In any case, recently I've discovered an interestingly orthogonal way of thinking about business ideas - that is orthogonal to my normal way of thinking. In general, most of the things that attract my attention are Internet businesses, and specifically bleeding edge Internet ideas and technologies - things like RSS, Digital Media, mashups, or even AJAX interface design. But lately I've been finding fruit in looking away from the cutting edge, and into applying the technologies and strategies of the cutting edge to what I call lagging marketplaces. That is industries where opportunity exists, but where adoption of the revolutionary powers of the web have not yet been applied. It's an interesting exercise, and one that I suspect will lead me to my next business. We'll see, and I'll post on it once I get going.

Walled Gardens == Prisons

Lots of interesting announcements and general innovation impetus around iPod and Wireless coming from CES this week. I've been thinking about the wireless industry as a result and the general state of innovation in that industry. It reminds me very much of the early Internet when companies like AOL, CompuServe (remember them), and a bit later MSN tried to create communities on the web. Closed, proprietary, insular places for paying subscribers only. Lately these kinds of communities have been called "Walled Gardens" and some are working spectacularly (so far). Examples of current walled gardens are all wireless carriers (e.g. Verizon, T-Mobile, etc) and Apple iPod/iTunes. In general walled garden models are highly attractive to those who own them. You can capture lots of marketshare if you can pull it off, and a dominant position for your products and services. What investor wouldn't want that? The answer would be none - but it comes at a price, and free market innovators will eventually breach the walls.

All previous walled garden companies have suffered in the long run. AOL, CompuServe, and even MSN are not the high flyers they once were. Walls eventually turn from bounding a garden, to defining a prison. The maxims are endless: Less choice = Less choice, every time. Absolute power corrupts absolutely. If you've got a captive audience, why work hard to innovate? Just do enough to keep them happy.

One of the incredible features of Google is it's openess. They've even inspired a whole new term in innovation. Would mashups even exist without the Google Maps API? Doubtful.

The current wireless industry is a chaotic mess of garden walls. Different proprietary networks (CDMA, TDMA, GSM) - chaos that hurts innovation. Proprietary handsets that don't support much in the way of shared protocols - again, chaos that hurts innovation. Most don't even support any sort of standard for extensibility, although J2ME is starting to get a toehold. But just take Jamdat (recently acquired by Electronic Arts for a whopping, and crazy, $680M) that makes games for wireless phones. It has been reported that they have 700 different games in dozens of different formats and languages. This is what's required to penetrate a broad cross-section of a walled garden industry. Run on everything - every network, every protocol, every OS, every screen resolution....Chaos.

There is one ubiquitous protocol that I know of in the wireless industry - SMS - that runs across all wireless carriers. I suspect the next big wireless start-up uses SMS to create a breach in the walled garden. Eventually one of the wireless carriers will be brave enough (or desperate enough) to tear down their wall. When that happens, real innovation will come to that industry. Until then - prison for us users.