Notes from The San Francisco Fallacy by Jonathan Siegel

review the San Francisco fallacy

Rating: 8/10
Finished: 05/2017
Related Books: Anything You Want, The LEAN Startup, Running Lean, Scaling Lean, The 7-Day Startup

Buy the book on Amazon here / See all my lessons from books and smart people HERE.


The Short Summary of “The San Francisco Fallacy: The Ten Fallacies That Make Founders Fail” by Jonathan Siegel

The author is a serial entrepreneur and venture capitalist in San Francisco. In this book, he shares the 10 most common reasons why technology founders fail, and how to avoid them. The fallacies presented are useful to be aware of, but I think the underlying startup stories in the book is what makes it an interesting read.

As a founder, I painfully recognise all these fallacies, because I’ve done all the mistakes they lead to. Knowing that others out there do the same mistakes as me is somewhat reassuring, and somewhat sad also. Books like this serve an important role by highlighting that which nobody talks about: real-world fuckups and failures, and how others can learn from them. I’ll make sure to build these fallacies into out experiential, 8-week entrepreneurship bootcamp Early Stage next year!


Lessons Learned

San Francisco is beautiful city and a great place to party. But it’s a lousy city to build a startup. Yet San Francisco is seen as the global epicenter of startup culture. Would-be founders flock there from all over the United States—and the world. Why? Because they think, “If everybody else is doing it, then it must be the thing to do.” That’s the San Francisco Fallacy.

It feels good to be among our peers. It’s reassuring. And it’s exciting to be part of a “thing.” It’s only human. But it’s bad business.

The Tech Fallacy

The Tech Fallacy says it’s all about the tech. Tech is the be-all and end-all of what we do. Get the tech right and the rest will follow.

The raison d’être for any business is to give the customer what he wants. He doesn’t want the tech; he wants what the tech can deliver. The tech is just the means to an end.

Take two rival companies. Each is armed with $1 million in investments. One spends $900,000 on its technology development, with $100,000 reserved for going to market (i.e., customer development, sales, and marketing). The other spends $100,000 on technology and $900,000 on going to market. Who wins? The market-driven one does. It’s not the better product that wins; it’s the product that best knows how to reach its market.

in the startups that I encounter, if the company has a team of ten, there’ll be nine developers and just one person who is business driven. Contrast that with companies that have gone public: you’ll see ninety salespeople for ten developers.

The Democracy Fallacy

The Democracy Fallacy is the belief that everything is awesome when you’re part of a team; or, more prosaically, that team members should have an equal say—and stake—in your venture.

When we set up companies, we do it as a team. Which can be awesome—until things go wrong.

More often, a flawed ethos of shared ownership and responsibility gets in the way of decision making and accountability. Businesses need leadership. Leaders need to be rewarded. All the more so in youthful startups.

Larry Ellison, Michael Dell, Bill Gates, Steve Jobs, Mark Zuckerberg… None of them ever found themselves agonizing over team conflict. Perhaps that was because they were all college dropouts. They weren’t trying to build great peer environments where everyone could thrive together. These founders didn’t get fully baked into the “equal equity” tendencies that I found myself (and other founders) mired in. Or maybe they just had an astute and aggressive internal compass for leadership.

Sharing power and trying to make everyone happy diminishes the ability to take bold risks and make bold decisions.

EXAMPLE: The iPod Shuffle. People think visionary leadership is about convincing the markets. But you need strong leaders to take the kinds of stances and make the kinds of choices that are often unpopular within their companies.

Take the iPod Shuffle—a product that makes no sense. Apple launched the Shuffle at a time when everyone else was adding more displays, more information, more features to their MP3 players. In contrast, Apple took away every single feature that you’d expect. All that remained was one button, PLAY/PAUSE, and with that button you got random music. You could not choose what you were going to listen to. They took a ridiculous lack of features, an almost insulting lack of features, and sold that as a benefit – with extraordinary success.


This was only possible because of the single-minded focus of Jobs’s leadership: no committee would ever have let the Shuffle come to market in such a competitive environment. Under a company that subscribed to the Democracy Fallacy, this simply wouldn’t have been allowed.

If you find yourself down the path to forming a company with equal shareholders, here’s a good question to ask of each of the team: can they leave, and the business survive? Whose departure would cause the company to collapse? At an early stage, everyone feels vital—your programmer is needed to write the code, your artist to do the design, your hustler to win your first sale. But, depending on your business, you may be able to pay a little more and get a contractor if your developer leaves. It hurts, but it doesn’t kill the business. There is always one person who holds the key to investment, who rallies the team – the person who acquired the first hundred customers. If that person leaves, the company dies, and you can’t just replace him or her. That person needs to be your majority shareholder.

THE LESSON FOR YOUNG, WOULD-BE FOUNDERS IS THIS: by all means, start a business with your friends. Fellowship may be the crucial ingredient that gets you through the ardors and ordeals of making a startup work. But you and your friends need to know where the buck stops. There needs to be a primus inter pares—a first among equals. And that role is not merely a title or a casting vote if there’s a tie. That role is the boss.

TAKEAWAY: HOW TO AVOID THE DEMOCRACY FALLACY Don’t be seduced by the fraternity of teamwork. This is a business, not a sport. Businesses need leaders. And leaders need to be rewarded.

The Investment Fallacy

“Raising money from investors is a mark of success.” SUCCESS STORIES like these are a staple of the tech press: The numbers are big, the companies sound sexy, the tone of the stories is normally adulatory… This is success, right? Wrong. The idea that raising investment is a mark of success—and a badge of honor—is the Investment Fallacy. Investment is a burden as much as—or more than—an opportunity. It increases the pressure, corrupts your incentives, and creates a communications minefield. Court it at your peril.

The belief that raising investment is a mark of success and that it increases the likelihood of you, the founder, ultimately getting a return on your business. This belief is false.

Early Stage VCs and angel investors expect that most of the eggs in their basket will break: six or seven out of ten of their investments will be write-offs; another two or three will be base hits; one in ten will make a tenfold return. That’s the one they’re waiting for. That’s what they need in order to compensate for the other failures. But that’s not what a founder necessarily needs.

EXAMPLE of misaligned founder/investor incentives: Recently, a friend called me for advice. He is a CEO and founder, and a large competitor had approached him with an offer to acquire his company for $15 million. He has a one-third share, so he would pocket $5 million from the deal. He is recently married and still carrying debts from years of struggle to bring this company to life.

Five million dollars would be life changing. But he is under pressure from his investors not to take it. His largest investor bought a third of the business the previous year at a $12 million valuation. He stands to make $1 million on a $4 million investment—a 25 percent return. That may seem like a reasonable return, but VCs typically aren’t interested in reasonable returns. They are looking for the one in ten that will make a tenfold return.

My friend’s VC investor would rather my friend hold on in pursuit of that outcome than take the money on offer and exit now. The emotional and financial pressure that VC can bring to bear is likely to mean that my friend will turn down the offer, which could be the biggest mistake of his life.

To appreciate the significance of this, place yourself in his shoes, but imagine you also have $5 million in savings. Refusing an acquisition that will net you $5 million is exactly the same in effect as taking your entire $5 million savings and investing it in the business. In each case, $5 million in cash is being forsaken in the (very uncertain) hope of a greater future payoff. That’s the kind of decision that VCs make on behalf of their super wealthy investors. And it’s a decision that can be entirely at odds with the interests of the founder.

When I took on the role of CEO, I hadn’t realized that there was a whole new role of investor relations that needed to be performed. I didn’t realize that I needed to manage my shareholders on top of all the other management challenges.

With investors, when you don’t talk to them, they assume everything’s going great. The longer you don’t talk to them, the greater they think things are going.

But as time went on and their expectations went up, my ability to execute went down. This mismatch was a time bomb. I allowed it to go so far that eventually it exploded.

Investment success tells you nothing about whether you can deliver on your vision, get that vision into the market, or if the market will appreciate it. The chief thing that investment success gives you is an extra burden of responsibility on your shoulders.

As I learned, it requires time spent communicating as well as simply doing—and time may be as precious a resource, or more precious, than the funding you raised. I took investment. I didn’t fully understand the consequences. And I paid for it.

Ignore your team, the tech press, the cheerleaders: when you get a decent investment offer, they will all tell you to accept it. The longer you can hold out without investment, the greater your control, the greater the ultimate rewards, and the greater your chance of success. If you must take investment, remember: the job now gets harder, not easier. Don’t party: get back to work.

The “Failure is Not an Option” Fallacy

“TRYING” IS FOR LOSERS. Visionaries, leaders, founders—these are not the kind of people who try—these are people who win. The winner mentality brooks no compromise—there is no room in it for thought of failure. That was how I approached my first businesses too. But by my mid-twenties, I had already failed multiple times. “Failure is not an option” is one of the most beloved mantras of gurus everywhere. It is a fallacy. Failure is not a choice: it is an outcome. That outcome may come about as a result of your mistakes; or it may come about as a result of events outside your control.

The trick is not to act like failure is not an option—the trick is to know when failure is the right option. I had yet to have a success—but, with my next startup, I had my first “good” failure.

There may be a niche in the market, but is there a market in the niche?

All startup founders need a failure plan: a plan for how to identify when your company has failed, what to do to shut it down, and how to do it. Who do you go to? How much does it cost? (Yes, closing a company costs money.) What sort of severance and notice for staff do you need to budget for?

The failure plan should contain automatic triggers for when you should activate the plan (or at least consider it). The point of this is to make the decision to activate the plan—i.e., to shut down the company—as clinical and automatic as possible in order to remove the risk of being blinded by passion or fear.

You should write down the plan and share it with the team and investors. Once the triggers are reached, the failure plan should kick in. The company will get wound up as efficiently and as fairly as possible, there will be minimal collateral damage and—crucially—you, the founder, will be free to rebound quickly onto the next project.

TAKEAWAY: HOW TO AVOID THE “FAILURE IS NOT AN OPTION” FALLACY Plan for failure. Don’t expect to fail—but do expect that you might fail. Learn about the process of closing down a business: how to do it fairly and efficiently. Set negative targets: if you hit these, despite your best efforts, then you automatically trigger your failure plan and start winding down the company. Failing this way means you’re more likely to retain the loyalty of your colleagues and the respect of your clients and customers. And that makes you more likely to bounce back and succeed the next time.

FAILURE BOOT CAMP Incubators, universities, mentors, and business-development programs all offer advice and instruction on how to succeed with your business. But no one teaches you how to fail. This is a glaring oversight. Fail badly, and you may be truly finished. Fail well, and you can take the best of your experience with you—the learning, the contacts, the ideas—and start again. This is why there’s an urgent need for a “failure boot camp.” This would teach you to make your own bespoke failure plan—a plan for how to identify when your company has failed and what to do to shut it down.

It’s not the failing that really hurts. It’s the stuff you do in your bid to avoid recognizing the failure that has already happened that really hurts.

The Expert Fallacy

The Expert Fallacy is the belief that the experts know best. In startup culture, the Expert Fallacy leads many a founder to rely on the analysis of established experts when, by definition, nobody can be an expert in a new product, service or market.

The experts know how things traditionally work better than anyone else does, but when markets are changing, their perspective can be misleading. The experts have bought into the existing system more than other people have. Experts can’t see the need for a market move in the first place. They assume the premises of the existing market so strongly that they often don’t understand the need for change.

Experts are good when you want to know how something works. But when you want to challenge the very premise of something, experts are the last people you should talk to. Their expertise roots them even more firmly than most in the systems within which they work. They have invested more in them and are more committed to them. So when you want to challenge those systems, you can’t rely on the experts.

If you’re trying to do something new, you can’t sell it to the people who want the old. For new products, you need new markets.

Beware of the experts. Don’t ignore them altogether, but look to them for targeted expertise, not systemic analysis. Experts, by definition, have bought into the system. If you want to create systemic change, they won’t help you.

The Idea Fallacy

The Idea Fallacy afflicts not just the tech sector, but the wider culture. The Idea Fallacy is the deep-rooted belief that what really counts is the idea, not the implementation. There’s nothing wrong with a good idea—but an idea without implementation is largely worthless. Good ideas are far less rare than we think—what’s really scarce is the ability to execute.

THE IDEA FALLACY REVISITED During the dot-com boom, in 2001, it seemed like anyone with a half-baked idea for a dot-com had money thrown at them. This was the epitome of the Idea Fallacy: “It’s all about the idea,” the VCs screamed and the media chorused; the would-be founders soaked it up and were duly soaked in cash, no matter that many of them lacked so badly in the ability to execute. Websites for selling pet supplies (pets.com) and groceries (Webvan) attracted hundreds of millions of dollars in venture capital almost overnight and then went spectacularly bust because their models were chronically unprofitable. Webvan, for example, had raised $800 million and taken thirty-year leases on warehouses, only to find that its core business of grocery deliveries didn’t work in the market.

Every time somebody reads about Mark Zuckerberg or Jack Dorsey or Larry Page or Sergey Brin and thinks, “Lucky bastard. I wish I’d thought of that,” that’s the Idea Fallacy again.

Rarely is an idea original. Society’s focus on the “Big Idea” is misplaced. As Jim Collins shows in Great by Choice, many of our business icons build their success on the back of other people’s ideas: it wasn’t the McDonald brothers who built McDonald’s into an empire, it was Ray Kroc who saw the seed of greater success in their operation and bought it from them. Southwest Airlines copied its model directly from Pacific Southwest Airlines. Ryanair, Europe’s largest airline—named after one of its founders, Tony Ryan—was a loss-making tiny Irish airline until Michael O’Leary applied the Southwest model and duly revolutionized the European airline industry. Facebook, Google, Apple, Uber, Airbnb, Zappos—none of them were built on original ideas. Competitors were doing the same thing at the same time, sometimes even before them. But they executed better.

This is counterintuitive to many first-time founders. Let’s say you have what you think is a brilliant business idea and you want to see if it’s viable. Which of these situations would you prefer to find? There are existing businesses with the same idea that are thriving. There are existing businesses with the same idea that are struggling. There are no businesses with that idea. First-time founders always answer (c). For me, the answer is always (a).

One of the first challenges a startup faces is to prove that there is a market for its product. The existence of thriving competitors proves that there is a market. After that, it’s all about execution: if you execute better than the competitors, you will win market share.

The Scale Fallacy

The Scale Fallacy convinces would-be founders to focus on digital products that scale. But focusing on the services they could sell would make many of them more successful more quickly, and that might give them a platform on which to later build a scalable startup.

As I lurched from startup failure to failure, I had a safety net that caught me and helped me rebound each time. It ensured my failure never wiped me out, that I had a team of colleagues to support me, and that I had a regular income. It gave me access to the executives and boardrooms of leading companies and insight into changes in the market and technology. This safety net was a consultancy. Even as I relentlessly pursued the founder dream, I was never afraid to dial for dollars.

Watching client after client repeat these mistakes, I started to change the way we built products for clients. I would make them do a “mini” project—a rough prototype, a kind of minimum viable product—in order to get feedback early. This insight would become crucial to my own subsequent startup success.

Consultancy is the unsexy part of business. There are hundreds of best-selling books about how to make a business succeed, not so many about how to help other people make theirs succeed.

I never intended to be a consultant, or to own and run a consultancy. But without the consultancy, I would likely never have had the success I’ve had as an entrepreneur. Consultancy provided me with an invaluable bedrock for my own projects and an unbeatable learning ground.

Startups tend to be driven by the shared passion of a small group of founders, who are willing to push themselves to burn out in pursuit of their project. By definition, that’s not sustainable. They’re driven by passion to the exclusion of pragmatism. That can only take you so far. It may take you to the cusp of success, but it can rarely manage that success to the best effect. When people burn out, they lose perspective. They make bad decisions. Teams tear themselves apart.

So VCs won’t be interested if your startup doesn’t scale, and neither will the media and neither will the public. This is because the American dream isn’t a fantasy of steady, incremental growth—it’s a dream of celebrity, stardom, and riches. If you’re prepared to put the dream on hold and take a cold look at your prospects, you’ll realize that there are significant advantages to creating a services business—one that doesn’t scale. You’ll see money on day one, instead of working towards a future payday—which may never come. You’ll learn about the cutting edge of what customers are demanding (and developing). And this combination of revenue to play with and a sense of what is in demand can provide the perfect ingredients with which to subsequently create a successful scalable product business.

The L’Oréal Fallacy

The L’Oréal Fallacy is the belief that you should hold out for the exit you deserve—because you’re worth it. This fallacy corrupts decision making at a crucial point—the point when monetary success is actually a tangible prospect. First-time founders, in particular, should take their exit when they can. Get out, go on a holiday, and then get back in the game. Instead of holding out for a better exit, move on and create one with a new product.

As an angel investor and a mentor and friend to younger founders, I’m regularly exposed to founders faced with an offer for their company or their stock. This should be a cause for celebration. More often, it’s a source of stress. This is typically their first encounter with a company valuation—the first time they have a concrete value put on their share, and the prospect of converting that share into cash. Most founders, in my experience, think that cash value is embarrassingly low. It may be $100,000, $1 million, or $10 million—irrespective of the figure, they will quote it to me with something approaching derision, as if I might think them insane for being tempted by it.

But let’s say your perspective on these things hasn’t been distorted—but you still think the value being placed on your stake is too low—it is objectively too low, in other words. Take the offer, I say. It proves you have a cool business head; hubris drives too many founders to self-implode in pursuit of vainglorious ideas of their worth. It proves you can take a business from conception to exit. It frees you to go back and start again, celebrating the raw creativity of tech entrepreneurialism unhindered by the accumulated expectations of a team and investors. It gives you a cash cushion to support that.

Most importantly, it’s a chance to prove to the market (and yourself) that you’re a closer. You’re not simply another founder with dreams that are deeper than the market’s pockets. You’re someone who has developed and delivered a startup to an exit—a rare thing. It may not have made you a millionaire. You may not be ready to retire. But why would you want to retire? This is what you do.

An exit gives you the chance (and some funds) to start again. You’ve had your first success: the second should be easier. Better to be out there creating anew than stewing over your first creation and trying to sweat the maximum return from it.

I’ve stopped relying on what I think I’m worth. My equity is worth what the market will pay and only worth that when the market will pay it.

It doesn’t matter how much work you’ve put in or how great your idea is. There is no magic sum that you are “worth.” There is only what the market will pay. That will change for reasons outside your control, and it may go down as well as up. Take the money. And don’t look back. So take your exit.

The Quality Fallacy

The Quality Fallacy is the belief that quality is a goal in itself—that your product should be as good as it can be before bringing it to market. On the contrary, quality is a distraction. Your product should be only as good as it needs to be to be brought to market. Anything more is a waste.

People say, If it ain’t broken, don’t fix it. I say, Even if it is broken, don’t fix it. Or as Reid Hoffman, founder of LinkedIn, puts it: If your product isn’t embarrassing when you launch it, you’ve launched it too late. Put it out there. Let people work it out. Let them respond. Let them contribute to making it better.

The Passion Fallacy

The Passion Fallacy is the belief that passion should drive your startup—that the magic ingredient is your belief in your product.

On the contrary, passion clouds judgment. I want to see evidence of cold, hard business acumen before I invest in a startup; that can exist alongside passion, sure, but more often founders seem to think that passion is an acceptable substitute.

But I’m not interested in ideas. And I’m not interested in passion. In fact, passion worries me. Too often, it hides other weaknesses. I’m interested in execution.

“Execution” means the ability to bring a product to market.

But the question is: how do you reach that market? How does that market learn of your existence? (There is a paradox here: a large market may not be a good thing. The larger the market, the harder it is to be seen by it.)

There are four things you need to know when building a new product:

  1. Do people want it?
  2. How much will it cost to find them?
  3. How much are they willing to pay for it?
  4. How many of them are there?

By definition, a disruptive technology can have no preexisting experts. Experts become experts because of their dedication to a field of study, which is a good thing in itself. But it’s precisely that dedication that makes them singularly unqualified to anticipate challenges to the basis of that field of study: systemic change.

 


Also published on Medium.

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