Archive for the ‘risk’ tag
[T]here are known knowns; there are things we know we know.
We also know there are known unknowns;
that is to say we know there are some things we do not know.
But there are also unknown unknowns – the ones we don’t know we don’t know.
– Donald Rumsfeld
I first heard the word “de-risked” from a Silicon Valley VC as he passed on the GoCrossCampus deal a few years ago. I’ve heard it a number of times since, always in the same early-stage investment context. It’s an odd word. It has always reminded me of the Rumsfeld quote, at once mixing political doublespeak with a certain higher-level truth and meaning.
And in a way, Rumsfeld and the venture capitalists are saying the same thing, although I think Rumsfeld said it more meaningfully. At the simplest level, de-risking has two components:
– Converting the unknown to the known
– Converting unknown unknowns to known unknowns
That is, de-risking is about taking the unknowns of a business and turning them into knowns. But it’s also about discovering what we don’t know; it’s about cataloguing the unknowns and scheduling them for future exploration.
I think this has some significant implications for the entrepreneur. I’ve found that much of the work an entrepreneur should do prior to seed funding is not simply “proving things out” but rather exploring the key unknowns that stand in the way between the entrepreneur and massive success. Said another way, I see entrepreneurs doing too much work discovering and not enough work figuring out what they should be discovering.
Doing this will enable a healthy incrementalism and structure, bringing the spirit of a scientific experiment to an otherwise qualitative exercise in guesswork. As unknowns are converted to knowns in a deliberate fashion, the business is “de-risked” and the door is opened to more significant relationships with partners and investors. Without this discipline, the entrepreneur risks wasting time exploring things that aren’t all that meaningful – or worse, will lead to the wrong conclusion about where the business should go.
And from a purely practical perspective, an entrepreneur may be surprised at how well a list of the unknowns in their business – framed as a robust list of the things that must be proven out with the money they are raising – will go over with any investor.
I had the opportunity to spend Thanksgiving week in Costa Rica, which was a welcome change in scenery from Manhattan. I’m not much for hanging out at the beach, so I found some time to talk to a few people involved in Costa Rican real estate and finance while I was traveling around the country. I was particularly curious about the startup community, which seemed to be totally absent throughout the country.
The difficulty I heard from everyone in Costa Rica was the same: while the country is one of the world’s oldest democracies and most stable Latin American nations, its legal system is frustratingly unfair and unpredictable. Property laws are Byzantine, and squatters have powerful — albeit vague — rights. Costa Rican citizens are explicitly favored in all legal disputes. Tax law is complicated and seems to be made up as you go along. Despite Costa Rica being the most developed country in Latin America, the uncertainty injected into the system by needless legal complications has made technology innovation extremely difficult.
Reports of the United States’ death as the startup capital of the world are greatly exaggerated. Our embarrassing lack of startup visas, bureaucratic burdens and high cost of labor are small inconveniences in comparison to the quality of the States’s legal system, which is largely fair and — most importantly — consistent. In the United States, I have a pretty good idea of what will happen in almost any legal situation. If my company goes bankrupt, there are centuries of precedent governing what creditors can and cannot do. If I want to sue someone, I know the costs and risks. Insurance is available for everything imaginable — mostly because our legal system is so sound.
Consistency is the most underappreciated driver of success in a product or service. This isn’t just about legal structures. Great brands are built through the delivery of consistent and predictable experiences as much as PR, pricing and growth strategy. As a consumer, Apple, Starbucks, Wal-Mart, McDonald’s and dozens of other successful brands will each give me exactly what I’m expecting to get from them. I simply don’t have to worry about the risk of getting something different or unexpected. Humans are naturally risk-averse creatures, and we’d much rather take something guaranteed than something that might be 25% better or 25% worse.
By removing the uncertainty around business law, the state of Delaware has prospered, generating over $750 million in revenue in 2009 from corporate services alone. The majority of entrepreneurs I know send Delaware a sizable check every year for doing nothing other than having less uncertainty around corporate law than other states — and anywhere else in the world. If this isn’t an example of a brilliant hack, I’m not sure what is. For doing something without any fundamental cost — providing a consistent legal framework — Delaware has created a massively successful business.
Ironically, having a stable, un-disruptable legal system around our entrepreneurs gives them the power to disrupt industries and aging business models. Until other countries develop the kind of legal infrastructure that will give innovators the certainty to know that their creations and profits are protected from corrupt officials, greedy politicians, populists and nativists, the United States will continue to produce and host the vast majority of innovative, billion-dollar companies and entrepreneurs.