Moving a startup from bottom third to top third (it’s the people, silly)

The common wisdom of venture is that you lose all your money in the bottom third of your companies, score singles to triples in the middle third, and drive the vast majority of value in your top third. A “Midas Lister” we know astutely refines this saying, “It’s actually the top third of the top third where you make all your money”. This seems to resonate with another startup rule of thumb that 1 in 10 investments is a home run.

The problem with these rules of thumb is that a few years into a fund when you are making new investments, following on in existing ones and looking for patterns to determine where to invest time and money before winners are obvious, after-game learnings don’t help you see the future.

It turns out there is a pattern of early warnings we’ve seen in the fifty companies we’ve worked with. The roadsigns to understanding how the thirds **may** break down can be summarized as follows:

  • Top third: Top third companies are the ones where everyone is in the same room together (founders/mangement, board, investors), talking about how well sales are going and figuring out how to pour more money on.
  • Middle third: Middle third companies are the ones where sales are not going swimmingly, but everyone is still in the same room together discussing how to make them better, either through product, go-to-market or team adjustments.
  • Bottom third: Bottom third companies are ones where sales are not going swimmingly, and everyone is in different rooms (calls, coffees) talking about everything except sales.

Upon reading this, entrepreneurs and investors will immediately know where their compan(ies) stand. Don’t worry, I use the word “roadsign” intentionally. This trio of forewarnings allows time to course correct. So how do you do it?

Top third companies are incredibly rewarding for everyone (sometimes fun, sometimes challenging, sometimes stressful… but always rewarding). Revenue is beating plan, talent is flocking in and VCs keep calling. But you can still screw it up. The common modes of failure include: not hire experienced functional leaders to manage scale; not building market leadership, integration and distribution among other key market players; over-focusing on top-line to the detriment of other key metrics like churn and unit economics (eg, growth at all cost); and generally getting over-confident. Even if you avoid these potholes, ultimately landing in the top third of the top third is still highly dependent on market timing and often pursuit of a non-consensus thesis – not just perfect execution.

Middle third companies are really a fat middle, typically representing 50% of a portfolio. Most VCs have lots of these investments, and most entrepreneurs are running one. Things aren’t going perfectly, or sometimes they are going poorly, but everyone is working hard together to figure it out. Getting into the top third from the middle third is about executing well on product and go-to-market strategy in your current market or finding a riper adjacent market space. If these course corrections don’t work with some time, then the next step may be a change in functional or CEO leadership. The latter is traumatic, time consuming and capital consuming. It is a last resort, but in middle third companies when it is done, it is done smoothly with open dialogue between founders, other managers, investors and board members. You continue to row together.

Bottom third companies (actually often about 10-20% of a portfolio) look very similar to middle third companies –  ranging in growth profile from slightly downward or flat to moderate growth – with the additional challenge that some combination of people aren’t getting along. This creates significant distraction to solving the root growth issue.

And since the theme of this post is threes, there seem to be three modes of such people challenges:

  • Founder – founder: We’ve seen a number of companies handicapped by founder-founder problems, sometimes due to performance issues but more usually personality conflict. If they can’t be worked out, then board members or investors need to quickly help arbitrate – sometimes with the result that one founder moves on.
  • Investor/board – management: These scenarios typically result from company under-performance that leads to investors or the board “moving on” a CEO… or the CEO thinking they will. There are also more nuanced instances where performance is good, but there are disagreements over personnel, strategy or ethics. Because investor/CEO relationships can be accompanied by baggage from prior financing negotiations or fear of VCs “stealing my company,” we’ve found that independent board members are critical in helping a company through these times. Independents can play an objective referee and build consensus around a leadership decision, helping the company move to a new chapter whether with that CEO or a different one. Of note, many startups have independent seats on their board that are not filled. This is one reason among many that it is worth filling them ASAP.
  • Everyone – everyone: Call this a complicated love triangle without the love, where some investors don’t agree on a key issue with other investors, whom in turn don’t agree with management and independents, etc. Factions form. These are really tough situations (often related to leadership or financing) and require a strong CEO, independent director or Chairman to call bullshit, get everyone in a room together and hash it out. Such fractures generally arise from a difference in economic position or differences in perspectives on people or market – all valid business views. In the end, parties need to commit to eating a little crow and moving forward. The other solution is to sell the company – effectively a divorce – but this is easier said than done. Selling a company requires development of consensus on process and takeout price, no easy feat when people aren’t getting along.

Why are these situations so destructive? Time and emotion are the key factors. A complete set of 1:1 side conversations for a board of five people takes 10 times as much time as a single group conversation (see math below). These conversations are often emotional and exacting, reducing confidence in the company and belief in the opportunity for each individual and VC partnerships involved. Above all, they distract from the underlying issue the company has – usually growth. Growth can’t be fixed unless it has everyone’s focus and a mutually trusting team to pursue it.

As with so many ailments, diagnosis is the first step to recovery. If you and your team/board/investors can recognize a bottom third issue, then you can work to get back into the middle third and eventually to the top!

Fun math on side conversations:


Meet eTurns: Marshalls + eCommerce Returns

I am a Marshalls shopper. For most utility purchases ranging from socks to sheets to olive oil, Marshalls is my go-to. I am not alone. My regular visits see a line of 10-20 shoppers (often families) waiting to check out against a long row of 5-10 cashiers, all ringing up $X00 basket sizes. With TJX’s (Marhsalls and TJMaxx’s parent) stock up 35% in the last year, it’s clear their model works… an amazing feat in the face of amazon and amidst hundreds of waffling retailers.  The WSJ attributes TJX’s contrarian success to great prices, skillful merchandising and the temporal nature of an ever-changing inventory that drives consumers to buy on sight. The Journal also notes that off-price retailers are visited about twice as often per year as department stores, have a fifty percent higher purchase likelihood per visit and benefit from a short 25 day inventory hold versus the 100 day industry norm. TJX is truly the bright spot in the brick and mortar blight.

At the same time, given HPVP’s activity in the logistics space (FourKites, Shipbob, Roadsync), I’ve been mulling the ever-growing returns problem for e-commerce companies. Estimates are that up to 30 to 40% of e-commerce purchases are returned (versus 8% across all of retail), creating a cost structure that nearly matches the costs of bricks and mortar. Wow, that is what eCommerce companies were trying to avoid in the first place! “Free returns” can cost an online retailer as much as $15 per return in shipping and handling, and the returned merchandise itself is often liquidated for pennies or dimes on the dollar. This is the dark spot in eCommerce’s halo.

Dark spot, meet bright spot. If you put the two together, there is a great opportunity for a Marshalls-like retailer that deals only in eCommerce returns. I am calling it eTurns. Like any budding entrepreneur, I did Google research looking for competitors:

Marshalls/TJX: Certainly TJX could do this itself, but it would have to grow its sourcing to include e/retailers instead of just brands, where it currently sources most of its product directly. This may be a challenge for TJX as most other full-priced home goods and clothing retailers view TJX as an unwelcome discount substitute to their struggling sales.

Happy Returns: Happy Returns is one of a few leading startups addressing the returns issue. They partner with brick and mortar retailers to accept eCommerce returns in person for a variety of online brands and etailers, promising more foot traffic to the brick and mortar and lower returns shipping costs to online brands and etailers. After receiving returns through Happy Returns, etailers resell or disposition returned products as they normally do. I love Happy Returns’ marrying of online and offline retailer needs, but the approach still means an extra forward and reverse shipment for a returned item to reach ultimate sale. Meanwhile, time lost in Happy Returns’ supply chain increases the carrying costs and obsolescence risk of returns.

Optoro: Optoro is another startup making strides in this space. Optoro takes ownership of e/retailer reverse logistics, receiving returns to its own warehouses, assessing quality and remarketing at reduced prices on Amazon, Ebay, and its own site Blinq for ~20-70% off retail. Remnants are then sold in bulk at its own site Bulq for pennies or dimes on the dollar. Certainly this service helps e/retailers outsource the headache and distraction of reverse logistics while monetizing returned merchandise, but it still relies on multiple extra round trips and a longer obsolescing supply chain.

The missing link in these models is speed to (re)market to avoid obsolescence and forgoing additional shipping and handling. If these two problems are solved, more value can be captured from returned merchandise.

Meet eTurns! (no, not that eTurns)

eTurns is a brick and mortar retail concept carrying only merchandise from “local” eCommerce returns. Returns are collected from eTurns bins around a city or neighborhood, as well as at eTurns locations, for a timely refund from the original etailer. eTurns takes the merchandise on consignment and revenue shares the proceeds with the original seller. Like TJX, eTurns is a discount retailer of unique name-brand items with fast inventory turns, reducing obsolescence and increasing  consumers’ propensity to buy on sight.

With retail rents declining and billions of dollars in returned merchandise supply increasing with the market at more than 20% a year, the model could really have legs. It is also self-merchandising. An eTurns location would be a bit smaller than the average 28,000 square foot TJX, servicing concentrated urban neighborhoods where consumers are likely to order (and return) items that others in their neighborhood are also likely to want.  This increases the chance of finding a returned item’s “next best buyer” through common geography.

There are certainly holes to poke in this model – imagine the glut of inventory from Holiday returns – but it feels worth the try. If shipping round trips and time-in-supply-chain are minimized, the drag of returns on e-commerce could be greatly reduced. And who doesn’t love a good deal? Okay, so it doesn’t exist yet. If there is a tenured entrepreneur out there interested in giving this a run, let me know!