Wait a sec. Now you’re breaking the two-crime rule. Do you know what that is?

No, we didn’t. What’s that?

Cops will often pull someone over for some minor offense like speeding or a headlight being out. That’s no big deal and you can usually work your way out of it… unless you’ve got some drugs in the car or are driving drunk. The second crime is the one that gets you locked up.

Huh?

Look – there’s enough uncertainty about your success in [market]. Now you want to add the complexity of [crazy new technology]? I know you guys are smart and can do a lot of stuff, but you just added to your degree of difficulty.

Obviously, this person didn’t invest… but it was some good feedback. Investors can deal with uncertainty surrounding your market or technology, but rarely both.

During the 6 weeks we were looking for investors and advisers, we actually moved between a seed round in the hundreds of thousands to a series A for a couple of million to a “series A lite” around a million.

This movement between types is a siren call – as you get some interest you feel you should raise a little more. After all, more money is more runway. It’s more for hiring good people. It’s more for a nicer office. It’s more for marketing and business development opportunities. Right?

Elliott Dahan has a nice breakdown in a recent presentation of the difference between types of funding. Two things differentiating between a seed and funding stage?

• team vs. traction – if you have a product with users, a series A is much easier to attempt
• quick (< 1 week) vs slow turnaround – seed investors can move really fast if they are interested, while institutions will have lots of due diligence

My experience corroborated this. Angels would respond much more quickly than institutional investors. Usually the difference was one week vs about 3-4 weeks to go through the multiple presentations and interviews.

The current economic crisis, though, has made most investors more cautious. In fact, traction is now something even prominent angels want to see. One thing we heard: past small series A investments are now seed, while past seed investments are now going un-funded.

If you’re an entrepreneur looking for investment, realize that the road to financing is getting longer and more uncertain. It’s not necessarily that your idea needs work, it may also be that the investors you’re speaking to are scared.

I read Growing a Business last week, a book by Paul Hawken of Smith & Hawken. The book is pretty old, from 1988, so there is no mention of the Internet, little about software, and nothing at all about startups. In fact, I was struck when the author mentioned the computer for the company. Not a, but the.

Even so, the book is a must-read for anyone who actually wants to build a business that makes money, contributes to society, and does something useful. Hawken doesn’t go into a ton of specifics about finding an idea or market, but he says a few things I’ll keep in mind going forward:

Address problems that money alone cannot solve.

If you’re chasing after an idea that could be solved by an estabished company throwing some dollars and people at it, that’s likely a bad sign. (Whether they do it, can focus on it, etc., is a different consideration.) If you hear about people paying consultants or contractors to do something and it still sucks, there just may be an opportunity there.

Money goes where it causes the least embarrassment.

This one relates to the whole “no one ever got fired for picking IBM” thought process. It’s true, both when it comes to internal spending and when it involves VC funding. Why does it seem like funding cycles come in waves? Why did a bunch of social networks get funded all at the same time, but then it took a few years and a risk for the new wave (led by Facebook) to get additional funding)? Why do some entrepreneurs repeatedly get funding when they have no past success while new guys find it impossible to even get in the door?

Focus on a niche instead of developing a new market.

Hawken discusses how hard it is to create a whole new market, one that people don’t realize is needed or one where the benefits are not apparent until you try it. Instead, he suggests focusing on a niche. If it buys in, you can explore and grow from there.

Also discussed are building a good culture, focusing on customers, funding, and lots of other great insights. The lack of technology talk produces a list of business lessons and people skills necessary for those who want to create a business instead of just raising funding or boosting egos.

I finished Guy Kawasaki’s book Rules for Revolutionaries yesterday, and there is one chapter in the book I wanted to highlight because it summarizes some common mistakes when building a business.

Kawasaki calls these mistakes death magnets, the “traditional habits and patterns of thinking that seduce companies”. Here are his top ten:

1. picking low-hanging fruit – make sure your initial market focus fits not those most rabid for your product (the early adopters who will nitpick), but those who are strategically viable.
2. just sucking less – don’t be happy with just sucking less than your competitors, because you will remain open to a new market entrant.
3. overemphasizing budget – remember to take opportunities when they come even if it costs more than you wish.
4. overemphasizing consistency – don’t fall into cycles and patterns just because that’s they way it has been before.
5. attacking too many markets at once – this one is so awesome it gets a quote: “You have to pay your dues by knocking down barriers and dominating niche markets one at a time.”
6. diluting your brand – don’t waste any brand recognition by going in an odd direction.
7. outsourcing – don’t outsource core competencies.
8. mimicking the big guys – don’t copy processes and activities just because a big competitor does it.
9. lowering prices – gaining market share, killing competitors, increasing profits on volume… none of these are a guarantee.
10. assuming that “best product wins” – one of the greatest business lessons ever

The book was written in 1999, so it’s great to see how applicable these points are today. I wonder what Guy Kawasaki would say now about #9. The freemium model emphasizes the 0 price point as a way to gain market share (and mind share).

1. Don’t poach people (including a co-founder in a new venture)
2. Don’t take bizdev, IP, or other insider info
3. Don’t blast the company or its VCs in the press/blogs/media
4. Don’t shop your shares (exercised options) unless there’s a way to do it through the company

This list was described as a set of “social norms” within the Valley that are a “huge sin” if not followed.

The first item is the most surprising, as I constantly hear stories about friends leaving a company (both big and small) to go work on their own idea. It’s part of the myth of Silicon Valley, isn’t it?

#2 and #3 seem obvious and generally good practice in life. #4 I have no data points on.

If you have any feedback or thoughts, I’d love to hear it.

Things to look for in a startup:

1. the team – some of the best in the field
2. the market – must be huge because the first idea rarely works and you need room to maneuver
3. proprietary / difficult technology – something that compounds over time into a distinct competitive advantage
4. proprietary distribution channel – some sort of viral marketing, search engine optimization (SEO), or partnerships
5. direct monetization model – not just joining an ad network

The technology description is important – most ideas I hear (and come up with) are pretty straight-forward. Anyone who knows Python or Ruby on Rails can come up with a basic database-backed site. Is there any real complexity to what you’re trying to do that two folks in an apartment can’t copy in three months?

Rob Hayes, a partner at First Round Capital and one of Xobni’s main investors, actually gave one of the talks. His main points:

• “I am often wrong but never in doubt.” – ok…
• “Can I work with these people for the next five years?” – founders should also ask this question
• PowerPoint: first – what you do, second – who are you, cover what’s your business model – which slide covers the mutual friendships?
• 1-2 founders, 3 is rough, no more than that
• “don’t ask for $3-5MM just because you hear that’s what you’re supposed to do” – this seems like it’s a response to the rise of angel investors and seeding groups like ycombinator

He goes on to mention angels who want a “restaurant” deal. What do you call VCs who don’t want to be lead investors?

Of course, you have to watch Adeo Ressi’s response – he’s the guy behind The Funded and a great counter-balance to the fluff VCs come up with. I’d pay to hear the stories he’s privy to. The idea of opening up the closed data loop VCs have is one I’m behind 100%.

For [target customer], [your company] is a [your category] that [need filled]. Unlike [competitor], we [describe difference].

If you can clearly describe your company using this template, it’s a major positive.

For scientists and engineers, NI is a hardware and software vendor that provides measurement and automation tools. Unlike HP, we focus from the beginning on the software (like LabVIEW), so that scientists and engineers can interact with the hardware in a standard way.

Of course, NI is huge and incredibly successful – they defined their market over the past 30 years. PR and X are new, and both are creating new markets.

For e-commerce merchants and shoppers, PR is a web software company that provides a free review display and mining engine for merchants and a product research website for shoppers. Unlike other shopping websites, the focus is on product research and comparison so that the shopper can find the right product for him/her. The PR review engine is better than competitors because it’s free, in line with merchant interests, and self-hosted.

That is confusing and doesn’t feel tight – the reason is because there are two objectives, and the two aren’t always in sync (the buyer and seller are adversaries). This actually explains a lot about why things weren’t smooth when it came to product timelines and development.

On to X:

For emailers/corporate emailers/power emailers/Outlook users/???, X is a software company that analyzes your inbox to liberate the meaning and data contained within it. Unlike other competitors, the focus is not on better filing or organization of your mail but instead on the people and relationships within it.

Really, all of the blanks are questionable. The company emphasis and vision aren’t clear yet. The great things about both PR and X, though, are clear by doing this exercise – the value added is not just one or two features. If executed correctly, both are establishing new ways of doing things in e-commerce and communication.

When analyzing ideas and future companies/employers, this exercise will definitely be part of the toolkit. If it’s hard to come up with the blanks or if they sound crazy/fluffy, that may be a sign of weakness. If the blanks fill perfectly, though, keep going.