Angel investing can generate returns that are highly uncorrelated and superior to the rest of an investor’s portfolio which is typically dominated by publicly traded equities, bonds or real estate. However, angel investing is fraught with risk and your investment may end up being worth zero which is why most individual investors stay away from what could be a highly profitable opportunity. The problem stems from the fact that most startups fail and less than one in a thousand delivers meaningful returns. In the article, Why and How to be an Angel Investor?, a fellow Forbes contributor, David Teten writes that angel investing outperforms any other investment class including Venture Capital and has averaged returns consistently well above 20% during the period from 1990s to 2014. The problem is that results vary widely from the mean. But what if there was a way to change the odds in your favor?
If you have decided to take the leap and are investing money or sweat equity in a startup, it is critical to pick your bets well. Merrick Furst, the wizard behind Flashpoint, is working to do just that – increase the probability of success of a start-up. Merrick works with both angel investors and entrepreneurs at his startup laboratory in Atlanta, Georgia to help them achieve success.
Katina Stefanova: Merrick, as you know I am fascinated about innovators in the investment industry and look for disruptive trends and entrepreneurs in the space (see Disrupt Investing). Your models aims to bring order and to systematize the creative process of starting a business. That can be truly disruptive and helpful to both angel investors and entreprenuers. What was the impetus behind creating Flashpoint?
Merrick Furst: I teach at Georgia Tech and have started seven companies, so in 2012, when the new administration at Tech decided to make accelerating entrepreneurship a central goal of the university, they pulled me in. We already had a first-rate incubator and other excellent programs, so we thought incremental improvements would just yield incremental results. I also knew that traditional approaches to starting companies, and to supporting founders, were unreliable. We needed a different approach. Flashpoint helps address the fundamental problem: how do you build scalable new companies that succeed? Beliefs on this subject swing between two poles. On one side is the magic entrepreneur theory. People like Steve Jobs and Elon Musk just seem to have the Midas touch – you can’t bottle it. The other side believes in market research – form a theory then go out and talk to customers; don’t build what they don’t love. Both sides point to examples, but the truth is that neither one produces reliable results. Whether you hitch your wagon to someone who looks like Midas, or you talk to hundreds of customers and carefully A/B test every color on your website, your chance of getting from initial idea to sustainably adding value is dismal; clearly less than one in a hundred, and probably more like one in a thousand. Failure is the norm.
Stefanova: I completely agree with you on the obvious challenge. Both entrepreneurs and investors are concerned with the low odds of success for start-ups. One way that the industry deals with that is by diversifying as much as possible. Venture Capitalist can afford to do so. However, most angel investors do not have enough capital to diversify meaningfully. Entrepreneurs also have limited capacity and have to focus on one opportunity and do it really well. Based on your experience, why do most start-up ventures fail?
Furst: There are too many paths to failure to count. A lot of them are familiar, and experienced entrepreneurs and smart investors try to improve their odds by recognizing and avoiding “old hat” ideas that the market won’t fund anymore, or ideas that address too small a market, or are beyond the technical reach of the team. But it’s not like there’s a finite set of failure paths and you can win by avoiding them all.
Stefanova: And yet, is seems that many of the mistakes that angel investors or entrepreneurs make are common and can be avoided if there were a way to share the lessons learned more broadly. While attending one of Flashpoint’s working sessions, I saw you working with entrepreneurs and angel investors to systematize the creative process of building a startup. Can you share with our readers, what are the most important factors that angel investors need to look for in a start-up?
Furst: Where flashpoint makes the greatest difference is in reducing failure to find authentic demand. Virtually all companies that don’t discover authentic demand fail, but the ones that do find it have a strong foundation for success.
Stefanova: What do you mean by authentic demand?
Authentic demand is what the interest in your product or service feels like when your customers can’t not buy what you seem capable of delivering. When you get it right, you know – it’s not ambiguous. It’s not that a lot of customers might buy, it’s not that a lot of customers say that want what you have. You almost feel like customers won’t let you not deliver to them.
Founders spin these fantasy scenarios about the role that a product will play in a customer’s life. A founder might convince herself, for example, that diligent parents need extra-reliable cars, and will see that as a product-market fit. She can go out and ask a thousand parents, “is it important to you that your kids get home really safely from school?” “Do you run into problems making sure this happens?” “Would a super-reliable car help you meet this goal?” She’ll probably bat 1,000 on those questions. But if she goes ahead on that basis, she’ll most likely end up with a lot of unsold reliable cars. As scientists know, you can’t prove something by locating examples where it happens to be true; you have to try to disconfirm your hypothesis. In this case, knowing that customers can imagine a place for the product in their lives isn’t enough. You need customers who cannot avoid solving the problem.
Stefanova: Merrick you shared with me that a successful start-up creates a product that the customer “can not not buy.” The double negative shows that customers would come to you and even pay you before you have developed the product because they truly need the solution you offer. However, finding authentic demand is incredibly difficult. How can entrepreneurs or angel investors “recognize” authentic demand?
I don’t know how you can find out about customers without spending time with them. But I don’t think asking questions about what they want and about the problems they have, as they see them, will get you there either. This is because often even customers do not know what they truly want. Figuring this piece out is a huge challenge for entrepreneurs. It’s the fundamental job of the startup CEO to be able to think clearly about whether or not the team has discovered a significant authentic demand that can be met. There’s a lot to the answer of how could you do this, and it’s the meat of what we do at flashpoint.
Stefanova: So how does flashpoint address these problems?
Furst: At flashpoint, we focus on three areas:
- A way of seeing customers that holds the promise of enabling founders to recognize and work with authentic demand,
- A way of figuring out how to design products that improve the lives of customers by enabling them to make the changes in their lives necessary to achieve the improvements, and
- A way to overcome the team’s own immunities to change, that stand in the way of their being able to find authentic demand, and stand in the way of their being able to make a company that meets it.
Stefanova: Has your approach been successful so far?
Furst: It is too early to really measure that. I can say that the results we’ve seen so far are consistent with eventual success. Companies come to flashpoint most often at the very initial stage. We’ve had four cohorts go through the program so far, totaling 45 companies. Many of the companies now have recurring revenue. About half have raised significant venture funding, totaling a bit over $150 million. Investors include: Kleiner Perkins, Google Ventures, Andreesen Horowitz, Sigma Prime, FF Ventures, Mosley Ventures, and many other leading firms. Total market cap of the portfolio is in the $500+ million range.
Stefanova: Can the creative process of entrepreneurship be made more systematic? Why and why not?
Furst: Our approach seems to encourage the creative process and open people up to thinking in bigger terms about disruptive possibilities. Brunelleschi’s system for perspective opened new avenues of creativity in Renaissance painting; Werckmeister’s “well tempered” tuning system inspired and enabled composers like Bach. More broadly, science seems to provide a needed foundation for innovation.
We’re providing tools to entrepreneurs that help them make things that mean something to people and that customers incorporate into their lives. The greatest, most disruptive products: anesthetics, mobile phones, airplanes, are the ones that are created out of seeing, from a new perspective, how a product or technology can change lives. That’s what we’re trying to facilitate. We help companies improve on what’s normally a haphazard, inconclusive search process. What they search for is up to them, and what they find is up to the people their products touch.
Stefanova: What role models and ideas are you inspired by?
Furst: I’ve been inspired by Amos Tversky and Daniel Kahneman and Robin Dawes and other decision theorists who have pioneered the systematic study of biases and cognitive illusions. I owe a lot to Robert Kegan and Lisa Lahey at Harvard and their “immunity to change” model. The philosopher Martin Heidegger’s perspective on phenomena and how the aspects of things come to appear helps us clarify a lot of things about products and features.
Stefanova: How do you see the vision of Flashpoint evolving in the future?
Furst: I sometimes think of flashpoint as something like a working lab, or clean room for companies. We have tools and methodologies that we teach entrepreneurs to use, and help them apply, we have procedures to reduce ambiguity, error, and misunderstanding. We’re constantly working to make those tools better – more accurate, easier to use. We’d also like them to be used more broadly, so we do a lot of outreach, and are looking at ways to make what we’ve learned more widely available. A lot of capital and effort goes into startups, and most of it goes to waste. I want to play a role in changing that.
Stefanova: What’s the most important advice you would give to angel investors and entrepreneurs to improve their probability of success?
Furst: The most important thing an angel investor selecting a company to invest in is asses the founding team. I would only invest in companies where the founder who has a clear picture in her head of what has to be accomplished to achieve success. At the same time, the hardest thing an entrepreneur has to do is remember that being clear isn’t the same as being right.
Many of the things people “know” aren’t necessarily true in the sense of having scientific validity. In everyday life this doesn’t often matter that much. For the entrepreneur, the sort of person who is disposed to action, the risk in “knowing” something that isn’t true is that it often leads to doing something that doesn’t work. Since entrepreneurs are generally working with little margin for error, it doesn’t take much to go from “knowing” something false to doing something that will ultimately be fatal to the project.
The best entrepreneurs learn ways to distinguish between what they know that actually is true, and what they “know” that might not be. In particular, when it comes to things you think are true about what a customer will do, or what any person will do, you simply cannot rely on the everyday ways of knowing things to run a startup. Your assumptions, even the ones that seem too trivial or obvious to merit attention, need to be exposed and questioned. Appreciating and continually taking into account this one fact is enough to give an entrepreneur a better shot at success. In practice at flashpoint, we have developed a lot of experience with how an entrepreneur can do this in the setting of a startup – I can’t fit what we do to this end into a short answer.
The second thing an angel investor should pay attention is the culture of start-up. Founding teams that operate with super enabling candor are positioned for success. Candor, in the sense of truthful, forthright, sincere, communication, is more than a cultural value that improves the feeling of a startup. It is a key tool for success that allows people to gain clarity from the interaction between perspectives. Create a system that enables a diverse set of people to get a grip on what each is assuming, allow yourself and the team the space to be fully candid with each other about it, and allow yourself, and the team, to take full advantage of reconciling perspectives. The job of a startup entrepreneur is not to convince others they’re wrong, or to “sell” them. Few people naturally seek candor. Fewer meet candor with curiosity. Every statement you hear – don’t view it as an affirmation of someone’s position — view it as a question. This is what we think the best entrepreneurs do, probably without thinking of it. If you would like more of our thoughts on this, write to me explaining what you’re working on; you can reach me through firstname.lastname@example.org.
Stefanova: Thank you for your ti