vcwithme

There was a period early on when we called ourselves a SaaS fund, playing just slightly on the “me too” side of the biggest trend of the 2000s, the saasification of software. We have since honed our message, but in those earliest of days, being a SaaS entrepreneur or investor was differentiating.

Fast forward more than a decade, and SaaS is not a differentiator for companies or investors. It remains a terrific business model, but while there are increasingly a lot of good SaaS companies, there are decreasingly many great SaaS companies.

Why? There is ferocious competition when selling to customers. While customers now expect SaaS – versus the early days of educating – there is deafening noise and precious few green spaces or verticals. SaaS is no longer differentiating for another reason. While modern dev tools and the cloud make it cheap to start a SaaS company (or any tech company), SaaS companies are expensive to scale. It turns out the only thing better for scaling than getting paid consistently over time is being paid upfront! With SaaS, investors fund now what customers pay back later, and that leads to large liquidation preferences on cap tables. Thus, even good SaaS companies often struggle under this weight, yielding disappointing returns for founders, employees and investors.

So what is the key to a great SaaS company? It’s pretty simple… but hard to achieve. In a great SaaS company, the 10th sale is 10 times easier than the first, and the 100th sale is 10 times easier than the 10th. This concept applies to almost any SaaS company, but here I focus specifically on enterprise.

Hard questions are frustrating, and nothing is as hard in SaaS as answering “How will your 10th sale be 10x easier than the first, and the 100th 10x easier than the 10th?” Several entrepreneurs have given me a knitted frown in response to this question recently (among other reasons :-<).

Sounds nuts, right? Well, this effect can manifest in two distinct ways (for now holding everything else constant).

• First sale of $100K took 20 months in cycle time, 10th sale of $100K takes two months
• First sale of $100K took 20 months, 10th sale at $1M takes the same time.

The second mode above is more common, but both are possible and describe a like economic reality. As we know, sales cycle time is a proxy for CAC in enterprise SaaS. SaaS companies that can achieve this base-10 exponential sales ease effect are rare. We are lucky to have one in our portfolio – FourKites.

Does that mean a company with this characteristic actually grows base-10 exponentially on the same burn? Well, no, and that is why this effect is so needed. Here are all the reasons why most SaaS companies become less efficient over time and cannot even grow linearly on the same burn, holding inherent sales ease constant:

• Your 1st sales person is never as good as the founders at selling
• Your 10th sales person is never as good as your 1st at selling
• Half of the sales people you hire won’t work out
• Your first non-founding employee worked 10 hour days; your 50th works 9 to 5 (ish)
• Office politics themselves grow exponentially with employee count, consuming time
• It’s bring your dog to work day, and everyone is playing with a puppy
• Churn can fundamentally limit growth because of math
• Competitors catch up or otherwise muddy the waters
• You get the point

Even holding sales ease constant, a linear growth SaaS company will often asymptote at the same burn because of these, especially churn. The only way to maintain exponential growth is to have a sales ease effect that greatly outweighs this drag.

So how can you find this effect? There are a few obvious (but hard) ways:

Network effects: FourKites benefits from extreme network effects – it is software that tracks the location of long haul trucks for shippers. The supply chains they serve comprise a complex multi-part network of shippers, trucking companies and retailers. When they sell a new shipper, the shipper brings new trucking companies and retailers. Those trucking companies and retailers then bring more shippers. And so on.

Virality: Box, Dropbox, Slack. Need I say more?

De Facto Standardism: In a way, Epic has achieved this in the Hospital EMR world. “Nobody ever got fired for going with IBM.” Replace “IBM” with “Epic”. Veeva has done the same in pharma CRM and systems. The common theme between the two in reaching a de facto standardism is a vertical focus. Within a vertical, there is a resonance of brand and usership that can lead to standardization relatively quickly.

So ask yourself, what is your answer to making your 10th sale 10x easier than the first?

Remember when it was just the five of you – three co-founders and two devs? You were flying from city to city knocking down your first few big contracts. Every Uber ride and hotel night was a flurry of emails with your co-founders – COO and CTO – implementing your first few customers and steering your first two developers towards product market fit. When you got back to the office Thursday evening from three days on the road, your team was still nose to the grindstone at 8pm. All hands on deck, rowing together.

On your last trip, you got back to the office from a major contract proposal – $1M ARR! But the office at 6:30pm is a ghost town. 15,000 square feet with 200 desks and all you see is a smattering of developers and two SDRs flirting with each other. Why doesn’t everyone work longer, harder? Why aren’t they more committed like you?

Does this sound familiar?

The truth is things probably started changing between 25 to 50 people. A startup’s evolution is like the human journey from hunter/gatherer tribes to complex societies with specialization. The scale and timelines are different, but the analog holds. In humanity’s early days, we operated like a just-founded startup: a small extended family unit that trusts each other and carves out very broad sections of responsibility: hunting (sales), gathering (implementation and customer success), and child/family care (product)… or something like that.  For the most part, everyone did anything they needed, because a loss or win for one member equally affected the others, largely based on shared DNA (equity) and an inherent motivation to continue that line.

A small town of 200 people or a modern city of 1M is different. Most citizens are not family members, and the town or city thrives based on job specialization and a common currency of money, not DNA. Likewise, somewhere around 25 people, a startup begins to rapidly specialize. In sales, you now have SDRs, AEs and managers. In product/tech, you  have developers, dev ops and PMs. And while most new hires have a little equity, junior and mid-level hires tend not to place much value on it – a sad truth. Employees are now mostly motivated by cash, affiliation (also known as culture) and the opportunity for self-advancement.

So now we understand that motivations have evolved, but is it a problem that people aren’t in the office until 8pm like they used to be? In fact, this shift can be a positive sign of a startup’s maturity:

You’re hiring more senior people: Experienced hires have families. They like to be home to put Sue and Skippy to bed, and they require much less “on the job training”. Both mean fewer hours in the office overall versus an inexperienced predecessor or team member. However, experienced hires should also be happy to hop on a plane any time or hammer through some emails after children’s bedtime.

Sales is processifying: There is a basic reality that sales people cannot sell at night – prospects don’t want to talk then. Sure, they can update notes, prioritize leads, schedule emails, etc.. But guess what? When sales process is humming, those activities are done contemporaneously during calls or with the real-time support of a good sales tools stack and sales ops function. For sales people, evenings are for hitting the gym and pounding protein shakes… or whatever it is they do.

Growth is not a successive journey of firefighting: Startups are a marathon not a sprint. If every day is a new firefight, people won’t stick around. A calm but intense culture with a regular working pace can be a sign that your people are on top of things.

However, empty offices at 6:30pm can also be a bad sign if associated with any of the following:

Where are the developers? Developers tend to start their days later and end them later too. Night creatures – or maybe it’s to avoid screen glare from the sun. It would be concerning not to see some tech and product folks hanging around well past 6:30pm. You can work on product at night!

Too much layering: One of the first things that can happen as a startup gets bigger and adds management layers is managers push too much down to reports instead of running the ball themselves. Bad sign. This is especially true for “support functions” (anyone that doesn’t build or sell, like finance, recruiting, ops, HR) Everyone wants to be a leader. Fine. But everyone still needs to do work. I’ve seen 7M ARR startups with three person finance teams. That better be a sweeeeeet board deck.

Lack of accountability: Accountability is measured in process and outcomes. On the process front, when you ask people questions, do they have the answers? Or do they point to other people? Is everything becoming a group decision? On the outcomes side, I view things bi-modally: (1) outcomes that are controlled perfectly internally by an organization (product launches, financial reporting, budgeting, etc) and (2) outcomes that rely heavily on external factors (sales, partnerships and hiring). Misses of the second mode don’t necessarily mean you  have a company or culture problem – startups are hard, and there are a lot of external factors that affect them. But if your team is consistently whiffing things it perfectly controls, there is for sure a culture problem.

Missing numbers with excuses: Despite the realities of externalities in outcomes you don’t control, they should never be used as an excuse. Welcome to capitalism!

Inflexibility to heroic undertakings: While persistent firefighting is a problem, team members should not hesitate to grab buckets when a conflagration appears. Resistance to last minute travel, pulling a late night or working a weekend when needed spells trouble.

So how does your growing startup stack up?

As a kid, I remember a pile of holiday “update” letters on our sideboard during the Holidays. People wrote in depth about their year, positive milestones for their family, and bumps in the road too. These notes were personal, genuine and from a bygone age – before smart phones, texts and even e-mail. Few write these letters now, favoring the short form Minted card with family shots, “Look! our kids are beautiful too.”

I had the pleasure of receiving only two Holiday letters this year – one from an HPVP team member and one from an HPVP investor who runs his own large private equity firm. Two things struck me when I read these notes. The first is how little I know about (ask about?) someone who sits 20 feet from me 8 hours a day. The other is the timeless value of prose in expressing complex experiences and ideas. So, I thought I’d sit down and write a New Year’s letter sharing what is important in my life, and what I’m thinking about.  For simplicity, I’ll talk about Family, Profession and Context. Context is the world we live in: economy, politics, city, environment, arts, etc. This last section is probably the most interesting to most, so feel free to jump there. Spoiler alert: this year is dominated by politics and economy.

Family – the people we live with:

Lest you thought I would write this without a family picture because of my earlier swipe, ha! Here it is:

Hawaii sounded great for Christmas, but I’m cheap. So instead we went to Florida and bought matching Hawaiian outfits on sale. Try it sometime. It’s super fun, and, no, I don’t get an affiliate fee.

We’ve entered a new epoch with our daughter, Skye (6), and our son, Winter (5), in the last year. They are increasingly independent and speedily maturing, especially as thinkers and questioners. This has largely shifted the challenges of parenting from meeting banal needs like sleep, feeding and potty to making hard decisions about how we positively influence their character formation and self-management. One experience in 2018 highlighted this for us. One of our children “experimented” (ahem) with taking a toy from their very close friend and then lying about where they got it. In the middle of a Tuesday I received a call from the concerned mom of the friend. I was first annoyed by a call about “XYZ-Branded-Toy-Of-The-Seasons” that I was sure had simply gone missing. But I opened my ears a bit and promised to follow-up with my child. The mom was right, and we the parents of a budding bandit. While this episode is fairly mundane for a developing child, this was the first time Ashley and I really took pause to ask “what type of character and values are we instilling in our children?” The experience was also notable in the tremendous grace and forgiveness we received from the other parents and wronged child – who still remains very close with ours. The child and parents could have gotten upset and gone to the teacher; instead they approached us directly. You can’t ask for a better learning experience, and it highlights that openness to making mistakes and likewise rendering forgiveness are a key part of learning at all ages. It also highlights that child rearing is best done in community.

Notwithstanding the above, Ashley and I couldn’t be more proud of our kids who are truly good people and completely embracing of life and school. Skye has taken to swimming for sport, and Winter has taken to Legos. He also succumbed to peer pressure from Skye to learn how to swim and has become an equivalent waterbug after four years of screaming bloody murder whenever within sight of a pool!

I remain extremely proud and bedazzled by Ashley, our teacher-athlete-mother-wife who did the Chicago Marathon this year (her 14^th) at less than 3:15. Wow. Ashley is the best life partner I could have – businesslike when it comes to running a common family and household; loving and thoughtful as a spouse. I also decided this year that the running group Ashley leads was filling up with too many strapping-young-single-20-something-boys vying for her attention, so I ran my first marathon this year to keep up at 3:42.

Profession – the people we work with:

Hyde Park Venture Partners had a tremendous year – which in venture capital is to say that the dollar weighted balance of good and bad tipped heavily to good. We had a number of companies (G2 Crowd, FourKites, Shipbob and others) raise large financings from premier later stage VCs (IVP, Emergence, August, Menlo, Bain and others) at significant markups. But these financings are only smoke from the fire of momentum our partner entrepreneurs are creating in our portfolio. We are truly in awe. These three companies, for example, will each double or triple revenue in 2019 again and likely hire 400 people, just in Chicago. It is a great pleasure for our firm to play a small part in this, and I proudly acknowledge the leadership of two of my partners, Ira and Tim, in the role they play with these three companies in particular. We also had liquidity in both funds, something that feels good for our entrepreneurs, investors and selves alike.

Increasingly, we recognize that good outcomes like those above are the result of well-worn ruts by a consistent team combined with a smidge of process. Ira and I have been working together for ten years, Tim and Greg with us for nearly six, and Jackie for nearly three. As an investing team, we find great joy in our work and each other… and there are sure things to laugh about. We recently implemented an “email of the quarter” designation for craziest e-mail received. It turns out that sleep e-mailing on Ambien is a real thing, and, man, the Ambien e-mail we received was a doozy! Keep ‘em coming, world.

Of course, it’s not all roses. Lots of thorns too – certainly in the portfolio – but sometimes with each other. Just as in a marriage, investing partnerships bring out both the best and worst in people, including myself. In my unadulterated form, I can be questioning and standoffish with those I don’t know or don’t like, charming and caring for those I like, and demanding and wielding of the sharp edge of whit with those I love, including my partners Ira, Tim, Greg and Jackie. We all have our imperfections, but we’ve also developed a safe zone for dissent and disagreement both in our formal investment process and our tacit culture. Indeed, when we first grew the team beyond Ira and me, we talked with a number of top VCs and found that a common feature of their funds’ best venture investments was original disagreement about those startups’ potential. We embrace this reality: in the fog of early stage investing, full agreement only means that everyone is missing something! So, here’s to more fun, success and disagreement in 2019!

Context – the world we live in:

To see the context of 2018 (and likely 2019 to come) as not dominated by politics and the economy seems impossible from where I sit. And yet, save for a short post after the 2016 election, I avoid talking about either much professionally. In short form (eg Twitter) the world doesn’t need one more fan on either side of the stadium shouting, and I am generally losing interest in Twitter as a means of communication other than for simple brand advertising for HPVP and me. In long form (eg blog) I’ve often viewed the line between business and politics a distasteful one to cross. Call me simplistic, but I’m happy to do business with anyone regardless of their politics, as long as we share similar values. It is because of this belief, however, that now is an important time to speak about politics in some depth, even to a broad audience of my business network.

The basic job of leaders is to enable their team members and constituents. For 90% of the time at a large company (not a startup), this means maintaining a consistent set of principles (values!), policies and procedures so that individual employees can do their jobs and keep customers happy. 10% of the time it means making really hard decisions to change the direction of a company to iterate a business model or otherwise stay ahead of the competition. This rubric for leadership applies well to government also, and maybe even more in the extreme. In the US, it is supposed to be very hard to change policies and laws so that a consistent political and regulatory environment is maintained to allow a relatively free economy and capitalism to thrive. Then, 10% of the time, strong leadership in the Presidency, House and Senate is needed to, say, elevate our society with respect to civil rights, recast an outdated tax code every 30-50 years, protect an ally in duress, or restructure our laws and policies to reflect a changing national culture and business model (eg, agrarian –> industrial, analog –> digital, etc). Generally, stability in politics matters and is good, creating a healthy environment for business. Just recently, we’ve seen how political instability is starting to undermine our business environment.

There is no one who understands base human instinct more than Trump. He swept into power on the long wavelength rumblings of a quake of discontent that others couldn’t hear. Unfortunately, no one understands the role of government, domestically or internationally, less than Trump. The interview simply doesn’t match the job.

Moreover, politics and government are much like venture capital in that 9 out of 10 times, your greatest worries will come true. Bad things simply happen all the time; so a good President and presidential team has thoughtful principles, policies and procedures in place to make sure the little things and the big things don’t throw the country off track. Over the past six months, we’ve seen any vestige or attempt of such a structure around Trump crumble. With accelerating staff departures and myriad new troubles rising every week, the frenetic spring that is Trump is simply unfettered to bounce around in different directions, introducing shocks and vibrations into both our political and business environment. There is no stability.

Much has been written about Trump’s lack of values… or adherence to the single value of I. It is not without purpose that I use the word “principles” in the framework for leadership and government above, or why the theme of values has been woven so completely through this letter. Without shared values, every interaction is a transaction, not a step in the natural ebb and flow of a continuing and maturing relationship. Faith to a common set of principles is what business and government leaders need to maintain consistency 90% of the time and then garner support to make big leaps 10% of the time. Instead, Trump’s lack of values and self-embracing volatility leave domestic and international institutions confused and reeling.

Sounds awful and scary, right?

Yet, when I look at my kids, I am not discouraged. As much as we and they are learning from mistakes year-by-year to become of stronger character and values, I can feel the country learning from our Trump mistake as well. Our nation is beginning to reject Trump like the body’s protective sack around a splinter, pushed back through the skin. That doesn’t guarantee new leadership in 2020; a lot can happen in two years. At a minimum, however, mean reversion will bring a more competent and stable leader by the time this Presidency can be formational to how my kids see the world and our country. Trump will be history and a footnote for them… and ultimately for all of us. Good riddance. (Aside: Many of you may note that Trump’s impact has a long half-life because of his SCOTUS appointments. Perhaps, but his two choices could easily have been appointed by any Republican president. One’s preference for that or not is within the normal envelope of political discourse. My point here is that Trump, himself, is not.)

The holiday letter from our investor was marked in its ability to tie the current political climate to business. It greatly informed my thinking here and convinced me that business leaders need to speak up when political leadership is in crisis. Except, we reach a slightly different conclusion. For our investor who runs a multi $ billion “distressed” private equity fund, he sees the volatility and impact on asset values as a buying opportunity. I can’t disagree in the short run.

But in the medium and long term – what matters for my kids and our investors in a 10 year venture fund – I am incredibly bullish. On a recent visit with another of our investors to provide an update on HPVP, we sat over coffee at his kitchen table. I looked at his living room to see piles and piles of sweatshirts, the inventory for his high school senior’s e-commerce business! (Of course, I told them they should use Shipbob to manage their inventory.) When I was the age of this budding entrepreneur, 20 years ago, there was neither an easy supply source nor scalable marketing channel for that same business. It would have required far more startup money, more time, and by definition had a much smaller audience. Now on the brink of the 2020s, there has simply never been a better and easier time to build something new. The rabbit is out of the hat, and there is no going back.

I regularly argue with my partners about how amazing Tesla is or isn’t. We all agree Tesla’s technology and product are a leap forward, but the question is whether the company will become a significant or even dominant worldwide auto player (and justify its orbital valuation).  Despite its buzz, Tesla has only a bit more than 1% of the US auto market, though ~40% of the US electric car market. It is easy to analogize Tesla to Apple with the latter’s incredible iPhone tech and product, which consistently holds a 30% to 40% market share after initially creating the smart phone market (and killing the feature phone market).  To perfect the analog, the story would play out like this: most of the 98% of the US market that is now gas or hybrid will become electric in 10 years, and Tesla will continue to be a dominant player. Suddenly Tesla’s 51B market cap looks like a pittance!

Both Tesla and Apple have a superior technology, better products, better user experience and better buying experiences. So how could this not be a “fait accompli”?

Before I answer that, some background: I’ve recently been reading about genetics and its effects on human physical and social evolution. Why? Because I didn’t know crap about genetics, and it seemed a rather gaping hole in my collection of the lots of things I know just a tiny bit about (life of a VC).  If you are interested, read Violinist Thumb and Before the Dawn, in either order.

There is a lot of similarity between genetic evolution and technology evolution – perhaps not a surprise, as genetics is in the broadest sense the most natural of all technologies. So here are a few definitions in lay terms and their analog to technology evolution. Then we’ll get back to Tesla.

Natural selection: Some genes help people live longer or increase fertility, thereby increasing the chance that said gene gets passed on through carriers yielding more offspring than non-carriers.

Sexual selection: A certain type of natural selection where a gene creates a physical (phenotype) or social characteristic in the host making them more attractive to mates, leading to more offspring than for non-carriers.

Genetic drift: The natural fluctuation of versions of a gene in a population through generations when no version (called an allele) provides significant natural or sexual selection benefit over the other. It turns out that with time, genes within a small population and with a set of initial gene variations will tend to converge through generations to a single version because of the effect of early deaths and non-procreation. For finance geeks, the analog in finance is the “random walk”.

Genetic sweep: The rapid dominance of a gene version across a population over just a few generations because of very strong positive natural or sexual selection.

The analog: Technology evolution is like genetic evolution in that customers/consumers make choices between technologies and companies in moments of truth akin to sexual selection. Meanwhile certain technologies and accompanying business models may be more likely to survive longer (less capital intensive, stickier network effects, etc), a natural selection that allows longer survival to then be selected by more customers – a harmonious cycle. When technologies and business models are truly superior, they can literally “sweep” through a population of users, like the iPhone. This is increasingly likely when there are network effects, as the iPhone had with its app store, and virality, which the iPhone had as a fashion and status accessory (admit it).

In this analog, however, we must also account for the role of chance. Even when there isn’t a particularly better functioning or serving technology, certain conditions (last mover advantage, first mover advantage, influential customer, etc) and path dependency can lead to dominance of one technology from a small set of technology choices, a la genetic drift or a random walk.

The big difference between genetic and technology evolution is the time scale. Genetic changes are measured over millennia and across thousands of generations, whereas technology evolution is measured in years or decades. While gene variations can wait for eons to dominate, companies and especially startups don’t have that luxury. A consumer might make a choice about a new phone every two years, a business about an ERP every ten years, and a human being about a mate once in a generation (or so). Modern technology moves much faster than genetics, or at least natural genetics.

The key insight with regard to Apple and Tesla is that the longer decision cycles and product life cycles are, the more time competition has to compete and catch up between consumer decisions. When Apple introduced the smartphone, it was so superior to feature phones that smartphones in the form of the iPhone “swept” through the US phone market in only a few years and ultimately maintained a large 30 to 40% share for Apple itself. I’m an Android guy, but even I can admit that Apple kept a technology lead for almost 10 years – 6 or 7 “generations” of one to two year phone decision cycles. The speed of the market allowed Apple’s initial technology advantage to buoy it in the lead through a number of generations because it was too hard for competition to catch up quickly both with its technology and viral and network-based business model.

The auto market is different. I drive a fourteen year old Subaru, but I’ve purchased at least six phones in that same period. Granted, that is a long hold for a car, but even assuming the national 6.5 year average, that is simply a long time for competitors to have between consumer decisions to catch up. This is true both for consumer decisions between gas/hybrid/electric and for consumer decisions on brand within electric.

Gas and hybrid technologies continue to improve, and even if total cost of ownership for electric is reaching or surpassing parity, most of these calculations don’t account for unnaturally high human discount rates in decision making when considering electric’s higher upfront cost. This effectively slows the growth of Tesla’s electric market sandbox within the overall auto category, giving yet more time for competitors to catch up. By the time electric is a significant portion of the auto market, Tesla may well find itself in a state of “genetic drift” doing the same random walk for a few points of market share here and there – much as Ford, Chrysler and GM did for decades – and likely against those same brands.

What could change this? As far as I can tell, while there is some virality in Tesla’s business model as a fashion and status accessory (admit it), the network effects are more nuanced. So far, your Tesla does not make my Tesla or Tesla experience that much better. While it’s true that the more Teslas on the road, the better self driving features get with additional driving data, but I don’t think Tesla’s current autopilot features are the main buying reasons versus 100% electric, awesome design, status, etc. Tesla’s charging network is its strongest claim on network effects so far, but I would expect this to be fleeting as gas stations, c-stores and QSRs implement their own open networks in the coming decades given the clear opportunity to sell sugar and salt to waiting consumers. Major market share is still possible for Tesla, however, if it truly delivers on the promise of driverless autonomy and establishes a proprietary self-driving network that drives “sweeping” adoption through network effects. We haven’t heard as much talk of this lately.

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: