We spoke with Lee Essner, Entrepreneur-in-Residence at Idealab, about how the incubator builds such successful companies, what their process is, who they invest in, and the lesson’s Lee has learned in the field.
Lee Essner is an Entrepreneur-in-Residence at Idealab in Pasadena, California. Working with the legendary Bill Gross and Idealab’s Prototype Group, he is on the front lines building the next generation of internet companies. He is a startup advisor and serves as a mentor at Los Angeles-based accelerator Start Engine. Prior to Idealab, Lee founded AccessDNA (acquired by Informed Medical Decisions, Inc. in April 2011) and was the #2 executive at WeddingChannel.com (acquired by TheKnot.com in September 2006). Lee is an attorney, having worked for a number of years in the Corporate Finance and Mergers & Acquisitions Group at Skadden Arps as well as serving as the Assistant General Counsel for Mattel Inc. Lee can be followed on Twitter at @LeeEssner.
Tell me about the role as an Entrepreneur-in-Residence at Idealab?
As many people know, Idealab has a strong history of creating and operating innovative tech companies. To date, they have been enormously successful, with about 100 companies started and about 30 exits. So, as you can imagine, new company generation is a pretty critical thing around here and this is usually driven by an EIR, with lots of support and thinking from Idealab. Historically, EIRs will work on internal ideas, which are mainly Bill Gross’ ideas. Bill founded Idealab in 1996 and he has a vast list of ideas for new companies. He’s an enormously creative guy and has a lot of ideas, many of which revolve around problems he encounters in his own life or things he truly thinks will leave the world in a better place than he found it. So most EIR’s will focus on Bill’s list of ideas to help identify which have the greatest potential and then help to get them from ideation to an actual business. In my case, I am fortunate to be able to spend some of the time on my own ideas and some of the time on Bill’s ideas.
What’s the process used to build the business?
The process of getting from an idea to a viable company starts with our Prototype Group, which is made up of a bunch of hackers and designers who love to build stuff fast. They are people who are great at taking a vision for a product or company, conceptualizing it, and getting it into the form of a prototype, which can then be put in front of real users to learn and test the core hypotheses which need to prove true for there to be a viable business. Rather than first raising a bunch of money, spending 6 months building it and then figuring out if it works, we seek to build small tests that essentially mimic the important functionality of a full-featured product and then watch how they interface with it. So the Prototype Group is really great at coming up with those tests to see if our vision can be a reality.
Once we get past a threshold to prove the concept, Idealab would typically fund the business with seed capital and we would become an incubated company, with the EIR serving as a founder and the founding CEO. As an incubated company, we also get to take advantage of Idealab’s company building infrastructure and support services, such office space, finance, HR, legal, and PR. The great thing about that is they can focus on these more administrative things and really free up the EIR to focus on the product and the customer.
Do you also work with companies Idealab is investing in?
Most of Idealab’s companies are based on internally-generated ideas, but we do invest in select seed stage companies that are started by others when they’re working in areas synergistic with Idealab’s network and skills. We really focus on Southern California based digital media companies and I spend some of my time evaluating those opportunities. We work closely with the founders, give them access to the full range of Idealab support, our business contacts, and other Idealab companies. I have brought in a number of deals and definitely enjoy hearing other entrepreneurs pitch their vision.
In addition, I spend a good amount of time with the other EIR’s helping them think about their ideas and businesses. We are a really tight group and it is great to have other entrepreneurs internally to lean on for my own ideas and issues.
What key factors does Idealab look out for in new companies?
Generally, we look for the same things whether the company is based on an internally generated idea or an outside entrepreneur’s idea. Over time, we’ve definitely learned that successful companies are built by strong teams going after big addressable markets. As a result, we are always looking for good people. However, it is also really critical that they can show they understand all the drivers in their business. Things like how they drive user acquisition and get users to engage with and use the product, and how that translates into revenue, which is hopefully at the end of the day more than the cost of acquiring that user. It really helps to be able to show some element of proof that this is really happening. The great thing about that is that you don’t have to have a million users if you can show that at a micro-level you were able to bring in 1,000 users that cost you, let’s say, $10 each and that you are able to monetize them to the tune of $14 each. Showing that you can make $4 per acquired user with 1,000 users tells us that once we put some capital towards acquiring a larger number of users, we could have a really big business assuming there are enough of those users out there. Then your odds of getting funded go way up.
What excites you about startups?
There are a few things. One of the most exciting things is the unintended consequence of getting a prototype or product in front of people and really seeing what they do and learning what they want. Usually, this is often very different than what you were initially expecting to see and that’s how the big ideas get discovered. There’s incredible learning and power that comes from that. Look at Twitter, which has had a number of powerful unintended consequences including the toppling of governments. You only really have the opportunity to discover such unintended consequences by getting the product out there and seeing what happens.
Another thing I love is the idea of starting with a blank sheet of paper, identifying a problem somebody has and providing them with a solution that did not exist or is an improvement on an existing solution. Also, the process of sitting down with customers, learning from them and watching them is really cool.
More generally, I love being part of the startup ecosystem in Los Angeles. There is a lot of passion and energy in town right now and it’s really fun to be a part of that. So many people were so generous with their time and help when I was building my last company that it feels really good to be able to return the favor with other entrepreneurs trying to do great things. I am currently a mentor at Start Engine, which is the local accelerator headed by Howard Marks and I am advising two of their companies, PageWoo and Merge Local, which both have great teams going after big problems.
On the topic of accelerators and incubators, one thing I would like to mention is that, while there is a lot of talk and excitement about them these days, they are not the only options for entrepreneurs. If you can get into one of them, then great, go for it. However, it is not quite as easy as people think and there are some other good options. I think a key value of being in an accelerator or incubator is actually being in that environment with other entrepreneurs going through what you are going through and receiving the mentorship and guidance these programs offer. But you can get some of that by checking out the co-working facilities like Coloft, Cross Campus and Next Space. You will be surrounded by other entrepreneurs who are dealing with many of the same challenges and who are using many of the same resources you will need. You can’t replicate that by sitting at a Starbucks.
You’ve built and sold a number of successful startups. What lessons have you learned?
Well that’s a long list! I’ll try to cut it down.
Firstly, it’s important to focus on problems, not just ideas. Don’t build a solution that is chasing a problem. Focus on real problems shared by many and then design a solution that solves that problem. Try to avoid making yourself believe there is a problem when one doesn’t really exist.
Secondly, get a prototype in front of people ASAP. There is often a massive disconnect between people saying to my face that something is a great idea and people actually opening their wallets or using the product. Force people to vote with their wallet and/or actions and get them to actually use it. If they do use it, and they are delighted, then you are definitely on to something. There’s only one way to bridge that gap and that’s putting something in front of them. The great thing is that today, it has never been cheaper or easier to get a functional, but basic prototype in front of people. In the old days, the price of admission was like $5mm just for servers. With open source and Amazon Web Services, you can probably do that today for under $10K.
Thirdly, think about the revenue model from day one and make sure you can see a clear path to profitability. It’s very easy when you’re building a startup to not be honest with yourself about how many people might use your product, or how much they will pay, or how much it will cost you to acquire them. Hope is a really bad strategy. You have to have some element of reasonable proof that the math could work based on very reasonable assumptions or even a little actual usage data or traction.
Fourth, and this is an important one for me, treat your partners really well. I spent the bulk of the last 12 years doing two startups before I came to Idealab. In both cases, we were able to sell the company thanks to the really strong relationships we had with our strategic partners. In both cases, even though we were the smaller company, we bent over backwards, went beyond contract, and made sure they understood that the value we provided went beyond just our business terms. It’s very easy to look at a partnership as just a revenue opportunity and that’s really bad. Your partners are often the ones who will reference you, buy you, or refer you to other opportunities. It goes beyond just having the business development guy knock on the door, sell them, and then never to be heard of again after the deal closes. The CEO must recognize the strategic importance of those relationships and act accordingly. This point has had more impact on my career than any other over the last decade.
What opportunities do you see right now?
I certainly veer towards consumer Internet, partly because I’m a consumer and I like to think about problems from my perspective. I wouldn’t rule out an enterprise opportunity if I got comfortable that I was solving a real company problem. Mobile and ecommerce are going nuts, which makes sense given that we’re all carrying these little super computers in our pockets that are vastly more powerful than the boxes we had sitting on our desks during the first dotcom boom. This constant connectivity across an ever-larger portion of our world’s population will lead to a lot of exciting opportunities. With that said, I think it’s hard to build a big business by selling a 99cent app. Unless you’re a top app on someone’s phone it’s hard to get the kind of constant engagement and usage that could drive a business. Also, advertising doesn’t seem to work on mobile right now and the click-throughs and conversions are atrocious. I think that’s a really big opportunity for someone to figure out.