Public Goods: What a US #Startup can Learn From #China Sidewalks of Death

The greatest threat to modern China comes not from foreign invasion, but in the form of bicycles, millions of bicycles.

Chairman Xi Jinping take notice, the greatest threat to China is not from America, it is from the bazillion bicycles you’ve permitted to infest your sidewalks. Bicycles now cover pretty much every vacant piece of concrete and asphalt from Beijing to Urumqi. What am I talking about? The billion or so bike share start-ups that are now brilliantly exploiting what every entrepreneur should know about: public goods.

Look around anywhere in China lately and you’ll quickly see scads of bike-share bikes everywhere.  There are ten or so leading companies, each with its own distinctive paint scheme and bike design.  These bike services allow anyone to make either a large, one-time upfront payment (say $500 for life-time usage rights) or to make monthly subscription payments, like $20 a month, for unlimited use of that companies bikes. After subscribing or becoming a member, the user can take any bike from that company that they find, from any location, and ride it to wherever they want, then just leave it there. It is bikes on demand.

The bikes automatically lock themselves, and can be opened by taking a picture of the bike’s individual ID tag using the bike sharing application on their phone.  To make the service convenient, the bikes are ubiquitous and deposited along almost every street, all over town.  Their presence on sidewalks, now impassable, and other areas around the city have become a blight and a danger (tell me about it, I had to jog in the street sometimes to avoid both stationary and moving bikes that formed a dynamic death maze on the sidewalk).

However sketchy to pedestrians, this business model is proving to be very popular in the smog and traffic-choked cities of the middle kingdom.  In cities where parking is very hard to find and the sheer number of cars causes massive disruption akin to the plagues of Egypt, bike sharing solves an important human need for cheap and reliable local transportation. And in that success lies a powerful lesson for the eagle-eyed entrepreneur: leverage public goods to get a free lunch.

Public goods are things that we commonly share, like roads, sidewalks and schools.  They are typically free to use for the public. A free asset to leverage is more than just nice for start-ups that can utilize these public goods rather than invest in the same resource for themselves, often at very great expense. In the case of China’s bike menace, the public good is the sidewalks all around town where their bikes can be parked. If the bike start-ups had to build their own bike parking lots across the entire city, the whole venture would be too cost prohibitive. By leveraging a public good, they dramatically lower their cost structure and have a viable path to market.

Other start-ups can learn from this model. For example, if you’re starting a night school for adult learners, why build a school building and invest a lot in capital expenditure when you could just lease unused classrooms at night from your local school district?  Using that public good is a lot cheaper for you to get started, even if you have to pay a nominal fee for it.

Another good example of this is the interstate highway system.  This public good is a boon to car manufacturers and transportation companies that don’t have to bear the full cost of their complimentary asset. So if you can find a novel way to use public goods to solve a social problem, you could be on to the next big thing.

Start-ups that have innovative ways to discover and use public goods save capital that can be redeployed into more productive, value-creating work.

Just please remember, don’t block the sidewalks. Runners need space too.

The Economics of #Fundraising – TNSTAAFL

Raising money?  Read this first.

Dilution, overvaluation, free money, TNSTAAFL, and how to deal with VCs like a pro.

First time founders are typically the most likely to object to dilution when fundraising. They tend to overvalue their companies early, thus creating problems for fundraising later. They do this to avoid dilution, which on the surface seems like a good idea, but can prove deadly to your start up when you get to the A round.

Dilution Is Your Friend

The adage, you can have 100% of nothing, or 50% of something is very true here. Keep in mind that while each round of funding does lower your overall stake in the business, it should increase the value of the company such that the increased pro rata value of your stake grows with each round of funding. This means that an increase in overall value should normally offset the loss of additional equity paid out. So take a deep breath, and, look at the overall economics of the deal.

When properly executed in a funding transaction, dilution should increase the dollar value of founder holdings even though your overall share of the company is less.

Overvaluation Can Kill

When you first get started, figuring out how to value your company is really, really hard. Discounted cash flow models and complex valuations (e.g. monte carlo forecast simulations) are utterly, utterly useless. The fact is, your start up is worth only the value of your future work, and since no one can tell the future, you might as well stop trying.

Despite this stark truth, many entrepreneurs put high values on their companies when they first get started. As a general rule, any company that says they are worth more than $3mm from the get-go, is pretty much overvalued. Unless you have magic beans and geese that lay golden eggs, your day-zero company is not worth more than a couple million.

So, if you raise money from family and friends at a valuation of $4mm, you lose face when six months later a pro VC funds you at $3mm and you have to explain the dilution and write-down to the people you love.  Have fun with that.

How to Avoid Overvaluation

Fortunately, there are two cool methods to avoid the overvaluation trap: SAFE notes and convertible debt. Let’s start with the latter.

Convertible notes are simple debts, convertible into shares of the company at a future date. If you take early funding with a convertible note, your investor becomes your bond holder and doesn’t have to know what you’re worth today. Since the note is convertible, it will become equity in the future and typically does so at a discount due to the increased risk the investor took when giving you the note. In this way you don’t have to worry about valuation until the professional money comes in, and they expect this kind of note will be on your balance sheet already.

The SAFE note was developed by Y Combinator to avoid putting debt on a new company, or to even permit funding an idea before it becomes a company. It works like a synthetic convertible note, except it is just a promise to pay equity in the future for the same discount to the valuation for funds given to develop the idea or company. It isn’t debt, just a promise to provide shares like convertible debt in the future.

Given these options, it is far better to use them for early pre-seed funding than run the risk of over valuation or over dilution.

When to Avoid Dilution – TNSTAAFL

If you need funding, then you’re going to get diluted. TNSTAAFL is economist jargon for, “there’s no such thing as a free lunch”, which definitely holds true here. However, there are some alternative funding sources you can still tap, albeit not free, but typically superior to dilution if you can pull one of them off:

  • Get your customers to prepay for services. You can do this by being honest with them about needing development money and how they can get a deal if they provide it: maybe giving them the finished service for free for a period of similar value. This not only helps you avoid dilution, but can also get you test-beds for product, as well as your first customers. This is often done on Kickstarter also, where you can get money in exchange for product betas. Just don’t become the Coolest Cooler, ever.
  • Look for grant money. This is rare, but most commonly found when your idea benefits the US military in some way. They give out a ton of grant money to develop start-up companies that solve their problems. And they have a lot of problems outside of how to more efficiently kill the enemy, like how to provide emergency relief services, quickly and safely refuel aircraft, feed a million people, etc.
  • SBA loan. The US government may actually give you a loan to start your company. Depending on the type of company you found and your creditworthiness, this may range from a small amount to some pretty large loans. It is worth looking into.  Check out their website to learn more.

However, the easiest way to avoid dilution is by learning to be what I call “ramen lean”. This means that you live so frugally, you basically can’t afford to eat more than ramen (not suggested by any doctor or myself, but it is a good metaphor here). If a start-up can reduce expenditure, every dollar they save is dollar of dilution avoided.

How to Manage Abusive VC Sharks

Sometimes, a VC will pressure you to do a deal that stinks, destroys the economics of your company, and/or is just too greedy. If you find yourself in front of a tough-talking VC who asks for more than her/his fair share, then you need to walk. Don’t talk yourself into a bad deal. Money is commodity, find the right flavor for you. Just be sure when you do walk that the greedy person isn’t you.

Walking away from a deal when you don’t feel good about it, is the best thing you can do when someone is ripping you off. Trust your instincts. It is empowering to turn your back on an offer and walk away. Sometimes, albeit rarely, the VC will come back with better terms, but be careful here too. People tend to be on their best behavior when dating, and you don’t see their true colors until after you marry. So if you see red flags while dating a VC, just move on to the next funding source and don’t waste time.

You can’t manage an abusive VC, but you can leave the room.

This can be avoided if you’re willing to do diligence on funding sources before you approach them. For example, email or talk to the companies in a VC’s portfolio and find out about how the VC is as investors. Did they do what they said they would do? Find out if they even are looking for investments in your sector. Focus on finding good-neighbor funding sources that add value by helping your company to grow in verticals where the angel/VC has both capital and subject expertise.

The 18 Month Rule

Regardless of the amount raised, it is almost a joke among VCs that your funding will last no more than 18 months. As well as you can plan how each penny will be spent, the best laid plans tend to meet reality. Things will be good for 10-12 months, then you’ll realize you’re burning money too fast and the next round is taking too long to raise. So, you’ll start to economize, pinching pennies and perhaps laying off the least productive workers so that you can keep your company alive. This is due to how humans manage according to expectations.

Now that you know this behavioral bias going into a funding round, you need to be cognitive of this bias, adapt your expectations accordingly, and then consciously manage your money more frugally over the full term of the funding round. For example, don’t wait until your funding is almost gone before making hard HR decisions. Let employees go sooner rather than later if they don’t contribute sufficiently or are a bad cultural fit. The best time to act miserly, is as soon as you get funded. Doing so leaves some of your powder dry for when you’ll need additional marketing dollars a year down the road, and would love to have them while fundraising. You’ll have a better product in the future, and will wish you had more money to market that when you’re fundraising and need to show traction. Don’t blow it all now.

Overall, don’t let fundraising intimidate you and be sensible about your choices with equity. A good VC partner like Sputnik ATX (honk, honk) will help you fundraise also. Now, go find that awesome angel or VC, and get started with your plans to change the world.

 

The Multi-Trillion Dollar Opportunity

Want to be wealthier? Stop being a jerk-face to #women.

America has a multi-trillion dollar problem that just hit home for me. My daughter was sexually harassed by another student at school, and worse, the school didn’t protect her when they knew it was going on.

When examining why some economic agents like companies, churches and schools continue to protect sexual predators, I’ve come to realize that this problem is probably the single largest drag on the global economy (at least the largest I’ve ever seen) and that our legal system provides warped, perverse incentives that perpetuate this perversion.  The cost to our society of this broken system is staggering.  And yet society continues to look the other way to a situation that reminds me of the old story about the gardener and the rabbit. It goes something like this:

Once there was a gardener who woke up every morning to discover that a rabbit ate much of his crop the night before. He tried everything to get rid of it, but the clever rabbit eluded him night after night. Finally, in desperation, the gardener built a strong fence around his garden, even digging a portion underground, to keep the rabbit out. Supremely confident in his fine fence, he slept well that night, only to awake and discover that the rabbit ravaged his beautiful garden once again. He had fenced in the rabbit the day before.

Like the farmer, our tort laws regarding sexual harassment are fencing in the rabbit, and providing incentives to churches, schools and workplaces to protect harassers.

So, let’s look closer at the perverted incentives for schools, churches and companies (which I will call social agents). If a person commits sexual harassment, and if anyone at a social agent had any inkling that that person was a perv, then the social agent bears some liability for the perv’s actions since it was foreseeable that harassment would take place. However, social agents and individuals tend to want to see the best in people, so when perv’s do something pervy, we try to explain it as “we must have just misunderstood what he/she meant”. That is because we are nice.

Predators depend upon our kindness to do their dirty deeds. I’m not suggesting that we stop being nice, but I think how we respond to inappropriate behavior must change.

First, we need to speak up when boundaries are crossed and not care if we offend. If a man or woman in your office puts their hand on your back or shoulder, that is crossing the line. You don’t need to touch people to do most jobs, and should only do so when it is required as a part of your job description and, even then, minimize this as much as possible. There is no such thing as an OK sexual joke at the office (or at home for that matter). Grooming people by talking around the edges on mature subject matter is not subtle, it is blunt and we don’t like it. Stop doing it now. It’s time to grow up and start respecting people appropriately.

Second, in today’s Donald Trump school of management, tort laws provide cover to economic agents who pride themselves by saying that they are protecting innocent men from the wild accusations of an accuser when really, they are just protecting their bottom line. This encourages the victim blaming and cover-ups that we see in the news every freakin’ day. Current tort law “fences in the rabbit”, by providing companies legal incentives to align with predators to fight off harassment claims to avoid paying damages. Instead, we need to look at the REAL damages.

Social agents incorrectly assume that the biggest harassment cost they need to avoid is financial damage from lawsuits. This false belief encourages them to deny harassment claims and fend off harassment accusations with no thought to the emotional and personal cost to the victims. In fact, the far bigger expense is the economic loss of productivity and the broken lives of their employees, investors and customers due to their policies that fence in rabbits.

At the macroeconomic level, ranges of the GDP cost due to gender discrimination and harassment vary between 10% and 25%. Given that global GDP is around 78 trillion dollars, we’re talking about 8 to 20 trillion dollars in lost global income creation each year due to harassment and discrimination. In contrast, we fret about the billions of dollars we spend defending lawsuits from harassment. Our priorities are wrong.

Social agents only hedge these defensive costs with defensive expenditure: insurance coverage, harassment training for employees, lawsuit settlements and, if they’re super progressive, on-site counselors to help those affected by sexual harassment. However, I believe that the best defense is a good offense. Let’s do something to get the 20 trillion dollars, please.

I would like to call upon our elected officials to pass new tort laws to permit and encourage persons sexually harassed to work with social agents to pursue justice against sexual predators together. This can be done by permitting and encouraging churches, schools, and companies to sue their students and employees who harass, and recover damages commensurate with the social cost, the total social cost -not just the defensive expenses. It is time for pervs to pay up or smart up. In this way, social agents have an economic incentive to identify and root out sexual harassment because they will share the benefit of legal actions against those who harass. Harassers have an incentive to change their behavior, and the homes that foster future harassers have economic losses to incentivize them to change their ways.

What I hope you now understand is that sexual harassment is an economically expensive epidemic, and the emotional and psychological cost to our wives, daughters, and girlfriends is incalculably higher. So, let’s shift that expense to those who create it, and make it possible for our churches, schools and companies to recover damages from those who create the problems.

When groping results in the loss of your parents 401(k), maybe parents, clergy and managers will stop saying, “boys will be boys”, excusing Trumpian “locker room banter” and begin teaching proper respect for women. Furthermore, suing predators will become an effective way for social agents to capture the expenses they bear to treat harassment victims who often require special accommodation to cope with school and the PTSD or other problems harassment creates in their lives. Better yet, maybe my daughters will be able to live in a world where their contributions are valued by society and they can live without fear.

Furthermore, when we replace faux corporate hand-wringing and cringing with “ka-ching” whenever a crude joke is told in the office, and the offenders lose real money to their employers, people will stop telling crude jokes, putting inappropriate hands on backs, grooming victims and doing other macro-aggressions. No one is trying to stop appropriately asking out a coworker on a date, it just needs to be done the right way, don’t be a perv.

In short, it is time we make harassment the problem of the perpetrators, and enable our social institutions to go after them to the economic and emotional benefit of all. Enough is enough.

The Grim Economics of Death

40% of Medicare spending is in the last month of life. There is a better way.

Economics is called the dismal science because it is precisely the right tool to answer some of society’s most depressing problems. In today’s post, we’re going to look at the economics of dying, have an honest conversation about where we spend our health care dollars when addressing terminal illness, and look at the opportunity cost of end-of-life decisions. If you read far enough, you might just learn how you can change the world.

For starters, let’s address a few truths about health care spending at end-of-life.

First, and foremost, we are all going to die regardless of the quality of care we get. Death is a heartbreaking reality of life that cannot be avoided.

According to the Department of Health and Human Services, 40% of Medicare dollars are spent in the last month of life. Most of this spending is dedicated to curative therapies, in an attempt to “fix” the health problem that, ultimately, causes death. However, there is another option.

Palliative care, sometimes called hospice, means easing symptoms of illness as opposed to attempt to cure it.  Palliative therapies typically provide people comfort rather than aggressive therapies when faced with end of life illness. There are, literally hundreds of studies that demonstrate that this kind of care not only improves the quality of life when facing terminal disease, but it actually extends the life of persons who receive when compared to those who receive aggressive therapies. Furthermore, palliative care costs about 50% less than curative therapies for end of life illnesses, according to just about every blind study of the subject that was conducted in the past 8-10 years. In short, Americans spend a massive amount of money when diagnosed with terminal illnesses in what will, ultimately, be a futile attempt to live longer, and often in more painful circumstances, because we choose expensive and aggressive curative therapies instead of palliative care.

Please, don’t get me wrong here. I’m not looking to unplug anyone’s loved one from the respirator. All I’m saying is that there comes a time in everyone’s life when out of heartbreak and desperation we make the choice to suffer more, cut our lives short, and leave our families buried in medical debt when there is a better option available to most of us -but it isn’t necessarily the obvious one.

Perhaps it is time that we consider our end of life choices more carefully. Do we really want to continue spending large sums of money so that we can have, on average, shorter, more miserable lives? Why don’t doctors inform us about the reality of these choices?

I think part of the problem is that we, as a society, tend to believe that the more aggressive the health care, the better are our chances for survival. Furthermore, hospitals profit more from providing aggressive care, and doctors are positively recognized for their ability to perform more of these aggressive procedures, and not necessarily measured by the quality of life of their patents. The perceived leaders of the health care system have public reputation and profit incentives to try and cure you, even if statistically that is not very likely to happen and your suffering actually increases.

For this reason, Freakonomics author Stephen Dubner has proposed that we change the incentives when terminal illness is diagnosed, suggesting that insurance companies offer these patients a financial offer: to split the difference between their curative therapy cost and palliative care, opting to pay them a share of monies saved so that they could take a final vacation with the family, or in some other way enjoy their last days with additional financial resources to spend as they see fit, rather then undergo expensive curative treatment that statistically will fail and cut their already precious life short. This would appear to be a good way to extend life, on average, and enjoy that life more before it is gone.

I would like to suggest another option, one that may not be for everyone facing a terminal diagnosis: rather than pursue curative therapies or split the difference with your insurer, why not do something extraordinary for society, something dangerous but effective for social good. For example, why not volunteer to drive an ambulance in Syria to rescue children and women injured in the fighting?  Or, perhaps volunteer to do violence intervention and training on the south side of Chicago? Anyone care to volunteer to de-mine former conflict zones?  You’ll likely save some lives and do tremendous good. These are certainly worthwhile pursuits, often not pursued by those who expect and desire to live for a long time.  However, if you knew you had precious little time left, then what do you have to lose?

Risky and valuable behavior sometimes go hand in hand, and if humanitarian in nature, you can use what little time you have left to leave behind a world much better than you found it. You also leave behind a legacy of selfless service, right up to the end. It may sound crazy, but why not leave behind an amazing legacy of love, choosing to spend your final days saving those that the world forgets?

Of course, there is no judgement or easy answers here. Like most humanitarian questions, there is no clear calculus to make these decisions. However, with a better understanding of what really happens at the end of life, and better options for how we can spend those precious days, we can be better prepared to make the right choices for our families.

Why Start Ups Need to Understand Consumer Surplus

Many start-ups fail because they can’t generate sufficient consumer surplus. What the heck is it anyway?

When someone says, “consumer surplus”, I strongly doubt that the first thing that comes into your mind is a burning urgency to make your customers happy.  And yet, it should.

Julesdupuit
My man Jules

Consumer surplus was pioneered by a French engineer, Jules Dupuit, in the 1840s.  He proposed the idea that the difference between what you would be willing to pay for something, and what you actually pay for it, is a benefit to you the consumer.  This is a surplus in value, that makes you happier.  He called it, consumer surplus.  For example, you may be willing to pay a lot more for that cool phone in your pocket than you really paid for it. I’m hoping you didn’t steal it, that would be illegal surplus, but I digress.

When you create a new company providing a product or service, you have to think about consumer surplus.  If your offering does not generate a massive amount of consumer surplus, beyond other substitutes and competitors in the market, then no one will buy your new stuff and your company will fail.

However, if you can aggressively price your service where people feel like they’re getting a steal, then you can create a position for yourself and actually sell something (assuming you’re even charging money to the customer).  Of course, Mark Zuckerberg decided to give Facebook away for free, thus creating massive consumer surplus for the billions of people using his service and not paying one thin dime for it.

However, Zuckerberg also creates a massive consumer surplus in another market: advertising.  Before Facebook, it was pretty tough to find customers who fit your companies demographic and consumer profile.  Most companies did mass mailings to zip codes where they suspected most of the readers had the most affinity for their product/service, or took out massive media campaigns most people saw and ignored since it didn’t apply to them.  This advertising was like firing a shotgun into a crowd and hoping you got your target.  Not only that, it was very expensive to reach everyone, and that was your only option.  For advertisers, Facebook created the opportunity to identify your most likely customers with pinpoint precision, and then only buy the marketing that specifically focused on them.  In this way, advertisers were able to save money over traditional campaigns, and get better, measurable results on their advertising (read: boat loads of additional consumer surplus in the advertising market).

So, now that you understand that to grow your business and sell a ton of cool stuff, you need to find ways to increase consumer surplus for your customers as much as you can.  Now, look over at your business partner and say, “hey buddy, lets start to brainstorm how we can create more consumer surplus.” If he looks at you funny, please share this post.  Well, even if he doesn’t, you probably should share it anyway.  It is a nerdy/cool article.