2001: A (Cyber) Space Odyssey

This post originally appeared on the Platforms & Networks blog

What I’ve said that turned out to be right will be considered obvious, and what was wrong will be humorous.

—Bill Gates, The Road Ahead, 1995

In 2001, I wrote a book explaining why accelerated growth strategies created value for some Internet companies and destroyed value for others. The book, Speed Trap, was poised for publication as I came up for promotion that year at Harvard Business School. However, in a reversal of the familiar prescription for scholars, my mentors told me, “If you publish, you might perish.” They were concerned that Speed Trap had been written in a hurry—a cruel irony, given its title and topic. I had confidence in the quality of my work, but not enough to bet my job. I canceled publication and forfeited my advance. It was painful to scuttle Speed Trap, but I don’t second guess my decision: I got promoted.

I recently read Speed Trap for the first time in many years, curious to see if its ideas had stood the test of time. I was surprised by the book’s sober tone. It has a morning-after hangover vibe: ”I guess last night was amazing, but I can’t remember it all; I must have blacked out. Now it hurts just to blink. Let’s never do that again.”

Speed Trap shows how we thought about online opportunities one year after the dot com bubble burst. In retrospect, many of my thoughts about the Internet’s future evolution missed the mark. If you think history repeats itself, then these forecasting errors might be germane, since startup valuations and VC investments are once again declining. Reasoning that today’s tech entrepreneurs and investors might value a history lesson, I’ve published Speed Trap as an ebook, which is downloadable for free in ePub, Mobi and PDF formats, and available in the iBooks Store for free and in the Kindle Store for $0.99.

With the benefit of fifteen years worth of hindsight, it is evident that Speed Trap, when looking ahead, had a profound status quo bias. The book did anticipate that broadband and wireless Internet access technologies would spread. Otherwise, Speed Trap didn’t foresee major changes in how consumers and businesses would use the Internet. As a result, Speed Trap’s errors of omission are alarming. Here’s a sample what I didn’t see coming as I wrote the book in 2001:

• Google’s dominance. Speed Trap devotes just two paragraphs to Google, which, by 2001, already was the 15th largest U.S. website. Despite this traffic, Google’s ecosystem impact was still modest at the time. The company was still a year away from adopting the paid search model that would revolutionize digital marketing.

• Apple’s iPod. As I finished writing Speed Trap, the music industry was celebrating the shutdown of Napster, and the major labels were busy organizing their own download services. A few months later, like a bolt out of the blue, Apple launched the iPod and changed everything.

• Amazon’s Kindle. Speed Trap speculates about whether Microsoft or Adobe would be better positioned to establish the dominant ebook standard. The possibility that the world’s biggest bookstore might eventually win that race hadn’t dawned on me.

• Social networks. We’d had hints of strong demand for social networking services, including AOL’s chat rooms and SixDegrees, a social networking site that peaked at 3.5 million members before failing in 2001. Despite these developments, I didn’t foresee the rapid rise of Friendster (founded in 2002), MySpace (2003), and Facebook (2004).

• User-generated content. Although GeoCities had demonstrated the appeal of user-generated content during the late 1990s, Speed Trap failed to anticipate that blogging and user-generated video would become mainstream phenomena within a few years.

Because it turned a blind eye to these black swans and big trends, Speed Trap assumed that market shares would remain stable in key online markets. For example, the book asserted that by 2001 online recruiting was a mature category, and predicted that Monster.com was unlikely to be usurped as its leader. By 2012, Monster’s 23% U.S. market share lagged CareerBuilder’s 34%. LinkedIn, propelled by the social networking wave, had captured 16% of the market in 2012 and was poised for explosive growth.

Readers who are too young to recall the dot com crash might reasonably ask whether my interpretations in 2001 were idiosyncratic—perhaps because I was, as an academic, either excessively cautious or simply clueless. With respect to my understanding of Internet businesses, I’ll let Speed Trap’s content speak for itself. With respect to the book’s conservative tone, I do think I was reflecting the Zeitgeist. If you are skeptical, read Michael Lewis’s 2002 New York Times Magazine article, “In Defense of the Boom.” Lewis writes, “The markets, having tasted skepticism, are beginning to overdose. The bust likes to think of itself as a radical departure from the boom, but it has in common with it one big thing: a mob mentality.” Likewise, the economist Charles Kindleberger, in his seminal 1978 book on the history of stock market bubbles, Manias, Panics and Crashes, explains that after a bubble bursts—during what he calls the “revulsion” phase—most investors lose their appetite for risk taking.

Our collective conservatism in the immediate wake of the dot com crash might be seen as what management scholars call a threat-rigidity response. Individuals and organizations, when confronted with a severe threat, tend to constrict their information processing, focusing “tunnel-vision” attention on dominant rather than peripheral environmental cues. Threatened parties then tend to rely, in a rigid manner, on familiar responses to those cues—often with bad results.

If this premise seems plausible, then we should ask: Have recent declines in startup valuations and VC investments been big enough to elicit another threat-rigidity response? Probably not—at least not yet. But when bright shiny objects—akin to today’s virtual reality or Internet of Things—finally fail to attract investor interest, then we might posit that the cycle is reaching its trough.

So if, in the wake of a future sector crash, entrepreneurs and investors anticipate a sector-level threat-rigidity response, what should they do? In a severe downturn, entrepreneurs must, of course, cut costs and conserve capital. Dozens of VC blogs over the past few months have already offered this advice. VCs face a more difficult decision if they expect an industry-wide threat-rigidity response: When most peers are cautious and skeptical of radical new venture concepts, maybe it’s time to be a contrarian?

Likewise, during a bubble’s revulsion phase, established corporations face interesting opportunities to acquire valuable assets at firesale prices. One surprise from the early 2000s was how few corporations exploited this opportunity, despite having strong balance sheets. Only a handful of Internet startups were acquired by big incumbents during 2001: HotJobs by Yahoo, MP3.Com by Universal, and Peapod by Ahold. The pace of acquisitions didn’t really pick up until 2004.

If you read Speed Trap, I hope you will find value. For Internet veterans, the book should rekindle nostalgic memories of startups that bring to mind my favorite line from the movie Blade Runner: “The light that burns twice as bright burns half as long.” Remember Boo.com, Webvan, eToys, Pseudo.com, Pets.com, and Kozmo? Disney’s $790 million Go.com debacle? For tech entrepreneurs who may have been in middle school during the late 1990s, Speed Trap may provide some historical perspective on the origins of the business models upon which you are building, and some lessons for navigating a boom-bust cycle.

Don't Just Fail — Fail Better!

This post was originally published on LinkedIn

[2021 Update: The research project mentioned in the next paragraph finally resulted a book, Why Startups Fail, published in March this year, and in an MBA elective launched in 2019. Things move slowly in academia; it's amusing that I projected, in 2014, that it would take "a year or so" to finish the book! And it's ironic that the book's working title for many years was False Start, because I made two false starts with this project, starting it then setting it aside in 2014 and again in 2016.]

I recently kicked off a research project on entrepreneurial failure that I hope will result — in a year or so — in a book to be titled False Start. In tandem, I plan to develop a new, case-based MBA elective on the topic.

I've written before about how entrepreneurs' egos can contribute to their ventures' demise. As I kick off my new project, however, I feel motivated to share a personal reflection on failure. Last summer, I gave the commencement address at my high school alma mater, Padua Franciscan High School. I spoke about failure and what we can learn from it. Here's what I said:

Hello, Class of 2013. Thank you for inviting me to your graduation. And congratulations: you’ve got a lot to be proud of! But I’m not here to celebrate your achievements. I want to talk about your failures — and about how you can fail better.

You can fail better if you follow the example of entrepreneurs. As Father Ted mentioned, I’m a professor at Harvard’s Business School, where I teach entrepreneurship. The most important thing we teach is that three out of four startups fail. Dreams are destroyed; it’s often heartbreaking. But great entrepreneurs persevere, against the odds. For them, setbacks are valuable. Figuring out what won’t work puts an entrepreneur one step closer to a solution that will work. And when an entrepreneur finds a solution that works, magic happens. They create something out of nothing. The best entrepreneurs create something that makes a big difference in the world. Think of Thomas Edison. Henry Ford. Steve Jobs. Oprah Winfrey. You can make a difference in the world too, but only if you accept the risk of failure. And only if you learn from failure. Only if you fail better.

It took me years to figure this out. I hope this talk tonight gives you a head start down the same path of discovery.

My education about failure started at Padua, when I had a reptile brain like yours. Insulted? Don’t be. It’s a scientific fact: compared to adults, teenagers rely more on their amygdala when responding to stimuli. The amygdala is the primitive part of the brain that we share with reptiles. It controls the fight-or-flight response. Adults, by contrast, are more likely to use their frontal cortex, which controls reasoning and allows rational planning.

So, graduates: until you turn 20, if you do something really dumb, you can just blame it on your amygdala — on your reptile brain. Try this on your parents if you dent the family car; I’m sure your father’s frontal cortex will tell him that you’ve offered a perfectly reasonable excuse.

My reptile brain was hard at work when I was at Padua. During my senior year, it masterminded an epic fail. I was the starting catcher on the varsity baseball team. Don’t be impressed. I may still have the lowest batting average in Padua history. So, not surprisingly, about two-thirds of the way through the season, with our team out of contention for league leadership, my coach benched me and put our 2nd string catcher — a junior — into the starting lineup.

Now, our coach was the strong, silent type. He wasn’t big on explanations or reassurance. He didn’t tell me why I was benched. You can probably guess that he was thinking ahead to next year, and he wanted my teammate to get more practice. But through the blind rage and deep shame that surged through my reptile brain, I couldn’t see that. Fight, or flight? My amygdala picked flight. I sulked through the game, and when we got back to the locker room, I announced that I was quitting. My coach just shrugged, and my teammates didn’t try to talk me out of it. They were probably dumbfounded by my shocking immaturity and my self-centered behavior. No one on the team spoke to me for months afterward, and I can’t blame them.

It was a true failure of character. But it took me a while to see it that way, and even longer to understand my mistake and learn from it. Lance Armstrong, before his own colossal failure of character was exposed, summed up the lesson well. He said, “Pain is temporary. Quitting lasts forever.”

Failure came into sharper focus for me years later when I started studying entrepreneurs. I learned that running from failure, like I did at Padua, is a common response. Our egos are easily bruised, so we often avoid situations where we might fail. But the best entrepreneurs are different. They seek out new challenges and view failure as a necessary part of the learning process. If you can’t fail, you can’t learn. And if you can’t learn, you can’t improve.

Entrepreneurs fail, over and over. Steve Jobs, the founder of Apple, is a great example. He was fired from Apple in 1985, just one year after launching the original Macintosh computer. He said, “The focus of my entire adult life was gone; it was devastating. I thought about running away from Silicon Valley. But I still loved what I did. So I decided to start over.” Over the next eleven years, in exodus from Apple, Jobs led Pixar to greatness. He also launched another computer company that Apple eventually acquired. That set the stage for Job’s triumphant return to Apple in 1996, and for the dazzling iPhone that’s in your pocket.

In 2001, I got a chance to put these lessons into practice — and to atone for quitting Padua’s baseball team. I was up for promotion at Harvard Business School. Like most universities, we have a “publish or perish” promotion process. If you don’t publish compelling research, and plenty of it, you perish. Promotion odds at my school are low: three out of four new professors eventually get fired. So, I was facing the same odds of failure as a typical entrepreneur.

I thought I was in good shape. I was studying internet companies, and a publisher had paid me a big advance for a book about this hot new phenomenon. But the senior professors who reviewed a draft of my book and my other work saw things differently. They said my research seemed like it was done in a hurry; it had a lot of intellectual loose ends. That was ironic, because my book was titled Speed Trap. The book analyzed mistakes that many internet companies made by growing too fast.

My boss told me that I wasn’t being fired — at least not immediately. Instead, the School would put me on probation and give me two more years to try to improve my research. But he added, “There are no guarantees that this will work. You should think about whether you are cut out for this job, and you should seriously consider leaving academia now. You’ve got plenty of good opportunities in the real world.”

I was shell-shocked. You may be familiar with the five stages of grief: denial, anger, bargaining, depression, and gradual, grudging acceptance. We experience these stages when we confront impending death or some other extreme, awful fate. The risk of getting fired after spending seven years trying to reach my goal seemed truly terrible. So, I passed through the five stages of grief. I lingered at anger.

But I also recalled my regrets after quitting the Padua baseball team. And like Steve Jobs, I knew that I still loved my work. I resolved to not run from my failure this time. I would try to learn from my setback, even though that would expose me to the risk of future failure. My book was finished but not yet printed. I told my publisher to cancel my contract. I gave them their money back, and I kissed goodbye to a year’s worth of work. I put my head down and cranked out better research. I lived on edge for two years, but I got promoted. The pain was temporary, but worth it.

If you want to fail better, accepting risk is just half the battle. The other half is learning from our mistakes. As Henry Ford said, “The only real mistake is the one from which we learn nothing.”

Learning from failure isn’t easy. Our brains are wired up to see what we want to see. As a result, we often ignore signs of failure. And when we acknowledge the signs, we often misdiagnose causes. We are prone to blaming others or events outside of our control, rather than attributing failure to our own shortcomings.

Because our brains conspire against us, learning from failure requires discipline. The Army knows something about discipline, so it shouldn’t surprise us that they do a great job with learning from failure. After every engagement, an army unit runs what’s called an “After-Action Review.” The team asks four simple questions: What was our objective? What happened? Why did it happen? What do we do next?

Great entrepreneurs are likewise disciplined about learning from failure. They rely on the scientific method, formulating hypotheses about their new business and structuring experiments to test those hypotheses. They expect that many of these tests will fail. Thomas Edison knew this when he invented the light bulb. He famously said, “I have not failed. I’ve just found 10,000 ways that won’t work.”

You don’t have to join the Army or launch a business to learn from failure. You are about to enter the world’s best learning laboratory: college. College is a safe place to fail — one that offers tremendous freedom to experiment. This freedom will feel amazing after high school. At college, you will be a blank slate. No one will have preconceptions about who you are or what you can and cannot do. You can reinvent yourself.

Try new things at college. Experiment with different courses. Different causes and clubs. Different kinds of friends. Different jobs. But be disciplined about what you are learning. Approach these experiments with hypotheses, and end them with an After-Action Review. Most importantly, accept the fact that if you try new things, some of them won’t fit. But some will, and if you try, you may find lifelong soulmates. You may find your true calling, your way to make a difference in the world. As Steve Jobs would say, a way to “put a dent in the universe.”

So, Class of 2013, I hope you find great happiness and success. But I hope you embrace failure, too, as a path to improvement. And I hope you’ll live by the words of the playwright Samuel Beckett: “Ever tried. Ever failed. No matter. Try again. Fail again. Fail better.”

Ego and Startup Failure

This post originally appeared on Forbes.com

Entrepreneurial success hinges in large part on a founder’s mastery of psychology. This requires the ability to manage one’s responses to what Ben Horowitz calls “The Struggle,” that is, the emotional roller coaster of startup life. Paul DeJoe captures the ups and downs of being a startup CEO in a post reprinted in a book that I edited, Managing Startups: Best Blog Posts.

It’s all in a founder’s head: the drive to build something great; the resilience to dust yourself off when you repeatedly get knocked down; the passion powering a Reality Distortion Field that mesmerizes potential teammates, investors, and partners. But inside a founder’s head may also be delusional arrogance; an overly impulsive “ready-fire-aim” bias for action; a preoccupation with control; fear of failure; and self-doubt fueling the impostor syndrome. That’s why VC-turned-founder-coach Jerry Colonna named his blog The Monster in Your Head. In a recent interview with Jason Calacanis, Colonna does a nice job of summarizing some of the psychological challenges confronting entrepreneurs. So does a classic article by the psychoanalyst Manfred Kets de Vries: “The Dark Side of Entrepreneurship.”

Causes of Entrepreneurial Failure

If entrepreneurial success hinges on a founder’s mastery of psychology, it stands to reason that a founder’s flawed ego is often the root cause of startup failure.

Categorizing causes of entrepreneurial failure is tricky. Asking entrepreneurs why their venture failed doesn’t always yield reliable answers. To bolster our fragile egos, we credit our successes to our own brilliance and skill, and we attribute our failures to the shortcomings of others or to events outside our control. This pattern is so deeply ingrained that psychologists have labeled it the Fundamental Attribution Error.

Furthermore, just as a living organism might die for many reasons—for example, hunger, predation, or illness—startup failure has diverse causes. Paul Graham cites 18 reasons why startups fail; in her post, What Goes Wrong, reprinted in Managing Startups, Graham’s partner at Y Combinator, Jessica Livingston, warns founders that they must navigate a “tunnel full of monsters that kill.”

Finally, explanations for startup failure are often linked in a complex chain of causality. Running out of capital is often the proximate cause of death. But this implies that an entrepreneur couldn’t raise more funds. Why? Because the venture had little traction. Why? Because the team was slow to market with an inferior product, relative to rivals. Why?

In the spirit of “Five Whys” analysis, one should continue probing until the root cause for failure is revealed. Digging deeper often reveals that startup failures have ego problems at their core.

Ego-Driven Failure

At the risk of oversimplifying, the ego issues that can derail an early-stage startup come in two broad groupings. Some founders are ambivalent about their vision or their level of commitment to their venture. Others are headstrong—too confident about their vision and their ability to lead. In fact, Peter Thiel hypothesizes that plotting founders along such a spectrum would yield an inverted normal distribution—one that is fat at both tails, rather than in the middle.

Ambivalence. Steve Blank tells a tragic story of a founder failing from a lack of nerve. Entrepreneurs who are irresolute, weak-willed, and wavering can cause problems like these:

• They fail to recruit a great team because strong candidates can sense the founder’s ambivalence and know that resolve is required to lead a startup through its ups and downs.

• They pivot too quickly, never devoting enough effort to any one opportunity to refine their offering and gain traction. Some founders get bored easily and rapidly cycle through new ideas. Others are overly compliant: they lack the strength to say “no” to team members, investors, or customers who suggest different course corrections. Another post from Blank republished in Managing Startups describes Yuri, an indecisive entrepreneur who shifted strategy constantly because he was unable to distinguish between vision and hallucination and was thus “buffeted by the realities of his burn rate, declining bank account, and depressing comments from customers.” His team “was afraid to make a decision, because they couldn’t guess what Yuri wanted to do that week.”

• They scale prematurely, burning through their capital before they have achieved product-market fit, because they are unwilling to resist pressure from investors who urge them to “swing for the fences.” The anonymous author of the new blog My Startup Has 30 Days to Live, a moving real-time account of the pressures, doubts and personal costs confronting a struggling startup’s founder, acknowledges making this mistake: “I had the power to reject these suggestions, at the risk of being labeled as un-coachable…These men never put a gun to my head, never threatened me into making the decisions I did. I just didn’t challenge them.”

• They stay in stealth mode too long, missing a window of opportunity or launch a flawed product due to a lack of early customer feedback. As Paul Graham points out, such procrastination sometimes stems from a fear of being judged.

• They provoke cofounder disputes—especially when, in Livingston’s words, a cofounder’s irresolute behavior raises questions about whether he is “trustworthy or works hard enough or is competent.”

• They throw in the towel without putting up much of a fight, because they lack, in Livingston’s view, the drive and determination “to overcome the sheer variety of problems you face in a startup” or they are “immobilized by sadness when things go wrong.” As Jason Cohen says, “It’s so easy to stop. There are so many reasons to stop. And that—stopping—is how most little startups actually fail.” Andrew Montalenti adds, in a post republished in Managing Startups, that founders are likely to get “antsy” when they pursue a startup mostly to advance their career but lack personal passion for its mission.

• They follow the herd, perhaps because they are insecure about their ability to set direction. Such founders often pursue derivative ideas or copy rivals’ features.

• They take their eye off the ball. Mark Suster bemoans entrepreneurs who crave the limelight and lack the discipline to say “no” to offers to speak at conferences. Livingston warns founders to avoid distractions—in particular, conversations with corporate development executives who want to learn about a startup but have no real intention of pursuing a deal.

Obstinacy. Startups run by founders who are control freaks, headstrong, or arrogant often precipitate the same problems listed above, but in very different ways:

• They fail to recruit a great team because they don’t recognize their own shortcomings or they are unwilling to delegate. According to Kets de Vries, they also may be prone to driving away talented colleagues by scapegoating or by viewing employees in extreme terms, putting some on a pedestal while vilifying others.

• They fail to pivot because, in some cases, an overconfident entrepreneur simply cannot comprehend that customers might be rejecting their product. Or, they may be cocksure that the path that led to success in their last venture will prove true again. In still other instances, founders may be loath to pivot away from a vision to which they are fervently committed—even if sticking with the startup’s original plan puts the venture in peril. This risk is compounded when an entrepreneur relies on a Steve Jobs-style “reality distortion field”—using personal charisma and riveting rhetoric to inspire people to go to extremes to achieve a startup’s vision. When a vision is sold this way, it is especially difficult to subsequently admit that it might have been flawed.

• They scale prematurely due to overconfidence or an impatient drive to see their vision become a reality. Kets de Vries says such founders often defend against anxiety by “turning to action as an antidote.”

• They stay in stealth mode too long. In some cases their founder, with a vision burning so brightly, feels no need to secure early market feedback. In other instances a founder’s perfectionism prevents a team from “launching early and often.”

• They provoke cofounder disputes by battling ceaselessly for dominance and control of their venture’s direction.

There’s no science behind my characterization of founders’ egos as lying somewhere on a spectrum that ranges from ambivalent to obstinate. I’m sure this one-dimensional view makes trained psychologists cringe, because it ignores a mountain of research pointing to a “Big Five” set of stable personality traits: openness, agreeableness, extraversion, conscientiousness, and neuroticism. Adeo Ressi’s Founder Institute draws on such research in the admissions test for its training program. Based on analysis of responses from over 15,000 aspiring entrepreneurs, the test sheds light both on the traits of successful founders and the attributes of Bad Founder DNA: excuse-making, predatory aggressiveness, deceit, emotional instability, and narcissism. Founder Institute’s research confirms: it’s all in the head!

Failing Better

So, what should a founder do to master the monsters in her head?

Self-reflection is the starting point. What motivates you? How do you respond to pressure and uncertainty? For some, therapy with a professional psychologist will put this in focus. For others, a startup coach like Colonna can provide helpful guidance, as can a good mentor. Regardless of where you seek such counsel: ask for help, tell the truth, and listen.

If you are thrashing around and pivoting too quickly, follow Steve Blank’s advice to Yuri: sit on any new insights for 72 hours, and brainstorm them with someone you trust.

Build the discipline of debriefing to learn from your startup’s failures. Discerning the causes of small setbacks may help you stave off big ones. The U.S. Army’s After-Action Review process provides a template. With an AAR, a team asks four simple questions: What was our objective? What happened? Why did it happen? What do we do next?

In conducting post-mortems, however, be on guard for the Fundamental Attribution Error, that is, a tendency to blame failure on events outside your control. Also, as Blank points out, you’ll be in a better position to learn from a big failure if you recognize that your emotional response to it may follow Kubler-Ross’s five stages of grief—denial, anger, bargaining, depression, and gradual, grudging acceptance.

Follow the advice of Spencer Fry and find healthy ways to relieve stress. Recognize that such stress puts entrepreneurs at increased risk for depression. If you believe that you or someone you work with may be depressed, seek treatment NOW. And read Brad Feld’s posts to learn more about depression and how to manage it.

Finally, follow the advice of David Tisch, and never lose sight of the ‘why.’ Tisch advises founders to constantly ask whether they are still on the path that originally motivated them to launch a startup, for example, the desire to disrupt an industry, to build a great company, or simply to be independent. If not, Tisch says, it’s time to wind things up. As Brad Feld points out, sometimes failure is your best option.

Photo by Kelly Sikkema on Unsplash

No Regrets (Mostly): Reflections from HBS MBA '99 Entrepreneurs

Originally published on the Platforms & Networks blog

MBA students who are debating whether to launch a startup upon graduation often ask me, "What are the career consequences if my business fails? What do MBAs who founded failed firms do now? Do they regret their decision to launch a business right out of school?"

We have plenty of experience with student entrepreneurship at HBS. Over the past 15 years, an average of 3-4% of students in each class of 900 HBS MBAs have founded firms upon graduation, and another 4-5% have joined startups in non-founder roles. [author's note, 2/26/14: the comparable statistics for the HBS MBA Class of 2013 were 7% founding and 4% joining startups.]

At the dot com bubble's peak in 2000, 11% of our MBA class founded firms upon graduation. To determine whether we're in another bubble, I'll track this figure for the Class of 2011. Interest in entrepreneurship has been rising at HBS, but so far, it lags 1999/2000 levels.

To respond to my students' questions, I assembled some data on career outcomes for a sample of a dozen MBAs who founded firms upon graduation in 1999 or 2000. I also asked these alums whether they had any regrets about their decision to follow an entrepreneurial path. Most of the startups in my sample failed. A pattern of highly skewed outcomes—with just a few big winners, a modest fraction of firms that earned back their investment, and many failures—is just what we'd expect from any portfolio of VC-backed tech startups.

Specifically, in my sample, one firm is still a going concern; one was sold at a price that roughly yielded a breakeven return to early investors; two were sold at prices that returned only a small fraction of capital invested; and the rest were complete wipeouts. So, most of the alumni I contacted can comment from direct personal experience about the career consequences of startup failure.

What are these alums doing now? One is still CEO of the firm he cofounded upon graduation. Three are serial entrepreneurs who have been successful—so far—with a second startup. Three are partners in VC firms. Two are presidents of medium-sized businesses, having stepped in as professional managers to replace founders. One is at Boston Consulting Group. One is planning to launch another startup after holding a senior marketing job in a public Internet company. One is searching for a role in a new venture after a hiatus to start a family. As a group, the alums are in impressive positions. Those whose first startups failed do not seem to have suffered negative career consequences.

Do the alums regret their decisions to found firms upon graduation? Eight of nine who answered my email query said "no." Here's a sample of their comments:

• No: There is no substitute for the sense of pride and accomplishment that comes with starting a business.

• No: But you need realism, an understanding of drawbacks and most importantly, to be passionately entrepreneurial. Starting a business is not for the timid. You need to be resilient, optimistic, able to deal with uncertainty, and strong-willed.

• No: The lessons learned have applied to my subsequent businesses. Each has been less stressful, because the experience provides groundwork for doing a better job the next time.

• No: Right after graduation is a great time to get start a business. You have amazing drive, focus and a smaller personal overhead.

• No: I got to participate in every aspect of my company as a true general manager. I never would have that opportunity in a large, established company.

• No: The Internet boom was a unique moment and I could not pass up that opportunity.

One alum did voice regrets:

Yes. But I have no regrets about launching another business later. For me, it was just a matter of timing. Coming out of HBS, I had blind spots. I was an engineer undergrad, and even after HBS, a couple years with McKinsey or on Wall Street would have made a world of difference in developing structured thinking and hardcore analytics. I also needed more experience in areas like partner selection and more maturity in dealing with negotiations and employees. These blind spots introduced founder risk and reduced the likelihood of our success. The smart investment would have been to spend 2-5 years doing other stuff, getting paid while addressing blind spots.

Photo by Brett Jordan on Unsplash

Tonight We're Going to Party Like It's 1999

Originally published on the Platforms & Networks blog

Are we in a new bubble, as Steve Blank recently wrote, or do current high valuations for early- and late-stage consumer Internet companies reflect sound fundamentals?

From an academic's perspective, this is a difficult question, and I won't tackle it here. Instead, I'll share some data on the performance of Internet startups launched during in the late-1990s boom.

The table below compares the market value at the end of 2001—the trough of the valuation cycle that began in the mid-1990s—to total capital raised since inception (private and public) for all 2,121 U.S-based Internet companies that had ever got funding from VCs or public markets (see appendix below for my definitions and methods). The firms had an aggregate market value of $99 billion at the end of 2001, and they had raised $85 billion of capital. This doesn't imply an attractive return for someone who invested pro rata in all rounds, especially if you consider the time value of money and the fact that investors had to share part of the $99 billion with company founders. But it's not a wipe-out, either.

Of course, focusing on sector-level, aggregate results may mask serious problems with overinvestment in individual markets, for example, online pet supply retailing—where four rivals burned through over $500 million and all failed. Also, it's important to note that returns from individual companies were very skewed. As the table below indicates, only 139 (7%) of the 2,121 Internet companies completed an IPO. Among these public companies, only 37 had a market value at the end of 2001 that exceed the total capital they had raised historically. A full 42% of the sector's $99 billion in yearend 2001 market value was accounted for by just five companies: Amazon, eBay, E*Trade, Yahoo!, and WebMD.

In summary, if the Internet sector had been subject to grossly excessive rates of entry and investment during the last bubble, as conventional wisdom holds, we would have expected a significant sector-level capital loss, rather than a shoulder shrug, "got-my-money-back" aggregate return. Conventional wisdom exaggerates the economic damage wrought by the late-1990s bubble. In considering the impact of valuation bubbles, it's important to separate stock market gains and losses—transfers of wealth between traders—from poor long-term returns on the capital invested directly in companies. It is also important not to conflate the high business failure rates that result from excessive rates of entry with the high failure rates we would normally expect to observe in new markets with “winners-take-most” potential and low entry barriers—like those targeted by many Internet companies. Given lottery-style payoffs, high rates of entry and failure are consistent with rational economic behavior.

As a new bubble emerges around social media startups, we should expect to see similar performance patterns.

APPENDIX

Definitions. The table above includes all U.S.-based Internet companies that raised capital from professional investors prior to 2002. Internet companies were defined as firms that relied on the Web as their principal channel for delivering products or services to consumers or businesses. This definition excludes: 1) companies that earned most of their revenue by providing professional services, software, or hardware to Internet companies; 2) firms that provided Internet access or hosting services; and 3) the online units of established, brick-and-mortar corporations. Professional investors were defined as venture capital firms (including corporate venture funds) and institutions that purchased public securities. Firms funded exclusively by angels or by strategic investments from non-Internet companies were excluded, although strategic investments were included in estimates of total capital raised by VC-backed firms.

Valuations. Enterprise values were estimated as of December 31, 2001. Valuations for private Internet companies reflect only the market value of equity; few such firms had any debt. Enterprise values for public firms reflect the market value of their equity as of yearend 2001, plus the book value of any debt.

For active, private Internet companies that raised funds sometime during 2001, yearend 2001 equity market value was assumed to equal 98% of total capital raised historically, based on average post-round valuations for funding transactions completed during the second half of 2001. For active private firms that did not raise funds during 2001, yearend 2001 equity market value was assumed to equal 49% of total capital raised historically, based on analysis of performance for VC funds launched during 1999.

For merged firms, valuations reflect their contribution to the yearend 2001 market values of the companies that acquired them, rather than proceeds realized by the merged firms’ shareholders. For mergers involving two Internet companies, the acquired company’s value is included in the acquiring company’s yearend 2001 market capitalization. Capital raised by the acquired company is added to the capital raised by the acquiring firm.
For acquisitions of Internet companies by non-Internet companies completed during 2001, yearend 2001 market value was assumed to equal announced merger transaction proceeds, which averaged 76% of total equity capital raised historically by the acquired companies. For such firms acquired prior to 2001, yearend 2001 market value was conservatively assumed to equal the total capital they raised historically.

Source: Eisenmann, "Valuation bubbles and broadband deployment," Ch. 4 in The Broadband Explosion, edited by Austin & Bradley, HBS Press, 2005

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