(Special thanks to my agent, Steve Hanselman, and my anonymous sources within the world’s biggest publishing houses)

Print is dead!

This has become a popular headline, and a great way to get quoted, as Nicholas Negroponte has shown. Iconic author Seth Godin, after 12 bestsellers, just announced that he will no longer pursue traditional publishing, and the writing seems to be on the wall: the e-book is the future, plain and simple.

But what are the real concrete numbers? How are established authors actually making money, and what should new authors do? Go straight to e-book?

In this post, I’ll look at real-world numbers to discuss some hard truths of publishing, explain economics and pay-offs, and provide a few suggestions for aspiring authors.

To start, some contrasting numbers…

- The 4-Hour Workweek is one of the top-10 most highlighted Kindle books of all time.

- The 4-Hour Workweek was the #1 business book when Kindle first shipped after November 2007, and is currently around #116 in the Kindle store.

- In my last royalty statement, December 2009, digital book sales (all formats, including Kindle) totaled…. ready?… a mere 1.6% of total units sold.

My own book has been on the bestseller lists for more than three years, and I’ve tracked most multi-month bestsellers for all of those 36+ months using Nielsen Bookscan (among other tools) which covers about 75% of all retail book sales since 2001, including Amazon but excluding discount clubs such as Sam’s Club. Titlez has also been useful for looking at detailed trending on Amazon.

This all gives me a good pool of data, and I feel like I have a good grasp of what authors are selling and… realistically earning directly from books. If you’d like to get a basic idea, just subscribe to Publishers Lunch to see what authors are getting paid as advances. Enjoy.

We’ll come back to the Kindle numbers, but first, here’s a sketch of book economics, incentives and options:

- For a hardcover book, authors typically receive a 10-15% royalty on cover price. This means that for a $20 cover price, the author will receive $2-3. If you have a $50,000 advance, a $20 cover price, and a 10% royalty, you therefore need to sell 25,000 copies (“earn out” the advance) before you receive your first dollar beyond the advance. This is the basic rule, but several quietly aggressive outfits — both Barnes and Noble’s in-house imprint (Sterling, acquired in 2003) and Amazon’s in-house print arms, AmazonEncore and AmazonCrossing — could prove to offer more attractive terms. Then there are the fascinating rogues like Andrew “The Jackal” Wylie.

- For a trade paperback book, authors typically receive around half the royalty of a hard cover. If you are making 15% on your hardcover, you might get 7.5% when it goes to paperback. Guess what? This means you now need to sell twice as many books to break even. I think going to paperback is a bad idea for almost all authors, unless you want to double your work for the same income. Do you really need the people who won’t buy a $20 book hardcover that’s already discounted to $12-14 dollars through Amazon or Barnes and Noble? I don’t think so, yet most authors follow the hardcover-to-paperback progression without question.

- Electronic books, including Kindle, do not count towards the most famous bestseller lists, such as The New York Times bestseller list. I suspect this will change within the next two years, but for now: print is what will make you famous in the mainstream.

- If you choose to self-publish but stick with print format and retail distribution, you might double your royalty earnings. This is based on conversations with friends who own their own boutique publishing houses, all of which have distribution in large chains like Barnes and Noble. It’s fun to imagine that you could print a book with a $20 cover price and pocket $15, but that isn’t how the math works out. Once you factor in retailer discounts and distributor percentages, you might end up netting 30% of cover price vs. 15%, if you’re lucky and have a print run of 20,000+ units (Can you afford the upfront cost, especially if retailers are paying net-30, net-60, or beyond?). Keep in mind you also need to manage things as a publisher, which could make your dollars-per-hour earnings less than with a traditional publisher. There are a few promising companies, like Author Solutions, trying to solve this problem for authors.

- If you choose to go digital only as an e-book, this is where profit rules and amazing numbers can be achieved. How amazing? I know one man who nets between $5,000,000 and $10,000,000 per month with a single e-book and affiliate cross-selling to his customer lists. I’m not kidding. The downside is that you need to be a world-class marketer and understand affiliate and CPA advertising better than anyone else in your niche (since there is little barrier to entry, and therefore plenty of competition). Prepare to be an uber-competent CEO or fail if you choose this option.

The Kindle Phenomenon — How Press Releases Are Misread

Amazon is incredible and I expect nothing but more innovation from them. Putting aside their coming bloodbath with Apple, though…

What of this announcement that Kindle sales have now passed hardcover sales on Amazon? I believe this to be true, but there are a few things I suggest we keep in mind:

1) Kindle books selling well does not mean that print books are selling poorly. In fact, it appears quite the opposite. From the Wall Street Journal coverage of the announcement:

Still, the hardback comparison figure doesn’t necessarily mean the end is near for paper books. Amazon said its hardback book unit sales also continued to increase.

It will be fun to see more precise Kindle sales when they are shown as a separate line item in Nielsen Bookscan, which should happen in the next year.

2) The top-five Kindle selling authors of all-time, over 500,000 copies each, are all fiction writers (including Stieg Larsson, Stephanie Meyer, and others). In the top-50 Kindle bestsellers right now, I counted just three (3!) non-fiction books. If you’re a non-fiction author, I’d think carefully before jumping the gun to all digital. Remember that comment about print being dead? What if we ask a high-level exec at one of the “Big Six” (explained later) about how print sales are declining?

Hardcover trend is mixed and dependent on hot books. If you are wondering about ebooks, commercial fiction is where you’re seeing the erosion. Paperbacks are ok. Mass markets are taking a hit.

What are “mass market” books? The NY Times describes them thus:

Mass-market books are designed to fit into the racks set near the checkout counter at supermarkets, drugstores, hospital gift shops and airport newsstands. They are priced affordably so they can be bought on impulse. There are other production differences in binding and paper quality (historically, paperbacks were printed on “pulp” and could fit in the consumer’s pocket). The format is often used for genre fiction, science fiction, romance, thrillers and mysteries.

Is it a coincidence that print impulse purchases are also the biggest sellers on Kindle? I don’t think so.

3) I believe (conjecture, yes) that the figure we are missing is Books-Per-Person. If you have a Kindle, as I do, how many books did you buy in the first week or two? How many unread books do you have on your Kindle? Unlike with print books, you don’t have to look at a stack of unread material like undone homework. Ergo, you purchase more digital books than you would ever purchase in print. If Amazon is selling 180 Kindle books for every 100 print books, I wouldn’t be surprised if 10-20 people are responsible for the former, whereas 80-100 people are responsible for the latter. This reflects that Kindle owners are buying more books per capita, not that paper purchasers are buying fewer.

Now, don’t get me wrong. There has to be some cannibalization of sales, and much of print will die eventually, but it will take a long time. Print is far from dead… and far from unprofitable. Despite the industry-encouraged myth that print has no margins, a hardcover book sold for $20, assuming no graphics or color, can often be produced for less than $2 a copy. With the proper economies of scale (unavailable to most individuals), the publishing biz can be quite a little cash cow.

Let’s cover some basics of traditional publishing next.

What “Traditional” Publishing Looks Like

Traditional publishing looks something like the following for non-fiction authors. For fiction authors, you need to write the entire manuscript first. Here are the five steps:

Step 1. Get an agent (best done through a referral from one of their authors).

Step 2. Put together a book proposal, which is like a business plan. It will contain marketing plans, your existing “platform” (who you can sell to or reach without publisher help), an executive summary of the book concept, and 1-3 sample chapters, among other things.

Step 3. Pitch to specific editors at different publishers through the agent and schedule meetings.

Step 4. Sell the book. The editor will probably have signing authority up to a certain advance amount, but higher ups will need to sign off on larger advances. If you don’t have a great platform for selling books without publisher help, don’t expect anything more than $50,000, and that’s being optimistic. The $50,000 will not be paid all at once, but in several installments, something like this: 1/4 upon signing the deal, 1/4 upon publisher acceptance of manuscript, 1/4 upon publication, and 1/4 upon paperback publication (assuming you start with hardcover).

Step 5. Write the book. Keep in mind, you’re not getting paid the advance all upfront, and writing a good book will probably take at least a year if you’re hoping to have good word-of-mouth and some longevity. I’ve been working on my new book for more than three years. I’ve spent this time because I want it to sell like mad for no fewer than five years after publication, preferably more than a decade if I update it on an annual or semi-annual basis.

For more detail and recommended books, which I used as guides, read “How to Sell a Book to the World’s Largest Publisher,” which explains exactly what I did.

Below are the “Big Six” publishers — most of the bestsellers you see come out of one of their divisions (called “imprints”). In no particular order:

Lagardere (owns Hachette)
Harper Collins
Macmillan (owns St. Martin’s)
Penguin Group
Random House (the largest, and where my book lives within the “Crown Publishing” imprint)
Simon and Schuster

All of these publishers have iBook agreements with Apple except for one… Random House. Why? Is Random House just unable to see the obvious future? Nah, I don’t think that’s true. There are plenty of smart people working at Random House, and that includes their legal department.

The paragraph that follows is all hypothetical:

What might happen if the iBooks agreements of the other Big Five all have suspiciously similar terms? If there were a federal investigation, might that lead to charges of collusion among the publishers and have terrible financial consequences for an already fragile industry? It certainly would. By distancing themselves and coming in late to the game, Random House — again, hypothetically — would be playing a very smart hand, indeed.

For those of you who are devoted to your iPads (I do like mine), you can always use the Kindle app to read Random House books on them pretty screens.

So What Should Authors Do?

First off, writing books is a terrible revenue model for authors.

Precious few books sell more than 25,000 copies, so it’s unlikely you’ll make even $75,000 a year from book royalties. In rare cases, you might have a perennial bestseller, but this is less than 1% of all books sold and not a good bet to make.

There are still a few reasons you might consider writing a book and going through traditional channels:

- Speaking: Particularly in the business category, if you target your Fortune 500 audience well enough, you can stair-step your way into $20,000 per 60-minute keynote without needing a miracle. Hundreds, if not thousands, of authors earn this kind of money. The higher echelon can make $80,000 or more per speaking engagement. Needless to say, this adds up fast.

- Reputation and audience: Money is a means to something else. Not unlike wampum, income is traded for either a possession or an experience. If you use your book to build a reputation as a thought leader, and if you can establish a direct line of communication to intelligent readers (through a blog, for instance), it is possible to bypass income and get almost any experience for free or next-to-free. The middleman of currency is removed, and you also have access to things money can’t buy, whether it’s interesting people or unusual resources.

Though I have done high-level speaking and enjoy it with the right audience, I typically do fewer than a dozen engagements a year. I prefer to focus on connecting with my readers and having fun with cashless adventures.

How do you build a base of fans or supporters and build a high-traffic blog? Here are two detailed closely related case studies:

How Does a Bestseller Happen? A Case Study in Hitting #1 on the New York Times
How to Create a Global Phenomenon for Less Than $10,000

So what of self-publishing versus the more traditional route?

Reputation, at least in the mainstream and for the next few years, is difficult to build if you self-publish. In the below five-minute discussion, NY Times bestselling author Ramit Sethi and I discuss the pros and cons of self-publishing vs. getting a “real” publisher:

In Closing

For established and successful authors, like Seth Godin or Jim Collins, self-publishing in print or digital is a supremely viable option. Jim Collins self-published his last print book, How the Mighty Fall, and was featured on the cover of BusinessWeek magazine to help push it up the bestseller ranks. Seth could do the same.

Why is this possible?

Because they have incredible reputations that were built, in part, on top of the traditional publishing machine. The Big Six and their close cousins are in real trouble. Some of them might adapt (which will include massive lay-offs), but most will not. In the next few short years, there will also be many interesting publishing alternatives for aspiring authors.

But, all that said, there is still real value in having the rare stamp of approval that a “traditional” publisher provides. I don’t think this will change much in the next 12 months, perhaps even 24 months.

Now, a handful of first-time, self-published authors hit the New York Times list, that’s an entirely different story…

###

Recommended reading – Below are the three books I’ve suggested to a dozen or so aspiring-author friends. Almost half of them later hit the New York Times bestseller list. Reading these doesn’t guarantee that outcome, of course, but it will help:

The 22 Immutable Laws of Marketing (to help you craft the right message and themes)
Bird by Bird (to help you write the damn thing and not shoot yourself)
Author 101: Bestselling Book Publicity (to help you reach and excite big media)

Afterword: Book Format and Multimedia Books, etc.

In the comments below, I was asked the following question:

“Tim, I have a question… Before I decided to self-publish, I got a couple decent offers from traditional publishers, but they all involved 10+ months of lag time between when everything is ready to actually print and when they would actually print. I’m not nearly patient enough for that much delay. Is the world of “real published authors” really limited to people who are comfortable waiting around a year for their book to manifest?”

My answer addresses a few other common questions I get:

Hi Jeff,

With the big boys, yep. That’s the lag time in production. I actually kind of like it. Allow me to explain:

It forces you to think about your material and attempt to make it perennial. Which advice will be obsolete in 12 months? Delete. Which advice would be obsolete in 24 months? That means it will only be good about 12 months after pub date. Delete.

I find that it helps refine your thinking, just as having the content in a fixed form (print) forces you to consider your writing and editing more seriously than if you could change it willy-nilly like a blog post. There are certainly benefits to the multimedia books on the horizon, but I wouldn’t call them “books”, and I think the bells and whistles of video, hyperlinks, etc. will be used to mask sloppy thinking as often, if not more often, than they will be used to create a more compelling argument or presentation. The wordsmithing and precision of the language will suffer with the crutches of embeddable video, etc. Will they make perfect sense for some books? Absolutely. Will they distract and detract from the flow of the prose, story, or argument in most cases? Absolutely.

To me, “timely” books are a bad bet for writers. If the content delivers value based on timing near recent events, other media have it beat. I think long-form books should have a longer shelf life, and therefore require harder thinking throughout the process to ensure the content has value 1 year, 5 years, even 10 years down the line.

Hope that helps!

Tim

From today’s New York Times coverage of the Shopify/4-Hour Workweek build-a-business competition that just ended:

To encourage early, positive buzz among Apple iPad buyers, Mr. Dalton [of DODOcase] hired street teams via Craigslist to “hang out with Apple fanboys, while they waited on line for hours, maybe even days, outside of Apple retail stores for a chance to buy the first edition iPad.” The street teams, he said, hit Apple store locations in Boston, Chicago, Los Angeles, New York and San Francisco.

DODOcase also scored favorable reviews with the tech blogs Engadget and The Unofficial Apple Weblog. Some endorsements came unsolicited from high profile customers; on July 14, Evan Williams, chief executive of Twitter, posted a DODOcase endorsement on his Twitter feed: “Got my Dodocase. Sweet.”

The company, which plans to continue manufacturing its product and creating jobs in San Francisco, received more than 10,000 orders within a few months of the iPad’s debut…

DODOcase iPad cases cost around $60, so you can do the math. Amazing.

This post will cover how it all happened…

In December 2009, I published a post titled “No More Excuses – How to Make an Extra $100,000 in the Next 6 Months,” announcing a $100,000+ bribe intended to solve a problem: inertia. Perhaps a better translation: temptation to remain in comfortable routine.

The Shopify build-a-business competition was a financial carrot for anyone who’d dreamed of starting a business but hadn’t taken the jump. Each person had six months to build a business, and their two highest-grossing consecutive months would be matched against everyone else.

The competition just ended on June 30th. So what happened?

This post will cover the overall results and focus on the winners: their lessons learned, marketing tipping points, mistakes, and much more. First, some stats:

Revenue PER HOUR for the duration of the contest (180 days): $696.38
Total number of people competing: 1,819
Total number of orders placed: 66,503

Below is a sweet infographic that shows some of the highlights and a few other fun numbers (full-size here):

Click here for a gorgeous full-size view.

The Prize Winners and Analysis of Successes

I use the term “prize winners” because more than 500 viable businesses were created by you all, and I consider all of you winners (including those who participated but didn’t get this first attempt quite right).

For prize winners, here are the category and overall winners:

$5,000 Top Apparel Store: Nashville Flood Tees (www.nashvillefloodtees.com)
$5,000 Top Digital Good: Buy Mafia (www.buymafia.com)
$5,000 Top Miscellaneous: Grove (www.grovemade.com)
$5,000 Top Electronics Store: Vaporizers.com (www.vaporizers.com)

$100,000 Overall Top Store: DODOCase (www.dodocase.com)

In that order, I asked all of them the following questions:

1) How did you decide on your product? What ideas did you consider but reject, and why?
2) What were some of the main tipping points (if any) or a-ha moments?  How did the tipping points happen?
3) What were your biggest mistakes, or biggest wastes of time/money?
4) Key manufacturing and marketing lessons learned?
5) If you were to do it all over again, what would you do differently?
6) What’s next?

Here are their answers.

Lessons Learned: From Manufacturing to Marketing

NASHVILLE FLOOD TEES

Nashville Flood Tees is a group of artists and designers utilizing their talents to help the victims of the recent flooding in Nashville and the Middle TN area. We sell T-shirts for adults and children, with all of the profits going towards local charities.

Nashville Flood Tees was the brainchild of graphic designer Susannah Parrish, of texaSUS design, who posted 2 tshirt designs on Facebook. What was intended to be a modest project, turned into a viral marketing explosion- over 25,000 Facebook fans amassed within two days.

As it became clear this couldn’t be just a couple hundred tshirts printed in her basement, Susannah teamed up with Josh and Bethany Newman of ST8MNT design, a graphic design firm, to create an online store and additional designs. Josh and Bethany were able to get a Shopify store up and running within 2 days.

Render Apparel, a custom apparel company, joined the team to produce the product. The online store sold 800 shirts the first hour it went live. It’s been estimated that over $200,000 has been raised for the charities, of which $120,000 that has already been given to the charities.

1) How did you decide on your product? What ideas did you consider but reject, and why?

T-shirts seemed to be the perfect mix of raising money, as well as promoting the cause in the marketplace and giving the consumer sense if empowerment and ownership.

2) What were some of the main tipping points (if any) or a-ha moments?  How did the tipping points happen?

The tipping point was Facebook. There are now 36,970 fans. Google stats show online store visits from 93 countries/territories, with over a 108,000 visits total since we launched 2 months ago.

3) What were your biggest mistakes, or biggest wastes of time/money?

Our biggest mistake and waste of time: fulfillment. Since this was a charity idea that 3 small business owners set up to do in their spare time, we wanted to keep costs at a minimum. We wanted as much money as possible to go to the charities, so we didn’t partner with large expensive fulfillment houses or large capacity printers that could make our products the priority. This actually proved to take up more time that we didn’t have because we had to be so involved.

Our other biggest mistake: PayPal. For the same reason as fulfillment, we needed to set up payment as quickly and easily as possible. This has been a real challenge. Not only did PayPal shut us down for 24 hrs after only being live for less than 8 hrs, because of the sheer volume we sold, but they’ve been really slow and difficult releasing funds to us.

4) Key manufacturing and marketing lessons learned?

Lessons learned – the amazing power of online social networking. This idea exploded because of Facebook. We didn’t even have the time to actually use Google ad words or email marketing blasts with Emma.

5) If you were to do it all over again, what would you do differently?

If this had been a for-profit business, where we had more time and energy to devote to the resources, we would have set up a merchant account and payment gateway, instead of a third party payment processor like PayPal. We also would have integrated a more sophisticated online marketing strategy to truly capitalize on the viral explosion. And we definitely would have utilized a more turnkey fulfillment service. This has proven to be the most difficult aspect of an online store. And lastly we would have employed customer service staff to maintain communication with customers.

6) What’s next?

We plan on launching a new charity tshirt store that specializes in quality designs to raise money for a wider range of current causes: MyShirtHelps.com

This venture has been an amazing journey, (and at the risk of sounding like a kiss-ass :) that strangely happened only a few days after we finished reading The Four Hour Work Week. The idea for an online apparel company had already been on our minds as a curious side business to launch. And the steps for implementation outlined in the book were on the to do list as sort of a pie-in-the-sky-if-we-ever-get-more-time plan. So as we watched the flooding on tv, and our good friend and former colleague showed us pics of a tshirt design, it all fell into place. Thanks to Shopify and The Four Hour Work Week, we scrambled a store up in a matter of days and have raised over $200,000 for the flood victims of the middle Tennessee area.

BUY MAFIA

What I sell at my online store BuyMafia.com is a service of transferring virtual items that I collect from the game Mafia Wars on Facebook, items like weapons, vehicles, armors, collectibles and many others from the game that will help improve peoples character and make them stronger for the competitive wars and fights that people take seriously, even though is just a fun game.    

1) How did you decide on your product? What ideas did you consider but reject, and why?

I started playing the Mafia Wars game for Facebook and I notice that they had over 4 million fans playing the game daily (now there are over 10 million) and I did some research online and found a website that works like ebay but just for digital items for online games. I tried selling something there just to test the market, and on the same day I got an email from the site saying that someone purchased the items I listed there and they gave me their information so I could send to them, I did not expect that it would work that well but it did.

2) What were some of the main tipping points (if any) or a-ha moments?  How did the tipping points happen?

I had an a-ha moment when I saw how serious people were with the game and the competition between clans and that people wanted more and more items to become stronger and they would spend whatever it took to be the strongest player on the game. Then I used what I learned about business to create a business plan around that.

4) Key manufacturing and marketing lessons learned?

The best thing was that I did not put 1 penny out of my pocket until today do create this business, I just reinvested the money that was coming in from the items I collected in the game and sold until I got to the point that I pay people to collect them for me and I just focus on the marketing and sales.

I learned that marketing and getting traffic to the site are some of the most important things for a online business, the more I spent with marketing the more the sales grew, and that was exponential growth. 

5) If you were to do it all over again, what would you do differently?

I would have invested more time looking for ways to market the business instead of trying to collect more and more items on the game. I could have people doing that for me.

6) What’s next?

Now I’m working on a affiliate program for people that wants to make money by just sending people to the site, giving them a percentage of the sale when their customer purchases something. I’m always looking to leverage and to automate more and more of the business so I can have time to create new projects.

GROVEMADE

Grove is a design collective lead by Joe Mansfield and Ken Tomita bringing art and customized natural products into your daily life.

Everything is designed and made in Portland, Oregon. We take pride in how we do things and who we are, as much as in our products.  Our products reflect our pursuit of fine design and ethical consideration.  Our main product right now is a bamboo iPhone case for the iPhone3G and iPhone4.  We curate and artist series of laser engraved art on the cases, offer customization where you can upload your own artwork, and a plain case.  The cases are a blend of high tech manufacturing and old fashioned handwork, aiming to bring warmth back into your lives. 

1) How did you decide on your product? What ideas did you consider but reject, and why?

The product preceded the company.  Joe had an idea to make a bamboo iPhone case and I joined in to help him do it.  We thought we could make the best iPhone case in the world.  With so much of our lives becoming dominated by electronic products such as cell phones and computers, we felt that the world could use some products made with natural materials.  Also, contemporary design has been criticized for being cold and impersonal, while tradition is hailed as warm but old.  Why not bring back the warmth of tradition back into contemporary design?

2) What were some of the main tipping points (if any) or a-ha moments?  How did the tipping points happen?

The a-ha moment was when Joe and I decided to team up last summer.  I design/build custom furniture under the name TomitaDesigns and Joe coincidentally lived across the street from my woodshop where he conducted his laser business EngraveYourBook.  We became friends from the proximity and “nerded out” on design and art every day while tossing the football around on the street, not getting any real work done.  He had talked of the iPhone case idea for years actually.  I can’t even remember the actual moment when we decided to team up.  Now, it seems so obvious how our skills, talent, and spirit combine so well but back then we were completely oblivious to the possibility of working together.  I believed in his vision and we fed off each other to make it a reality.  

3) What were your biggest mistakes, or biggest wastes of time/money?

Ive heard somewhere that it is better business wise to release a mediocre product early than a great product late.  Timing is everything.  

Some people may point to our late release of the 3G model as a big mistake because of the timing.  It was in terms of sales.  However, if we were to do it again we would do the same thing.  We didn’t release till we had refined the product to our level of satisfaction.  We don’t release mediocre products just to make money.  We want to have pride in what we do, and that means sometimes we will be late to the game, and sometimes it won’t make business sense.  

4) Key manufacturing and marketing lessons learned?

From a marketing perspective, everything went according to our vision.  

Concentrate on making the best product possible.  If you succeed, the product will sell itself…. People will talk about it on their own.  

From a manufacturing perspective, I had a lot to learn.  I am accustomed to designing and building one-off high end furniture pieces with no regard to how difficult it is to make. The goal has always been to make the best piece possible.  I had a difficult time adjusting from that mindset to that of a production situation.  Our products are difficult to make and require a lot of labor because of my mindset and lack of willingness to compromise certain things.  For example, we hand rub 4 coats of natural oil/wax on our cases which doesn’t really make any sense for mass production.  

5) If you were to do it all over again, what would you do differently?

Nothing.  I don’t do the “wish I had a time machine” thing.  Experience–whether it be good decisions or mistakes–all lead us to where we are at now.  I love the ride and learning experience, bumps and all.

6) What’s next?

We have an iPad case coming up that we are really excited about.  We are mixing and matching some different materials that have radically different properties.  It will be thin, sleek, and customizable, of course.

We also have some amazing collaborations on the iPhone4 case coming up with artists and brands that we are fond of.  We love working with artists first and foremost.  Our spirit of creative pursuit is our greatest attribute and simply the most fun part.  

The truth is, we have a ton of projects in development constantly in our heads.  I can’t wait to get to all of them!

VAPORIZERS

1) How did you decide on your product? What ideas did you consider but reject, and why?

We decided on vaporizers because we already wholesale in the same industry. We decided to launch an online website. Shopify was easy to use and very convenient.

2) What were some of the main tipping points (if any) or a-ha moments?  How did the tipping points happen?

The main tipping points was figuring out the keywords they generate the most conversion. Once we were able to identify the keywords, using Google Analytics, it allowed us to be more aggressive and competitive. We determine it by amount of revenue generated per click minus cost per click.

3) What were your biggest mistakes, or biggest wastes of time/money?

The biggest mistakes were starting shopify contest late. It took us much longer to develop the website than we expected. We entered in the last 2 month of the contest. Besides that, everything went very smooth for the website.

4) Key manufacturing and marketing lessons learned?

The key marketing lesson learned was how to manage the cost of PPC campaign. PPC became one of our biggest cost, it was a challenge to maximize efficiency. We really had to watch our ad campaign to keep the website profitable.

5) If you were to do it all over again, what would you do differently?

We would focus more on search engine optimization other than ppc aspect. Also spend more time planning out the website with a deadline checklist. This would allow us to launch a new site much faster. The deadline would look more like a real estate project… [with] each phase of the website constructed in a synchronized fashion.

6) What’s next?

We plan to open another site for niche market products that wal-mart, target, and costco do not carry.

DODOCASE

1) How did you decide on your product? What ideas did you consider but reject, and why?

Going back to our use first use of a Kindle, we were amazed and excited about the idea of an e-reader. At the same time we started to feel a sense of loss about not holding and reading a good book (despite what one might think, reading is at least in part a tactile thing). While we didn’t act on this feeling on the Kindle as the iPad was announced it was clear that we had to do something. Patrick considered many different types of wood materials to compliment the book element and ultimately decided on bamboo based on its eco appeal and its historic relation to paper.

2) What were some of the main tipping points (if any) or a-ha moments? How did the tipping points happen?

Since the iPad form factor was new, we had designed the DODOcase based on Apple engineering drawings. The first a-ha moment was putting the iPad in the DODOcase on launch day. We realized we had not only achieved our design objectives, but it was a way nicer experience using the iPad in a DODOcase than on its own. The second a-ha moment was when Engadget called the DODOcase ‘the Rolls Royce of iPad cases”.

The Engadget connection happened through the viral activity that surrounded DODOcase.   Our target market on launch (obviously the early adopter of the iPad) is highly connected and highly social.   They wanted to talk about their new toy and we become part of the conversation.   These conversations spun up in the ‘echo chamber’ of Twitter and Facebook and quickly made it to the tech blogger community.   Josh from Engadget reached out to us directly and we recognized he was a guy we wanted to get our product to quickly (he got case #16).

3) What were your biggest mistakes, or biggest wastes of time/money?

Fighting the urge of distractions has been a challenge for us. We pursued an iPhone 4 case design for a week before checking ourselves and deciding that while we had a cool product design execution would be a distraction from our commitment to our customers.

4) Key manufacturing and marketing lessons learned?

We’ve learned tons about book binding and woodcraft which we will certainly take forward with us. On the marketing side, we’ve learned that having a great story is as important as having a great product. As a small company, you need to connect with your customers on an emotional level as well as on the physical level of the product. We sell DODOcase’s exclusively online which means most of our customers are buying a product without ever touching it. To achieve sales in this way, its important that customers ‘want’ to buy into the story as well as the product. We’ve believe that we are in the middle of a giant cultural shift from the book to the computer (e-reader/iPad). We hope that DODOcase can help ease that transition by providing the tactile experience we’ve all grown up with applied to these amazing new devices.

Let me take a stab at ‘formulating a good story’.

For a small business like DODOcase, it is critical that our products have a story behind them.   The seeds of product development for the DODOcase originated when we first held the Kindle.   We were amazed by the power and convenience of the Kindle, but immediately felt a sense of loss about the traditional book.   That loss was a combination of the tactile feeling of a book as well as the potential that an entire traditional industry (book binding) could ultimately be destroyed by such technology.    These feelings became the core of the DODOcase product story.   We set out to make a product that helped assuage these feeling as consumers embraced the iPad.   Users of an iPad in the DODOcase ‘feel’ like they are reading a hardback book which created a positive association with their past feelings of reading actual books.    Further, through our use of YouTube videos and other online messaging, we told the story of how DODOcase is made using traditional book binding techniques.   

The combination of a product that delivered on expectations we set and the story we’ve told in our messaging has strongly resonated with customers.    At the end of the day, we made a product that we wanted to use and have tried to share liberally the many reasons why we’ve made the product and manufacturing decisions we’ve made. 

5) If you were to do it all over again, what would you do differently?

If we had the opportunity to do it all over again, we might look a little more carefully at our choice of wood. Bamboo is an amazing material, but it is also very difficult to work with. Choosing a different type of wood might have made our lives easier.

6) What’s next?

We will continue to expand and invest in our production capabilities. We strive to eliminate the wait to get a DODOcase and to better service our customers. We will be expanding our product line to support additional colors and customizations for corporate clients and universities. We will look at new tablet devices as they come out and decide if the market will be large enough to support a DODOcase model.

We are thrilled to grow our business in the great city of San Francisco and contribute to the local economy.

Disclaimer: nothing on this site is legal advice, and I am not an investing expert.

This post is continued from Part I.

Part I explained how, instead of getting an MBA, I invested the tuition dollars into angel investing. To recap, my current stats for the two-year “Tim Ferriss Fund” look like this:

15 or so total investments
0 deaths
2 successful “exits”, or sales (including my own company)

If we look at the value of my remaining start-ups on paper, based on subsequent funding and valuations, the portfolio is probably up well over 4x. This means nothing (remember Webvan?), but it’s fun to look at the spreadsheet.

This post will look at how I’ve found deals, how I filter deals, and the rules I’ve set for myself. The latter can teach broader business lessons, even if angel investing never enters your life…

Before we get started: you almost always need to be an “accredited investor” to angel invest. If you aren’t comfortable lighting your money on fire, you shouldn’t invest in start-ups–period. That doesn’t mean, however, that you can’t learn a few things from the sidelines.

Before we get started – part deux: angel investing can be complicated. I’ll be using some fuzzy math and simple examples to get the point across. This is intended as a primer, not as a guide to the intricacies of investing.

Last but not least, I’ll use a gender-neutral “he” for the sake of simplicity instead of “he or she”, which is cumbersome. Both sexes can play well in this game (check out Esther Dyson), and both can screw it up equally badly.

For those who want some resources upfront, here are a few:

If you want to be an angel investor:
Read – How to Be an Angel Investor
Read – Is it Time for You to Earn or to Learn? by Mark Suster – this is a must-read reality-check that takes into account dilution and other nasties. Though written for people thinking of joining start-ups as employees, it applies to angels.

If you want to recruit/be an advisor:
Read – Everything you ever wanted to know about advisors, Part 1
Read – the above Suster piece if you think advising a few start-ups will make you rich. Run the numbers first.

If you want to find angel investors:
AngelList (go here to pitch me or anyone else in their roster)

Consider applying to a “seed accelerator” program that will cultivate you. For a complete list of such programs and upcoming application deadlines, visit Kaljundi’s site. Here are few well-known examples:

Y-Combinator (Mountain View, CA)
TechStars (Boulder, CO)
LaunchBox (Washington, DC)
LaunchPad (Los Angeles)
SeedCamp (London)
Capital Factory (Austin)
i/o Ventures (San Francisco)

Investors vs. Bootstrapping – Some Warnings

As exciting as I find the start-up game in Silicon Valley, it can also be depressing.

I see capable first-time entrepreneurs, full of piss and vinegar, run into fundraising and get their asses kicked by seasoned venture capitalists (often affectionately called “vulture capitalists”). Two or three years later, their start-up baby is either dead or their ownership has dwindled to the point where their enthusiasm is gone.

Here are some questions and warnings that might help avoid this:

1) Why do you need funding?

If you can bootstrap to profitability and one of your goals is to work for yourself, I’d suggest thinking twice. If you take a few million dollars, you will–on some level–be working for investors. If you make a mistake and allow investors to have board control, which can happen if you spend funding faster than expected, you no longer run your start-up. :(

2) Avoid angel investors with few or no prior start-up investments.

The family dentist wants to put in $50,000 and will give you whatever terms you want? Sounds great! Don’t do it. Ditto for the successful CEO who’s never done angel investing, as seductive as it will be.

One good friend just had her start-up implode (after millions of investment) because her primary investor, a former tech CEO, didn’t have the stomach for start-up investing. He panicked when things deviated from the business plan (um, welcome to start-up land), and began doling out funding in two-week increments and insisting on near-weekly board meetings. He became the micromanager from hell. No longer was the real start-up CEO able to make CEO decisions, and the company was doomed.

Only take investment from people who have invested in a few start-ups. Having run a start-up doesn’t qualify one as risk-tolerant enough for start-up investing.

3) Don’t take a ton of money just because the valuation is sexy, or because you give up less ownership.

This problem is more common with venture capital (VC), but it worth learning early: it’s a bad idea to take money from someone simply because they offer a high valuation. Let’s say two investors want to be your lead investor. Investor A thinks your start-up is worth $3 million and offers to buy 33% of the company for $1 million — to fund you with $1 million. Investor B thinks you’re worth $10 million and offers to also give you $1 million, but you’ll only give up 10% of the company!

Go with Investor B, right? Well, not so fast. If you come out of the gates with very little to show but a $10 million valuation, things can blow up in your face a few ways:

- Your exit options become fewer. If Investor B needs a 10x return for his portfolio and has the ability to block your sale for less, this means you have to sell for at least $100 million. If you’re a first-time founder, putting $1-2 million in your pocket with an early sale for $10 million could have changed your life forever and given you “f**k you” money to do anything you wanted. Now it’s home run or nothing.

- You run the real risk of a “down round”. If you don’t make it to profitability with that $1-million round, you’ll need to raise more money later. If you haven’t made a ton of progress, including a ton of new customers, the fundraising community will be skeptical and probably insist your $10-million valuation was too high, or that you’ve lost value since that round. Now you’ll need to do what’s called a “down round” (some examples here). In most cases, this spells the end for your start-up.

OK, with those warning out of my system, let’s look at some definitions and how I’ve done things so far.

Investor vs. Advisor, and Some Definitions

When dealing with tech start-ups, the following terms are important to understand. Below are some very general definitions, keeping in mind that almost everything is negotiated and on a case-by-case basis:

“Seed” or “Series-A” = two early rounds of financing common in the start-up world. “Seed” is first, and often either family and friends or $100,000-$1,000,000 from angels. “Series-A” might be around $1,000,000-$5,000,000 and comprise primarily angels and perhaps 1-2 venture capitalists from larger firms that could later participate in larger “Series-B” or “Series-C” rounds, if needed for profitability or to compete. These “B” or “C” rounds usually involve many millions of dollars, which few angels will put up as individuals.

“Dilution” = Having your percentage ownership lowered when new investors come in. If, for example, you own 1% of a start-up at seed stage, if there are any future rounds of financing, your portion of the pie will almost always shrink–you will be diluted. This is critical to keep in mind when calculating potential outcomes as an investor or advisor.

“Investor” = someone who writes checks in exchange for equity (a certain % ownership) in the start-up.

“Advisor” = someone who advises a start-up in exchange for equity over time. “Advising” can include key introductions (to customers, partners, important hires), “syndicating” financing (getting other investors on board), developing/improving the product, helping with PR/marketing/customer-acquisition, or anything else a start-up might need.

So what percentage do advisors get? For someone who’s just doing a few intro’s, or whose name you’re using to get investors, it might be 0.10 – 0.25%. For someone who’s investing real time and helping to build the company, or someone whose involvement could make the difference between success and failure, it could be as high as 2%… or even more. There are start-ups who think giving more than 0.25% is ridiculous, and there are start-ups who find 2% a steal if they can get the right person.

Advisors generally receive their equity over a period of time, often 12-24 months.

This means that if an advisor signs an agreement for 1% that “vests” over 12 months, he would get 1/12 of one percent each month, and the start-up can cancel the deal at any time. If the start-up gets fed up with this advisor after six months, it means he gets the 0.5 percent that vested, but no more.

Different strokes for different folks, but all-star advisors generally = better investors, better investment terms, and faster outcomes. To me, that’s a legitimate no-brainer.

If I were to found a tech start-up and aim for the fences (IPO or sale), I would do what several successful tech CEOs I know are doing right now: give 3-5 bad-ass advisors 1-2% each, depending on time required, and self-fund until you hit break-even or profitability. Then, go out to raise $500-750,000 from key angels who can open doors to potential acquirers and help you get to “scale”. “Scale”, in this context, meaning the point at which you can go big, as in millions of users or nationwide, with the simple addition of money: the costs and revenues of your customer acquisition are predictable. Money in = more money out.

Last, you go to potential acquirers (often potential competitors) to see if they’d like to discuss “partnerships” or funding you; both approaches are used to start conversations that hopefully end with “why don’t we just buy you instead?” from their side.

If that doesn’t work, you get more funding, grow a lean monster, and eat their lunch.

The Start-Ups and Deal Flow

Here are the start-ups I’m involved with, whether as an investor or advisor, in no particular order:

Twitter (investor) – micro-blogging platform
Digg (investor) – see what’s most popular on the web
StumbleUpon (advisor) – Pandora for the coolest content on the web (this is how I find much of my most popular Twitter material)
Evernote (advisor) – capture anything in the world you want to remember
Posterous (investor, advisor) – the simplest blogging platform in the world
CrowdFlower (advisor) – crowd-source just about anything for pennies; 500,000 workers in 70+ countries.
SimpleGeo (investor) – on-demand geodata infrastructure
Graphic.ly (advisor) – the next (gorgeous) evolution of comic books
Foodzie (investor, advisor) – find and buy incredible artisinal food in the US (my favorite cookies in the world are here)
Shopify (advisor) – beautiful and easy e-commerce for selling anything
RescueTime (investor, advisor) – time and productivity tracking
ReputationDefender (investor) – monitor and repair your reputation online
TaskRabbit (advisor) – get any task done, from dry cleaning to research (use code “FERRISS10″ for $10 off your first task)
UberCab (advisor) – Fully automated car dispatch with built-in reputation system – ride like a European diplomat.
Badongo, DocumentHosting.com (investor) – file and document hosting/sharing
DailyBurn (investor, advisor) – exercise and diet tracking
iMarket Services (advisor) – creating hubs for niche markets like stand-up comedy
Samasource (not-for-profit – advisor) – outsource your tasks to those most in need (refugees, etc.)
Donorschoose.org (not-for-profit – advisor) – eBay for helping public school children in need of basic supplies.

“Deal flow” refers to how you find the start-ups you invest in, or how they find you. All of the companies except DonorsChoose.org and iMarket Services (respectively: have known the CEO for ages, chance meeting at SuperBowl party) were found through:

- Referrals from friends who are angels and tech CEOs
- Y-Combinator (Posterous, RescueTime)
- TechStars (DailyBurn, Foodzie, Graphic.ly)
- Facebook Fund (fbFund) (TaskRabbit, Samasource)
- Twitter DMs from me to the founders (Evernote, Shopify)

My Rules

What makes me interested in a start-up… or rules them out?

Let’s go through the bullet-points–general rules of thumb–first, some of which are borrowed from much more experienced folk like Mike Maples, Chris Sacca, Travis Kalanick, and others.

These are the considerations I run through when looking at start-ups, but it doesn’t mean that all of the companies in the portfolio passed all of the criteria.

In no particular order, and written as a stream of consciousness:

- If my readers won’t shut up about them, I listen (this led me to reach out to Evernote and Shopify)

- I generally look for these questions to be answered via email, but I now much prefer to have them answered through the AngelList form. If you don’t know the terms (“deck”, “traction”, etc.), you need to learn them before pitching Silicon Valley types.

- Does it offer the possibility of at least a 5x return? Good angel investors in Silicon Valley do not invest in lifestyle businesses or profit shares–they want to turn their $100,000 into millions. 5x return potential is just the entry point for working with decent angels at the seed or Series-A level. Many will be filtering for 20-30x potential, depending on the size of their fund.

- If it’s a single founder, the founder must be technical. Two technical co-founders are ideal.

- Have the founders ever had crappy service jobs, like waitering or bussing at restaurants? If so, they tend to stay grounded for longer. Less entitlement and megalomania usually means better decisions and better drinking company.

- I must be eager to use the product myself. This rules out many great companies, but I want a verified market I understand.

- I must understand their customers and be able to recruit, in military terms, HVTs–High Value Targets.

- Do the founders actually test some of what I’m recommending? My data is based on 15+ start-ups and more than $1M in direct response advertising–there are a few things I understand very well, sign-up conversion being one example. I will usually suggest 1-2 elements for testing in an initial meeting, well before investing, and if at least one element isn’t tested within a week, they’re out. If the product (usually a website) isn’t split tested or “iterated” fast enough, it usually foreshadows death for tech start-up. Speed is often the only competitive advantage smaller guys have.

- They need to understand the eco-system in which they play. What recent companies have sold for what amounts? Who are the most likely acquirers? Who are the most formidable competitors, and what types of funding (even investors) and resources do they anticipate needing to compete? It it a winner-takes-all market where only one company will reign supreme (e.g. businesses dependent on network effects), or can many large profitable companies co-exist?

- Founders must pass the “mall test”: if you were to see them in a mall, would you walk in a different direction, would you walk over to say “hi” and move on, or would you invite them to join you for coffee or whatever you’re doing next? If the founders don’t fall in the last group, don’t invest. This is a close cousin of the simpler “would you invite them out for beers just to catch up” test.

- Am I following my rules, but are other investors turning them down? These days, I take this as a positive sign. Mike Maples explained this to me: breaking your rules to co-invest with well-known investors is usually a bad idea, but following your rules when others reject a start-up can work out extremely well. DailyBurn, my only exit to date, was a mild example of this. They hit my checklist boxes, but the majority of the investors (but not all) I asked to participate declined. It thrills me that this start-up–from Alabama!–has so far outpaced most in Silicon Valley. Bravo.

Now the rules that require a little explanation:

1. Don’t do it solely for the money, but know your minimums.

Investing in start-ups has to be, on some level, a labor love. You need to love helping entrepreneurs. That said, don’t actively waste your money and life by failing to do basic math.

Set a minimum threshold for each start-up investment. The minimums could be what a success should cover, or a minimum dollar amount. For example:

A. Each start-up, if it exits at 5x its current valuation, should be able to cover 2/3 of your total fund.

Most entrepreneurs think their start-up will be the next Google, but you can’t base your investment strategy on the assumption that each company has the potential to exit for a billion dollars. Look at comparables (similar companies) that have sold, and their average purchase prices. If you want to keep it simple, you might use 5x at Series A round as your assumed “success” multiple.

What this means:

Let’s say a company is raising $500,000 in a Series A. Investors decide it is currently worth $1,000,000, so–after receiving the $500,000 infusion–it will have a $1,500,000 “post-money” valuation. (For sake of simplicity, we assume that Investors don’t require an option pool for new employees to be set aside in the pre-money valuation. For more on that, read this) Let’s also say that you put in $15,000, so you “own” 1% of the company post-money.

Remember the rule of the header: “Each start-up, if it exits at 5x its current valuation, should be able to cover 2/3 of your portfolio.”

Most of your start-ups will fail, so the successes need to make up for losses.

If we’re using the “2/3″ rule, and your fund (like mine from 2007-2009) is $120,000, you shouldn’t invest $15,000 in this start-up, as 15K x 5 = $75,000. 2/3 of $120,000 is $80,000, so you’d either have to invest slightly more, lower the valuation, or add in advising and get more equity in return. This isn’t even accounting for dilution, which is likely in most cases.

B. Each start-up, if it exits at 3x its current valuation, should allow you to walk away with $300,000.

This is one of my preferred methods for qualifying or disqualifying a start-up.

As much as I might love them, I’m not going to take another part-time job for 1-3 years for a $50,000 pay-off. This is where first-time entrepreneurs who refuse to give advisors more than 0.25% often lose the forest for the trees.

Let’s say a start-up ends up with a 3-million (3M) post-money valuation. If I help them more than triple the value of their company to 10M, how much do I walk away with if there are no more rounds of funding? If they offer me 0.5%, I walk away with $50,000. If, considering the time invested, I could earn 5x that doing other things, it makes no sense to do the deal if this is my rule.

Woe is the angel who bases his or her decisions on all start-ups having the potential for a billion-dollar exit. Rule #1 in angel investing is, as far as I’m concerned, the same as Warren Buffett’s first two rules of investing:

Rule #1: Don’t lose money.
Rule #2: Don’t forget Rule #1.

2. Move from investor –> investor/advisor –> advisor

Let’s assume you have committed to spending $60,000 per year on angel investments, just as I did. This means two things:

- You aren’t going to be able to satisfy the above rule of “2/3″ or the $200,000 minimum for many companies. At best, you’ll have 1-3 investments.

- 1-3 investments doesn’t work in angel investing, where most pros would agree that 9 out of 10 (on a good day) will fail.

- It’s therefore impossible for you to get a good statistical spread with $60,000 per year. The math just doesn’t work.

The math especially doesn’t work if you f*ck it up like I did (see Part I) by getting over-excited and dropping $50,000 on your first investment. Oops!

Here’s how I dealt with this problem:

First, I invested very small amounts in a few select start-ups, ideally those in close-knit “seed accelerator” (formerly called “incubator”) networks like Y-Combinator and TechStars. Then I did my best to deliver above and beyond the value of my investment. In other words, I wanted the founders to ask themselves “Why the hell is this guy helping us so much for a ridiculously small number of options?” This was critical for establishing a reputation as a major value-add, someone who helped a lot for very little.

Second, leaning on this burgeoning reputation, I began negotiating blended agreements with start-ups involving some investment, but additional advisory equity as a requirement.

Third and last, I made the jump to pure advising. Since the end of the first year of the “Tim Ferriss Fund,” more than 70% of my start-up “investments” have been with time rather than cash. In the last 6 months, I have written only one check for a start-up. The goal is still the same as in the first phase: deliver above and beyond the current value of my potential equity (if fully vested) as quickly as possible. The next post this week will give an example of this.

Comment from a proofreader and experienced angel, Naval Ravikant, who was also a co-founder at Genoa Corp (acquired by Finisar), Epinions.com (IPO via Shopping.com), and Vast.com (largest white-label classifieds marketplace):

One thought – if someone really wants to invest $200K as an angel investor, you’re right in that they can’t spread it across enough companies to diversify it or have it be worth their time. In that case, they could do advisory work as you suggest – or they could fork it over to a super-angel fund. They’d end up paying a 15% in management fees and 20%+ of the profits in carry, but most of the super-angels have pretty good returns and they would get startup exposure for basically a $30K + 20% of the profits cost, and their time is surely worth more than that…

Moving gradually from pure investing to pure advising allowed me to reduce the total amount of capital invested, increase equity percentages, and make the $120,000 work, despite my early slip-ups. This also, I believe, produced better results for the start-ups.

The reason for the better results is related to a common objection.

Some counsel against pure advisors, the belief being that pure advisors have no “skin in the game.” To address this, start-ups might insist on an investment before advising can be discussed. The logic isn’t bad–that an advisor will do more if they have something to lose–but this argument has never compelled me, and I don’t know many good advisors who are compelled by it.

Why?

I feel more compelled to help companies that I have pure advising relationships with for two reasons.

First, if I’ve given a start-up capital, I’ve already given some value. If it’s pure advising, I need to prove my value within the small world of start-up investing or my reputation goes downhill. Second, because my reputation is at stake, I do more due diligence than with pure investments to ensure an excellent fit (their needs + my capabilities) before signing up. Just as important: before offering real equity for advising, a start-up will do likewise, and our marriage–if we get to that point–ends up better as a result.

The start-ups that aren’t great fits, those who haven’t mapped my strengths and weaknesses to their own, look at me, laugh, and ask themselves: “Tim Ferriss wants what?!?”

They’re right, I’m not a good fit. If their desire for me as an advisor is contingent upon an investment, they probably haven’t thought enough about how I’d be able to help (or not help). Either I really can’t help much, in which case I shouldn’t be offered advisor equity at all, or I can really help, in which case they should get me on board with a compelling arrangement for everyone. Start-ups often forgot that the advisor equity vests monthly–advisors still have to earn it or they can be fired.

It’s a hell of a lot of fun advising start-ups with good product and personality fit, even if the companies don’t become the next Google.

But, I do miss a lot of great opportunities by focusing on advising and tight fit. This doesn’t bother me. I haven’t yet lost any money. Rule #1.

Let’s be clear on one point: if you don’t deliver real results for your start-ups, you do not deserve to be an advisor. If you can’t point to a track record of some sort, you haven’t earned the right to ask for advising equity. Pull out the checkbook and pay your dues.

Related Reading

Picking Warren Buffett’s Brain: Notes from a Novice
Rethinking Investing: Common-Sense Advice for Uncommon Times

It’s fun to think about getting an MBA.

They’re attractive for many reasons: developing new business skills, developing a better business network, or — most often — taking what is effectively a two-year vacation that looks good on a resume.

In 2001, and again in 2004, I wanted to do all three things.

This post is the first of two that will share my experience with MBA programs and how I created my own…

In the process, it’s my hope that these writings will make you think about real-world experiments vs. theoretical training, untested assumptions (especially about risk tolerance), and the good game of business as a whole. There is no need to spend $60,000 per year to apply the principles I’ll be discussing.

Last caveat: nothing here is intended to portray me as an investing expert, which I most certainly am not.

Beginnings

Stanford University Graduate School of Business (GSB). Ah, Stanford, with its palm tree-lined avenues and red terra cotta roofing, always held a unique place in my mind.

But my fantasies of attending GSB reached a fever pitch when I sat in on a class called “Entrepreneurship and Venture Capital,” taught by Peter Wendell, who had led early-stage investments in companies such as Intuit. The class is now co-taught by Eric Schmidt, CEO of Google, and Andy Rachleff, founding general partner of Benchmark Capital.

Within 30 minutes, Pete had taught me more about the real-world inside baseball of venture capital than all of the books I’d read on the subject.

I was ecstatic and ready to apply to GSB. Who wouldn’t be?

So I enthusiastically began a process I would repeat twice: downloading the application to get started, taking the full campus tour, and sitting in on other classes.

It was the other classes that got my panties in a twist. Some were incredible, taught by all-stars who’d done it all, but others — many others — were taught by PhD theoreticians who used big words and lots of PowerPoint slides. One teacher spent 45 minutes on slide after slide of equations that could be summed up with “If you build a crappy product, people won’t buy it.” No one needed to prove that to me with differential calculus.

At the end of that class, I turned to my student guide for the tour and asked him how it compared to other classes. He answered: “Oh, this is easily my favorite.”

That was the death of business school for me.

How to Make a Small Fortune

By 2005, I was done chasing my tail with business school, but I still ached to learn more.

Then, in 2007, I started having more frequent lunches with the brilliant Mike Maples, a co-founder of Motive Communications (IPO to $260,000,000 market cap) and a founding executive of Tivoli (sold to IBM for $750,000,000).

Our conversations usually bounced between a few topics, including physical performance, marketing campaigns (I’d just launched The 4-Hour Workweek), and his latest focus: angel investing.

“Angel investing” involves putting relatively small amounts of money — often from $15,000 to $100,000 — into early-stage start-ups. In Mike’s world, “early-stage” could mean two engineers with a prototype for a website, or it could mean a successful serial entrepreneur with a new idea. The angels usually have relevant business experience and are considered “smart money” — their advice and introductions are just as valuable as the money they put in.

After several lunches with Mike, I’d found my business school.

I decided to make (in my mind) a two-year “Tim Ferriss Fund” that would replace Stanford business school.

Stanford GSB isn’t cheap. I rounded it down to $60,000 a year, for a total of $120,000 over two years (these days, it’s $80,000+ per year).

For the “Tim Ferriss Fund,” I would aim to intelligently spend $120,000 over two years on angel investing in $10-20,000 chunks, so 6-12 companies in total. The goal of this “business school” would be to learn as much as possible about start-up finance, deal structuring, rapid product design, initiating acquisition conversations, etc. as possible.

The curriculum could be thought of as “The Start-up Lifecycle from Birth to Acquisition/IPO or Death.” But curriculum was just part of business school; the other part was getting to know the “students,” preferably the most astute movers and shakers in the start-up investing world. Business school = curriculum + network.

The most important characteristic of my personal MBA: I planned on “losing” $120,000.

I went into the “Tim Ferriss Fund” viewing the $120,000 as sunk tuition costs, but also expecting that the lessons learned, and people met, would be worth that $120,000 investment. The two-year plan was to methodically spend $120,000 for the learning experience, not for the ROI.

I would not suggest mimicking this approach:

1) Unless you have a clear informational advantage — insider access — that gives you a competitive advantage. I live in the nexus of Silicon Valley and know many top CEOs and investors, so I have better sources of information than the vast majority of the world. I don’t invest in public companies precisely because I know that professionals have better access to information than I do.

2) Unless you are 100% comfortable losing your “MBA” funds. You should only gamble with what you’re very comfortable losing. If financial loss drives you to even mild desperation or depression, you shouldn’t do it.

3) Unless you have started and/or managed successful businesses in the past.

4) Unless you limit angel investment funds to 10% or less of your liquid assets. I subscribe to the Nassim Taleb school of investment, with 90% in conservative asset classes like AAA bonds and the remaining 10% in speculative investments that can capitalize on positive “black swans”.

The problem is often that, even if the above criteria are met, people overestimate their risk tolerance. From my previous post, ‘Rethinking Investing: Common-Sense Rules for Uncommon Times’:

I’ve come to realize that the questions most investment advisers (and investors) ask are the wrong questions, or incomplete. Even if you have only $100 to invest, this is important to explore.

Most advice and decisions center on one question: what is your risk tolerance?

I had one wealth manager ask me this, and I answered honestly: “I have no idea.” It threw him off.

I then asked him for the average of his clients’ responses. The answer:
“Most answer that they would not panic, up to 20% down in one quarter.”

My follow-up question was: when do most panic and start selling low? His answer:
“When they’re down 5% in one quarter.”

Unless you’ve lost 20% in a quarter, it’s hard—neigh, impossible—to predict your response.

It’s not dissimilar from a common boxing maxim: everyone has a plan until they get punched in the face.

To would-be angel investors, I suggest the following: go to a casino or racetrack and don’t leave until you’ve spent 1/5 of a typical investment and watched it disappear.

Let’s say you’re planning on making $25,000 investments.

I’d ask you to then purposefully lose $5,000 over the course of at least three hours, and certainly not all at once. It’s important that you slowly bleed losses as you attempt to learn the game, to exert some control over something you can’t control. If you can remain unaffected after slowly losing your $5,000 (or 1/5 of your planned typical investment), consider making your first angel investment.

But proceed with caution.

Even among brilliant people in the start-up world, there is an expression: “If you want to make a small fortune, start with a large fortune and angel invest.”

The First Deal and First Lesson

So what did I do? I immediately went out and broke my own rules.

There was a very promising start-up which, based on comparables using Alexa ranking correlations to valuations, was more than 5x undervalued! If it hit even a “base hit” like a $25,000,000 exit, I could easily recoup my planned $120,000!

I got very excited — it’s the next Google! — and cut a check for $50,000. “That’s a bit aggressive for a first deal, don’t you think?” asked one of my mentors over coffee. Not a chance. My intuition was loud and clear. I was convinced, based on other investors and all of the excitement surrounding the deal, that this company was on the cusp of exploding.

Two years later, it still hasn’t popped.

Following the Rules

Lesson #1: If you’ve formulated intelligent rules, follow your own f*cking rules.

I learned many more important lessons over the following two years, most of which I’ll share in the next post. Thus far, following the rules, the stats look something like this:

15 total investments (some of which are listed here)
0 deaths
1 successful exit

The one successful exit thus far, DailyBurn, guarantees that I will not lose money on my two-year fund. But, as they say, “Once you’re lucky. Twice you’re good.” I’m still not convinced I know what I’m doing.

My hope, and that of most angels, is that each start-up will “exit”, or be bought within 3-5 years. I’ll therefore have a more complete view of the “Tim Ferriss Fund” two-year portfolio by 2013. There will be fatalities, no doubt.

But recall that the learning was my main reason for doing all of this.

I had one other exit: my own company. Using what I learned about acquistion deal structures through angel investing, I became less intimidated by the idea of “selling” a company. It need not be complicated, as I learned, and BrainQUICKEN was sold in late 2009. This means the ROI on my personal MBA is, so far, well over 2x and could end up more than 10x.

Creating Your Own MBA

How might you create your own MBA or graduate program? Here are three examples with hypothetical costs, which obviously depend on the program:

Master of Arts in Creative Writing – $12,000/year

How could you spend (or sacrifice) $12,000 a year to become a world-class creative writer? If you make $50,000 per year, this could mean that you join a writers’ group and negotiate Mondays off work (to focus on drafting a novel or screenplay) in exchange for a $10-15,000 salary cut.

Masters in Political Science – (same cost)

Use the same approach to dedicate one day per week to volunteering or working on a political campaign. Decide to read one book per week from the Georgetown PoliSci department’s required first-year curriculum.

MBA – $30,000 per year

Commit to spending $2,500 per month on testing different “muses” intended to be sources of automated income. For an example of such, see “How I Did It: From $7 an Hour to Coaching Major League Baseball MVPs.”

If you’re interested in experimenting with angel investing, whether as an angel or as a start-up, here are a few of my favorite resources:

AngelList
AngelSoft
VentureHacks

Commit–within financial reason–to action instead of theory. Learn to confront the realities and rewards of the real world, rather than resort to the protective womb of academia.

Question of the day (QOD): what would you like to learn specifically about start-ups, angel investing, or start-up financing? Please let me know in the comments with “QOD”.

Continued in Part II…

I’ve known the guys at 37Signals for a little while.

I first met Jason Fried at SXSW in 2008, and I then got to know David Heinemeier Hansson (DHH) over e-mail and in person last year. On a fundamental level, I think, our philosophies just mesh well.

Comfortably situated in Chicago outside of the “start-up” echo chamber, 37Signals is focused on getting sh*t done instead of chasing the Silicon Valley venture capital death spiral. Financing has it’s place, but it’s a means to an end and shouldn’t be confused with an end.

The end is a profitable business. Now, let’s be clear: there are ways to play the acquisition game (or even financing game) and make millions without ever turning a profit. But don’t let the media fool you–you hear of the few successes because the stories are fun to tell. The thousands of failures that die sad but unspectacular deaths don’t get on the magazine covers.

More than 3,000,000 people worldwide use 37Signals products, including me. I use one of them, Basecamp, for project management, and it rocks in its simplicity. I’m not the only one who thinks so: Basecamp generates millions of dollars in profit every year.

37Signals’ employees–fewer than 20 total–are spread across 8 cities on two continents, and no matter how many rules they break, profit seems to be the end result…

This is part of the reason I was excited to get an advanced copy of Rework, their new book, which I encourage people to think of as an Elements of Style for building profitable businesses in a web-savvy world. Each chapter is 2-5 pages long and delivers their tactics and principles fat-free, without fluff. Just like their business models.

Here are a few excerpts to whet your appetite. Profitability doesn’t need to be elusive. It’s a simple process… if you have the right recipe from the outset.

Why grow?

People ask, “How big is your company?” It’s small talk, but they’re not looking for a small answer. The bigger the number, the more impressive, professional, and powerful you sound. “Wow, nice!” they’ll say if you have a hundred-plus employees. If you’re small, you’ll get an “Oh . . . that’s nice.” The former is meant as a compliment; the latter is said just to be polite.

Why is that? What is it about growth and business? Why is expansion always the goal? What’s the attraction of big besides ego? (You’ll need a better answer than “economies of scale.”) What’s wrong with finding the right size and staying there?

Do we look at Harvard or Oxford and say, “If they’d only expand and branch out and hire thousands more professors and go global and open other campuses all over the world . . . then they’d be great schools.” Of course not. That’s not how we measure the value of these institutions. So why is it the way we measure businesses?

Maybe the right size for your company is five people. Maybe it’s forty. Maybe it’s two hundred. Or maybe it’s just you and a laptop. Don’t make assumptions about how big you should be ahead of time. Grow slow and see what feels right—premature hiring is the death of many companies. And avoid huge growth spurts too—they can cause you to skip right over your appropriate size.

Small is not just a stepping-stone. Small is a great destination in itself.

Have you ever noticed that while small businesses wish they were bigger, big businesses dream about being more agile and flexible? And remember, once you get big, it’s really hard to shrink without firing people, damaging morale, and changing the entire way you do business.

Ramping up doesn’t have to be your goal. And we’re not talking just about the number of employees you have either. It’s also true for expenses, rent, IT infrastructure, furniture, etc. These things don’t just happen to you. You decide whether or not to take them on. And if you do take them on, you’ll be taking on new headaches, too. Lock in lots of expenses and you force yourself into building a complex businesss—one that’s a lot more difficult and stressful to run.

Don’t be insecure about aiming to be a small business. Anyone who runs a business that’s sustainable and profitable, whether it’s big or small, should be proud.

Scratch your own itch

The easiest, most straightforward way to create a great product or service is to make something you want to use. That lets you design what you know—and you’ll figure out immediately whether or not what you’re making is any good.

At 37signals, we build products we need to run our own business. For example, we wanted a way to keep track of whom we talked to, what we said, and when we need to follow up next. So we created Highrise, our contact-management software. There was no need for focus groups, market studies, or middlemen. We had the itch, so we scratched it.

When you build a product or service, you make the call on hundreds of tiny decisions each day. If you’re solving someone else’s problem, you’re constantly stabbing in the dark. When you solve your own problem, the light comes on. You know exactly what the right answer is.

Inventor James Dyson scratched his own itch. While vacuuming his home, he realized his bag vacuum cleaner was constantly losing suction power—dust kept clogging the pores in the bag and blocking the airflow. It wasn’t someone else’s imaginary problem; it was a real one that he experienced firsthand. So he decided to solve the problem and came up with the world’s first cyclonic, bagless vacuum cleaner.

Vic Firth came up with the idea of making a better drumstick while playing timpani for the Boston Symphony Orchestra. The sticks he could buy commercially didn’t measure up to the job, so he began making and selling drumsticks from his basement at home. Then one day he dropped a bunch of sticks on the floor and heard all the different pitches. That’s when he began to match up sticks by moisture content, weight, density, and pitch so they were identical pairs. The result became his product’s tag line: “the perfect pair.” Today, Vic Firth’s factory turns out more than 85,000 drumsticks a day and has a 62 percent share in the drumstick market.

Track coach Bill Bowerman decided that his team needed better, lighter running shoes. So he went out to his workshop and poured rubber into the family waffle iron. That’s how Nike’s famous waffle sole was born.

These people scratched their own itch and exposed a huge market of people who needed exactly what they needed. That’s how you should do it too.

When you build what you need, you can also assess the quality of what you make quickly and directly, instead of by proxy.

Mary Kay Wagner, founder of Mary Kay Cosmetics, knew her skin-care products were great because she used them herself. She got them from a local cosmetologist who sold homemade formulas to patients, relatives, and friends. When the cosmetologist passed away, Wagner bought the formulas from the family. She didn’t need focus groups or studies to know the products were good. She just had to look at her own skin.

Best of all, this “solve your own problem” approach lets you fall in love with what you’re making. You know the problem and the value of its solution intimately. There’s no substitute for that. After all, you’ll (hopefully) be working on this for years to come. Maybe even the rest of your life. It better be something you really care about.

Tone is in your fingers

Guitar gurus say, “Tone is in your fingers.” You can buy the same guitar, effects pedals, and amplifier that Eddie Van Halen uses. But when you play that rig, it’s still going to sound like you.

Likewise, Eddie could plug into a crappy Strat/Pignose setup at a pawn shop, and you’d still be able to recognize that it’s Eddie Van Halen playing. Fancy gear can help, but the truth is your tone comes from you.

It’s tempting for people to obsess over tools instead of what they’re going to do with those tools. You know the type: Designers who use an avalanche of funky typefaces and fancy Photoshop filters but don’t have anything to say. Amateur photographers who want to debate film versus digital endlessly instead of focusing on what actually makes a photograph great.

Many amateur golfers think they need expensive clubs. But it’s the swing that matters, not the club. Give Tiger Woods a set of cheap clubs and he’ll still destroy you.

People use equipment as a crutch. They don’t want to put in the hours on the driving range so they spend a ton in the pro shop. They’re looking for a shortcut. But you just don’t need the best gear in the world to be good. And you definitely don’t need it to get started.

In business, too many people obsess over tools, software tricks, scaling issues, fancy office space, lavish furniture, and other frivolities instead of what really matters. And what really matters is how to actually get customers and make money.

You also see it in people who want to blog, podcast, or shoot videos for their business but get hung up on which tools to use. The content is what matters. You can spend tons on fancy equipment, but if you’ve got nothing to say . . . well, you’ve got nothing to say.

Use whatever you’ve got already or can afford cheaply. Then go. It’s not the gear that matters. It’s playing what you’ve got as well as you can. Your tone is in your fingers.

Say no by default

“If I’d listened to customers, I’d have given them a faster horse.”
—HENRY FORD

It’s so easy to say yes. Yes to another feature, yes to an overly optimistic deadline, yes to a mediocre design. Soon, the stack of things you’ve said yes to grows so tall you can’t even see the things you should really be doing.

Start getting into the habit of saying no—even to many of your best ideas. Use the power of no to get your priorities straight. You rarely regret saying no. But you often wind up regretting saying yes.

People avoid saying no because confrontation makes them uncomfortable. But the alternative is even worse. You drag things out, make things complicated, and work on ideas you don’t believe in.

It’s like a relationship: Breaking one up is hard to do, but staying in it just because you’re too chicken to drop the ax is even worse. Deal with the brief discomfort of confrontation up front and avoid the long-term regret.

Don’t believe that “customer is always right” stuff, either. Let’s say you’re a chef. If enough of your customers say your food is too salty or too hot, you change it. But if a few persnickety patrons tell you to add bananas to your lasagna, you’re going to turn them down, and that’s OK. Making a few vocal customers happy isn’t worth it if it ruins the product for everyone else.

ING Direct has built the fastest-growing bank in America by saying no. When customers ask for a credit card, the answer is no. When they ask for an online brokerage, the answer is no. When they ask if they can open an account with a million dollars in it, the answer is no (the bank has a strict deposit maximum). ING wants to keep things simple. That’s why the bank offers just a few savings accounts, certificates of deposit, and mutual funds—and that’s it.

Don’t be a jerk about saying no, though. Just be honest. If you’re not willing to yield to a customer request, be polite and explain why. People are surprisingly understanding when you take the time to explain your point of view. You may even win them over to your way of thinking. If not, recommend a competitor if you think there’s a better solution out there. It’s better to have people be happy using someone else’s product than disgruntled using yours.

Your goal is to make sure your product stays right for you. You’re the one who has to believe in it most. That way, you can say, “I think you’ll love it because I love it.”

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Odds and Ends:

Rework – the first mainstream book by 37Signals
Tim Ferriss on Twitter – Follow my misadventures, experiments, cool findings, and mischief in real-time. It’s fun to watch me stumble.