By Andy Gordon on August 15, 2014 Dear Early Investor,
CEOs aren't in the truth-telling business.
They're salesmen first and foremost. If they're not the best salespeople at their companies, they should walk away.
They don't deserve the job.
About 10 years ago, I wrote an article about this. I discussed the art of listening to a CEO.
I said that what a CEO doesn't say is as important as what he does say.
I even remember the example I gave. It was the CEO of Advanced Micro Devices (NYSE: AMD) talking about his chips. He was comparing them to Intel's. He talked about the problems Intel was having with its next generation of chips.
He went on and on.
But not once did he say that Advanced Micro's chips were faster or more efficient.
I got off the phone with him liking Intel a lot more and Advanced Micro a lot less.
What Aren't Founders Telling You?
Nor are founders in the truth-telling business.
The same advice applies. Listen to what they don't say.
They'll stick to the positives, as they should. So it's up to you to figure out what they're ignoring.
For example, the founder I spoke to yesterday seemed like a bright young man. He went to Cornell. Got an engineering degree. And started up his analytics company about a year ago.
There's a lot to like about his company. Customers and revenue are going up. And he says he's closing in on several big deals.
But one word never came up...
And that's "profit."
I expected that. The company is very young. I simply wanted to know what his map to profitability looked like. So I began by asking him when he was projecting his future breakeven date.
He couldn't even tell me. Not good.
Don't Ignore These Three P's
Profit is just one of three P's a company must show me. The other two are product and progress. And if they don't have one of them, they have to tell me how they're going to get it.
As an investor, you'd be ignoring these three P's at your own peril. Why?
Let's find out... - Profit. I know a young company that rakes in $4 billion a year. It's in the software as a service (SaaS) business. One of software companies' biggest advantages is that they're not weighed down by huge costs.
But this company will lose about $232 million this year!
Its name is Salesforce.com. Its customers pay by the month. Salesforce should be way past its breakeven point by now.
I'm singling Salesforce out as a particularly egregious example. But it's not the only software startup unable to find its way to profitability. Far too many SaaS companies are in the same predicament.
The problem?
I believe it's their investors. Many put a greater premium on growing customers than making a profit. In lieu of demanding a modest profit today, they wait (and wait and wait) for much bigger profits tomorrow.
Their investing approach has consequences.
Costs aren't corralled. Management doesn't have to make the hard decisions on where to spend.
Too much cash on hand leads to too much spending.
Some VC investors have given startups the wrong message: too much money. And now they're paying for it. - Product. Companies offer products that people don't want.
Putting out clunkers is something that tech companies, new and old, do all too often. Think Microsoft's Zune Media Player. Google's Nexus Q. Or Apple's Maps.
Amazon recently came out with a flawed product, the Amazon Fire Phone. It got horrendous reviews.
It seems there's always a clunker right around the corner. The next one?
How about Microsoft's "selfie" phone? It's debuting at the beginning of September. I bet it goes nowhere.
You probably can't stop the product development folks of these companies from falling in love with the fruits of their labor. But come on. These companies have to find a way of soliciting honest feedback inside and outside the company.
As an early investor, you should do the same thing. Get plenty of feedback from multiple customers. If they don't end up buying, you're not making any money on your investment. - Progress. What makes progress real? It has to lead to sustainable growth over an extended period. Be careful here. What's hot can come and go. And the hype machine eventually runs out of gas.
If a company can't turn short-term growth into something long-lasting, then you shouldn't invest. So remember the three P's: product, profit and progress.
If a founder is avoiding any of them, it's a red flag.
Steer clear.
Good investing,
Andy Gordon
Founder, Early Investing    
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