A speech by The Geek Squad founder, Robert Stephens and the London Marketing Society’s 2006 annual meeting.
BY JACKIE CROSBY – (MINNEAPOLIS) STAR TRIBUNE
MINNEAPOLIS – Robert Stephens recalls with precision the night he signed the deal that would put his sassy startup, Geek Squad, under the massive corporate umbrella of Best Buy.
Parked in an alley outside the lawyers’ office in downtown Minneapolis, Stephens and his mentor, Platinum Group founder Dean Bachelor, toasted the future with a $400 bottle of champagne. It was October 2002, and Stephens, then 33, was plotting the new heights to which he could take Geek Squad, the computer-repair company he had started in college.
"I felt like a fighter pilot stuck in a crop duster," Stephens said. "I couldn’t wait to get to Best Buy and learn how to take off in a Boeing 777."
Since then, Geek Squad has grown from 60 employees and nearly $3 million in sales to the world’s largest tech-support operation, taking in revenue of $1 billion to $1.5 billion a year, analysts say.
About 24,000 "agents" worldwide go to work each day dressed in white button-down shirts, black pants and clip-on ties. They still make house calls in iconic black-and-white "Geekmobiles" and are set up in all of Best Buy’s 1,143 U.S. stores.
Geek Squad remains Best Buy Co. Inc.’s killer app – something that sets it apart from other national chains, even more so with the demise of Circuit City. And the Geeks might be more important than ever to the company’s future.
As Wal-Mart, Sam’s Club, Target and Costco sell more computers and flat-screen televisions, they too are getting into the customer-service game. None uses staff to troubleshoot and do installations, however.
"Geek Squad’s going to become a bigger and bigger component of their core strategy," said Mitch Kaiser, an analyst with Piper Jaffray in Minneapolis. "Beyond driving sales, it increases customer satisfaction. Best Buy becomes the trusted adviser and the IT staff for the individual."
Crucial to the success of the quirky Geek Squad brand has been the remarkable harmony between Stephens, its freewheeling creator, and the multibillion Fortune 500 company that kept him on.
Corporate America has plenty of chronicles of successful entrepreneurs who leave their posts within 18 months after their startups are acquired. Some don’t mesh with the new culture or can’t stomach changes the parent company wants to make. Others get sidelined in budget meetings when they’d rather be inventing something.
Stephens, who launched Geek Squad with $200 and a bicycle, studied the failed transitions and vowed not to become another one.
"I was no longer the owner, and that was quite humbling," he said. "I decided I wouldn’t be this know-it-all founder who is a tyrant of the brand. My goal was to influence without authority. Learn and study."
Stephens once described Geek Squad as "a living comic book," inspired by Star Wars, Atari video games and cop shows such as Adam 12 and Dragnet. He put Geek Squad agents in that same light, as if to say: "Step away from the computer, ma’am. Geek Squad is here to help."
Stephens stole the idea of wearing uniforms and using vehicles as marketing from UPS. He lifted Geek Squad’s flat-rate pricing from Rapid Oil Change.
One of Stephens’ earliest customers (No.4, to be exact) was Frank Bennett, a successful venture capitalist who soon became a key adviser – his Obi-Wan Kenobi, Stephens said.
"He’d come over to fix the computers and then stay for dinner," Bennett said. "We’d talk about Greek philosophy, Renaissance art, French automobiles technology and the future of the American entrepreneur. He had a presence back then, and also intellect. I was entranced because I knew he was going to be successful."
Bennett pushed the young Stephens to get a business plan to go with his brilliant idea. "I encouraged him to keep talking to Best Buy, but not to be in a hurry," Bennett said.
Looking ahead, Stephens said: "Our work’s not complete yet. With mobile phones alone, and TVs becoming like computers, Geek Squad is in its infancy.
"I always said that as long as I feel I can contribute, as long as it’s fun, and as long as the company is willing to listen, I’ll stay. And the answer to all three is still yes."
At DFJ Frontier, we typically invest in companies that have little to no revenue or have yet to complete a working product.
Entrepreneurs often wonder how we calculate valuation for these companies that have very few assets and no proven financial results.
The joke in venture capital is that no matter how much money an entrepreneur raises, he will probably give up about one-third of the company.
In the early days of venture capital, investors often would shake hands with the founders of prospective portfolio companies, summarizing the valuation negotiation simply: “Here’s the money you need. You keep half the company, and we’ll own half.” Is valuation negotiation in the year 2010 really any different?
Valuing public companies is relatively straightforward: Every day a company’s stock is traded on an exchange such as Nasdaq or NYSE, buyers and sellers agree to a price per share for that stock, often thousands of times per day. By multiplying the number of shares in the company by that price, one calculates a market capitalization representing the total value of the company according to public investors.
Lurking behind the price that buyers are willing to pay is a set of assumptions about the future financial performance of the company. These assumptions are important for private companies, too.
Valuing private companies is more challenging, but the same basic approaches can be used. Private companies often refer to similar public companies, known as comparables, when attempting to justify a particular valuation for their stock. Using comparables resembles how valuation works in real estate: When a house is sold, lenders want to see that houses with similar square footage in the same neighborhood sold recently for a similar price.
If companies developing a particular technology trade at a multiple of 20 times net profit in the public market, private companies can apply a similar multiple to their own profit to calculate valuation. However, companies with no history of revenue, let alone profits, lack the financial metrics or predictable future cash flow needed to make such calculations credible.
The reality is that, at the beginning of a venture, most startup companies are probably worth next to nothing. In fact, the value may even be negative.
Venture capital firms rely on great entrepreneurs to turn an idea into reality, and turn that reality into a growth business worth substantially more than at the time of our investment.
For everyone involved to be able to buy a Ferrari when the dust settles, there needs to be enough ownership to motivate the management team to continue to work hard and build the business — this is why the value can’t be zero, even when the company is brand new.
The valuation negotiation also should provide enough ownership to the investors so they can achieve a risk-adjusted return competitive with their alternatives in the private equity market. Most of the time, this means the investors should believe that a return of 10 times or better is likely.
Once investors understand what business a company is pursuing and how that enterprise, if successful, might be perceived by the public market or by potential acquirers, we can ask four basic questions: What is the company going to be worth? When? How much money will it take to get there? How much of our ownership position will we lose along the way?
Because entrepreneurs tend to present overly optimistic forecasts and it is nearly impossible to predict exactly how events will unfold for a new company, investors rely on scenario analysis to explore potential outcomes, including the timing of exits and expected liquid value using comparables.
A typical valuation model makes “best guesses” about the percentage likelihood of the company going out of business, being acquired for a small amount, larger acquisition outcomes and the prospects of a public offering. The scenario analysis also includes the company’s likely future funding needs and dilution of the investor’s initial ownership position.
All of the techniques described above can be implemented in a sophisticated spreadsheet using inputs from the company’s profit and loss projections and databases with comparable transactions. It can be made to appear pretty scientific. But the truth is that few early-stage investors bother to put these calculations on paper, and early-stage valuation is still more art than science.
Instead, we tend to rely on having seen tens of thousands of businesses in our individual careers and use pattern recognition to determine our assumptions to the key questions above.
Investors might conclude, for example, that a company might get sold for $75 million in six years, requiring $1 million now and another $1.5 million of investment along the way.
To make a 10-times return on $2.5 million, the investor needs to own 33 percent at the time the company is sold, because 33 percent of $75 million equals $25 million, which is 10 times the investor’s $2.5 million investment.
Assuming some dilution if additional investors participate in future rounds, the investor may ask for 40 percent for that first $1 million. The old joke about venture capital valuation may be true after all.
Scott Lenet is a founder and managing director of DFJ Frontier, an early-stage venture capital firm with offices in Sacramento, Santa Barbara, Los Angeles and Portland, Ore. Visit dfjfrontier.com.
Tony Hsieh, the CEO of Zappos, was kind enough to take a few minutes after his keynote at the B.I.G. Summit to gives his advice to entrepreneurs on what they should focus on.
I can’t play poker, but I do enjoy watching it on TV. We’re in the middle of the 2009 World Series of Poker, an event that draws thousands of professional and amateur players to Las Vegas every year. The grand finale is the Main Event, a massive Texas Hold ’Em tournament with thousands of players and millions of dollars for the winner.
Tournament poker used to be the province of professionals. But starting a few years ago, a huge wave of amateurs has invaded the game. As a result, of the thousands of entrants into the Main Event, only a few hundred are real pros.
To my surprise, I’ve actually learned a lot about entrepreneurship from watching the World Series of Poker. But it shouldn’t be too surprising. Both rely on acting strategically under conditions of extreme uncertainty. And, in both, small changes in your odds of winning can have a big impact on the final outcome. In fact, I now routinely use the Main Event to help entrepreneurs cope with a frustrating paradox.
Why are some terrible entrepreneurs so successful?
Because the structural barriers to creating a high-tech startup have been lowered dramatically in the past few years, we’re experiencing a huge influx of entrepreneurs. This is a great thing. But it’s meant that there are an awful lot of startup stories floating around. When those stories take on the status of myths, they create tremendous confusion. Naturally, we want to emulate those that have been successful. But that’s not always a good idea.
In the World Series of Poker, no professional has won the Main Event in seven years. When you think about it, this is very surprising. Professional players are so much better than amateurs that they can make a living – in many cases, becoming very very rich – by exploiting the difference between their level of skill and the level of the people they play with. The best of the best win many tournaments each year. By any objective measure, they are much better players than the amateurs. Yet the Main Event has been won year in and year out by a complete unknown player. Some of those amateurs go on to become semi-pro players. But most have never won another tournament after their big win. Why?
The reason is that being a professional player shifts the odds of winning a given poker hand in the professional’s favor, just a little bit. Over the course of a year, a given pro will play thousands of poker hands, and so this shift in probabilities adds up to dramatic winnings. But on any given hand, they still have a significant probability of losing — even if their play is perfect.
Similarly, given enough amateurs in the field, the law of large numbers means that at least some of them will get lucky enough times to outperform even the best pros. That’s why I can say with some certainty that an amateur will win the Main Event this year, even though I have absolutely no idea which of the six thousand entrants it will be.
Entrepreneurship is similar. So much of what makes a startup successful is totally out of our control: the timing of the market, the behavior of competitors, the IPO or M&A window, underlying technology trends and, of course, the human factors of investors, co-founders and employees. Truly successful startup methodologies like customer development or the lean startup can only hope to increase our odds of success — they can’t guarantee it. The converse is also true: even entrepreneurs who do everything wrong sometimes get lucky and make a lot of money anyway. Some even do it repeatedly.
That’s why, for any tactic or strategy — no matter how hare-brained — you can find some “proof” that it works in some company somewhere. That’s what makes processing startup advice so hard. Just because someone has had a success doesn’t necessarily mean they understand why they were successful at all.
Which brings me to the second thing I’ve learned from the WSOP. It’s called a disciplined laydown. In poker, winning requires that your hand beats your opponents hand. The problem is that you don’t know what your opponent has. Amateur players often believe that their success depends on the quality of the cards they are dealt. Consequently, they fold their bad cards and wait for that one big hand to get their chips in with. Unfortunately, having a big hand doesn’t mean you’ll win — your opponent could have an even bigger hand. That’s why the most important skill in poker is not bluffing, counting cards, or computing the odds. It’s figuring out when you need to fold a big, big hand. Watching the pros do this on TV is amazing. Over time, they develop an uncanny instinct for knowing when they are beat, and not throwing more money after bad.
In fact, once you realize that this is the most important skill in poker, it becomes clear that when professional players bet, they are really probing for information. Everything is calculated to help them figure out if their opponent has one of those big hands that might beat them. Folding in those situations saves chips that can be used more profitably later in the tournament.
I think there’s some wisdom here for entrepreneurs, too. We get attached to our big ideas, but it’s those big visions that get us into trouble. Just because we’ve sunk a lot of time and energy into an idea doesn’t necessarily mean it’s a good one. In fact, the main reason we need to get out of the building and validate our ideas is so that we can realize we’re beat before it’s too late and pivot. Once you have that insight, you realize that all of the work we’re doing in building an initial idea — from minimum viable product to split-testing to customer validation — is all designed, like the bets of a poker pro, to promote learning about where we stand.
And that provides another possibility for dealing with startup advice. Instead of making an exhaustive search for all the smartest, most successful people and copying them — learn to place small bets. Take any advice (including mine), and think it through for yourself. Do you understand the underlying principles? Can you see how it applies to your specific context? Can you tease apart the impact of luck? And, once you think you have some advice you might like to follow, try it out. Find a way to pilot it without betting your whole company. And then be prepared to fold if it’s not working. Each time, make sure you do a root cause analysis, and figure out what you learned.
And, if you find advice that seems to work, be ready to go all-in.
Eric Ries is a serial entrepreneur and author of the blog Startup Lessons Learned.