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Why I failed at Product Incubation and why you probably will too?

4 years ago I had a great idea.. I'd invest my time, technical expertise & intellectual property in startups as an investor . It's certainly a not a new idea and I won't be the last person who thinks of it. Here's why I didn't work for me.


When I started Propulsion there wasn't anything called a Product Incubator not in NYC anyway. There were a couple of companies doing it but not as their main focus. So I did a ton of research, talked with founders, investors and they loved the idea. Founders were struggling to find tech cofounders and engineers were getting burnt out trying to do everything by themselves. Everyone needed a team and I could provide that.


I went to Cofounderslab & meetups. The pitch was simple; let's build web & mobile products as an investment in a startup and if the startup is able to get funding and traction we'll have our people join the startup. If the idea took off we'd all join. The idea resonated with engineers in a big way, when no one else could find a tech cofounder, I recruited 12. There was no way to know it at the time but that was the first false validation. Of course the engineers didn't all stick around.. Most of them were not really committed, they just wanted to get rich quick and they walked when it came time to sacrifice and put in real work (keep this in mind, it's a reoccurring theme in early stage startups). By year 2 we had 3 partners and a bunch of employees.


I didn't do this in a vacuum. I met the other companies and got advice from their CEOs. The guy from Startup Giraffe is the one I think of most right now. When I met him, he was exhausted and cynical. He warned me against taking this direction. I thought I had learned from his mistakes but I just made new ones. Here's what they told me and what I'll tell you.


  • You'll be a dev shop / contractor working at a discount rate.
  • Taking equity is a mess.
    • I was warned about the the tax liabilities
    • I wasn't warned that investors wouldn't like us taking equity.
  • Founders who know what they're doing & have a truly great idea don't want to give up equity.
  • Founders will be learning on your dime.


As your going through it you don't know where you're making mistakes here are mine. Keep in mind, that I was pitched to by hundreds of founders. For each investment we took on, I had to speak to about 100-150 founders. It did get easier over time though. As I grew my network, friends started to send me higher quality leads. I've left this purposely general as I can't discuss some details.


One of our first investments. The founder was smart, charismatic, successfully built & sold multiple companies, had tons of industry connections, had big well known customers lined, impressive board of directors, mentors, & brought me in to the pitches. Everything a startup should have right? We built the MVP and it just sat there. We had some interest but after about 2 years it was totally dead. The lesson learned here was we had made the investment and the founder didn't have any skin in the game. It was easy for him to work on other things and when the time came they were able to walk with very little pain other then a bruised ego. So we took that lesson forward.. Founders have to be as invested in the product as we were.


Our next investment was a disaster.. The writer of a popular startup book introduced us to a startup in the midwest. One of the partners was a product manager from one of the largest tech companies and managed a product line worth hundreds of millions of dollars & the other partner was a serial entrepreneur with exceptional domain experience and a network of customers. They had contracted some college kid in India to build his V1 product (not MVP) and the guy just disappeared. They needed someone to finish it up so they could finalize their seed funding round from a bunch of rich friends. I talked to the investors and they assured me the money was there, they just wanted proof the product could launch. A jr partner of mine audited the code and he said it wasn't good but it was workable. He totally blew the assessment! We took on the deal and that partner started to work on the code. Except every time he made a change it broke everything. A months worth of work was dragged out to 3 months. The delay caused the founders to fight non-stop and the startup imploded. Our jr partner quit & I had to pay him off for his equity. All in all it cost us 50k plus time lost. The product did eventually launch but it was dead in the water. Not one single customer acquired!


This one is more of a cautionary tale then an investment. Word had gotten around and I was approached by a unicorn founder.. This guy had created a product that had a billion, let me repeat that BILLION dollar exit to major tech company. WOW talk about validation.!! But this person didn't make that much money from the deal. By the time the exit had occurred they really didn't have to much equity left. They wanted another bigger pay day. Their idea wasn't great, it was reductive (AirBnB for X) and a niche product at best but they knew what they was doing. So we went in to negotiations. It was clear they were figuring things out as they went along and kept moving the goal posts. At one point they switched their position and wanted me to be the CEO instead of them. They promised to be back me as a mentor and would be the product manager. They would open all the doors and get the investors on board. I was flattered but that made me super skeptical. Why would I be the CEO instead of them? They was far better qualified. But I went with it for a little while. In the end, they wanted 51% of the company, controlling interest, had the option to kick me out for no reason and wouldn't commit to anything they promised in a contract. After 3 months of work on the deal my partners & lawyer told me shut it down and I had to agree.


Our final investment is what did us in. We partnered with a founder who had their MVP developed, had investors onboard and was partnered with an ambitious and fast growing company that is a part of a large conglomerate. This company saw the startup as their way of testing a new business direction while keeping their risk low. They would be the buyer and the exit would happen as soon as we proved the idea. The startup was in the middle of a rebuild and my job was to bring the v2 product. Now this whole thing was a house of cards. The founder had made promises to everyone and was lying non-stop just to keep things going. Their MVP was supposed to have a propriety algorithm that was the core intellectual property that everything was going to be built on. Except they couldn't get it to work. The data science team that built it was supposed to move it to a new infrastructure and update it but they couldn't get it to turn back on. Since the core engine wasn't running, the dev shop that was doing the rebuild of v1 had built everything on dummy data. When we finally got the engine back online nothing the built had worked! The new v1 app had to have substantial rewrites, meanwhile the data science team were making changes without telling anyone which kept breaking things. Finally when the engine was back online I was able to test it and IT DIDN'T WORK! Four months in and I found out the core of the product was total B.S. I told the founder and they said ignore it, it's ok it didn't have to work, it just has to seem like it works. OMG! Well the delays caused the investors to drop out. That sent things in to a tail spin. The data science team just disappeared, the dev doing the rebuild of the v1 quit before it was finished. It was a disaster nothing worked it all had to be rebuilt from zero.Just as I started that the founder decided to change direction and wanted to spend 50-70k of our development resources on an investor pitch!! That was the nail in the coffin, you don't spend that kind of money to try to impress an investor.


After this last investment my partners and I realized this model couldn't work for us. We did have a somewhat successful dev shop and we could focus on that and grow it but no one had the energy to start over again, sowe decided to shut down the company and move on.


Here's my take away. Somethings I wish people would have been able to tell me.

  • If you go this route be prepared to be lied to a lot by founders. At best they have a fake it till you make it attitude, at worse they're con-artists.
  • You can't spot false validation when it's happening. It's impossible to distinguish from real validation.
  • Customers will mislead you on what they need and are willing to pay for.
  • Investors are unpredictable and will set ridiculous standards that increases costs & extends timelines.
  • Startups will grossly overestimate what they can accomplish.
  • Very few people actually know what a MVP is.
    • Most people think they can skip the prototyping stage if they are building an MVP and that's a huge mistake.
  • Most MVPs can't actually solve a problem or aren't engaging enough to get users/customers or investors on board.
  • Very few startups practice Lean Methodology or understand what it actually means.
    • Lean methodology has overhead costs that most startups can't handle.
    • Startups think Lean is about building a product instead of building a business.
    • Expert practicers of Lean can validate a product concept before building a product.
  • Equity is worthless until it isn't and the vast majority never will be.
  • A startup needs to have a larger business team in place then most think.
  • Software development is expensive and agile/lean makes budgeting impossible to predict.
  • People overestimate design and underestimate utility. Pretty products are a novelty not a means to success.

17 Replies

Ryan Yanchuleff
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Ryan Yanchuleff Entrepreneur
Application Developer, CEO, and Entrepreneur
Curious about your take on Lean Methodology. I'm unclear from your takeaways at the end what your thoughts are on it. Are you implying that Lean Methodology is inherently bad/wrong or just that most founders either don't implement it correctly or have incorrect or unrealistic expectations about it? We have tried to practice Lean Methodology in our business, but it often has left me feeling like we are moving too slowly in an effort to conserve cash that we are missing bigger opportunities that are available to us. (eg: fear of taking the leap if you will).
Joe Walling
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Joe Walling Entrepreneur • Advisor
Experienced software developer, software architect, owner of custom software development shop
@Dustin, you have written a very insightful post that is certainly making me think. I have done some small projects with with an ownership stake and have mixed results, mainly due to the other party not having skin in the game and not doing their part. I have since adjusted our approach. While we still will do software development for an equity stake, I am much more cautious about who I will do these deals with. I am not ready to drop this model, but your post gives me even more to think about whenever we are asked to partner with someone.
Dustin Williams
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Dustin Williams Advisor
Business Systems, Software Development, Information Technology
I think it's useful but the author of The Lean Startup has done major damage to the methodology by turning it in to pop culture self help book. Like most self help books he gives you just enough to think you understand the topic but no where near enough to actually practice it.

I think people would be be far better off studying Lean Six Sigma, Lean Enterprise, the Toyota Product System, etc. But keep in mind these are very complicated topics and they require a huge time investment to learn. Since most founders haven't taken the time to dig in to the details they're filling in those blanks by guessing as they go which is far more costly IMO.

https://en.wikipedia.org/wiki/Lean_manufacturing
Martin Omansky
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Martin Omansky Entrepreneur
Independent Venture Capital & Private Equity Professional
Your experience is common, and is even more relevant when one is involved in software deals. Our expertise is not in software anyway, so we concentrate on stuff we understand. The lesson to be learned by both of us is this: take your time and spend resources on a complete, independent, and cold-blooded evaluation of the technology *and *the history and character of the people involved. This approach does not necessarily filter out all problems - tech start-ups inherently have problems - but it can possibly reduce the intensity and/or the frequency of unfortunate outcomes. Here is a little-known, probably anecdotal, factoid: the largest single user of private investigators is the venture capital industry. Considering your experience, and the general experiences of other investors and developers, I wouldn't be surprised.
David Austin
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David Austin Entrepreneur
Entrepreneur
Thank you for it worthwhile contribution and what has seemed a spate of worthless emails getting sent to me by founder dating.

I'll add this to my air of lessons learned. Hindsight is 20-20. These have been my experiences as well. Leave nothing to chance and don't believe any validation until you've done it yourself. Never reinvent the wheel, make sure you have the right team, dedicated, and with mad skills. Realize there are few real entrepreneurs and avoid trusting mission critical to those who are just looking for work.

If a startup is open to new management or everything seems up for sell, run.

Constantly validate, even after it's validated, and he ready to pivot ... Never throw good $ after bad, and never expect money to fix anything. Too much $ too fast is a common death knell for seemingly adequately funded startups. It attracts the wrong talent and encourages putting the cart (or the MVP) before the horse (or the customer).

After getting burned by technical issues way too many times I've started adding "difficulty" to my startup investment assessment strategy, which is itself a rats nest to assess. I do however think that the more challenging startups are better left to enterprises ... Which is great if you're into that environment, but expect that even they'll pull the carpet out prematurely when executive changes are imminent - which is a common scenario when an enterprise is investing in multiple startup initiatives.
Guru Sharan
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Guru Sharan Advisor
Vice Chair of Programming, Gator Innovators, Student Government UF and Technology Director, UF Entrepreneurship Club
Dustin,

Thank you very much for sharing your experiences.
I agree with many of your takeaway points as I have learnt and experienced in the past.
1) Start-ups overestimating what they can accomplish, unrealistic expectations/deadlines from team and the unpredictable investors.
I have built an MVP and pitched to several investors, there are times when they oversee what the product/service has to do at the MVP stage and expect version 1 or 2 output during MVP stage. When you pitch them the vision you have for the product/service, they draw conclusions like "This can be done in 3 or 6 months"..... And the tough part is when you have 1 or 2 technical persons in a team of 4 or 5. All the work will be done by that 1 or 2 persons and in most of the cases they have to work round the clock to meet the unrealistic deadlines and in the end either they have close to what is required or they quit.
2) I have followed Lean methodology and I agree with you on the overhead costs which start-ups can't handle. This is particularly true with respect to technology/software oriented applications. It also depends on the complexity, time associated with the product/service by taking into account the skill level, expertise of every member in the team.
Running Lean by Ash Maurya is really a good book to follow for Software/Tech start-ups.
3) Equity - Slicing Pie model must be a good way to structure it, if the start-up takes off!
4) It is true that Software development is expensive and finding the right person for the right job is even more time consuming which start-ups can't handle. It is one of the main reasons for start-ups to outsource parts or in some cases full dev work to other outsourcing hubs. And this brings in a conflict with current and future investors.


Dustin Williams
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Dustin Williams Advisor
Business Systems, Software Development, Information Technology
I'd add that Slicing the Pie was only semi-effective for us. Even though it seemed very fair when we started. My partners later came to regret using it and were a bit demotivated by their slice. They also limited me in bringing in other partners out of fear that they're slice would shrink and because those people didn't prove themselves like the founding team did.

I can't say that it would be any better any other way. Just keep in mind that there are always unforeseeable downsides to every approach.
Dustin Williams
2
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Dustin Williams Advisor
Business Systems, Software Development, Information Technology
Guru - I totally understand where you're coming from about the complexity of software development. It can be very hard for non-engineers to understand just how complicated even simple features can be to implement.

To be fair they most people don't have any point of reference to compare what we do to. Very few professionals have deal with the level of complexity or constant change the engineers have to manage every day. This leads them to either overestimate what we can accomplish or underestimate the difficulty of certain tasks.

For instance Natural Language Processing. Non-engineers think it's magic and can solve huge problems. Engineers who deal with it know that it's crude and hard to get anything meaningful from without huge investments & a team of semantic experts.
Ema Chuku
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Ema Chuku Entrepreneur
Designer. Product Developer. Founder @ NuPad
Just a question:obviously you were buying into or falling for the overhype of the industry. Could it be perhaps this caused you to take on startups with so-called million dollar background, while overlooking the small ones with potentials?

p.s. Thanks for sharing the experience.




Dane H. Madsen
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Dane H. Madsen Entrepreneur • Advisor
CEO, SVP Business Development | Domestic & International, Product Marketing | Open to new connections
This is the most enlightening and articulate posting I have seen to date on FD. Thank you for the self examination, in public no less. Dane Madsen Dane@DaneMadsen.com [removed to protect privacy] Mobile Sent from my mobile device. Forgive typographical and grammatical errors.
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