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  • Writer's picturelise

The Third Rule of Threes - Three Strikes and You are Down and Out

There is an old fable about a fired CEO who leaves three envelopes for the new CEO taking his place with a note that says open them in order when you have a big problem. A few months later revenue is flat to declining. The new CEO opens the first envelope. The note inside says cut budgets and introduce a new product. So, the CEO does just that, and it helps for a while. A year later things are going downhill again, and the CEO opens the second envelope. The note inside says reorganize the company. The CEO does the restructure. It is painful, but costs come down and the company stabilizes for another year or so. Growth is still slow, the BOD is not happy, so the CEO opens the third envelope. The note inside says: write three notes.

This is essentially the third rule of threes for venture capital companies. You get to make three big expensive mistakes. After the third expect a down round of funding and big changes in the leadership team.

Now everyone makes mistakes in business, but all mistakes are not alike. Some are more expensive in terms of dollars, time and company reputation. Recognizing missteps and reacting quickly minimizes impact and keeps mistakes small. However, companies often instead stick stubbornly to a path that is not working or double down with another big mistake that adds to the first.

For example, one company in my past grew very fast with a breakthrough technology, but outran their headlights leading to quality problems in the field that undermined customer trust. Then there was a recall, ironically due to a customer misuse and not a quality problem. Recalls happen, almost every company has one, however this company made it worse by mishandling their response to regulatory bodies and trying to bandaid problematic quality records. This led to 18 months off the market which allowed the competition to develop. Quality problems and mishandling the regulatory bodies were two big mistakes. The third was an emergence from the recall that was poorly received by existing customers who were required to buy specialized cleaning components and employ a labor-intensive cleaning process. A next generation product that still had quality issues and not giving customers any financial credit for trading their old systems soured many in the market for years. The company survived, and ultimately thrived, but only after a major down round and complete leadership refresh.

Big mistakes come different forms and in many business areas. Product mistakes include not delivering on development schedules, failing to achieve regulatory clearances, pursuing non-viable market segments with non-viable value propositions. Missing a big customer need, going for complex but high regulatory claims, letting perfect get in the way of good are common versions of product problems. Get that minimally viable product out on the market fast and have the plans and wherewithal to adapt quickly after release. Know your risks, build contingency plans, keep tight focus on top priorities, and constantly monitor execution to minimize the impact of mistakes.

Go to market errors are another common type of big mistake These are almost always about not knowing your customer, not communicating clearly or building a channel that does not match the customers buying process. Examples of expensive mistakes include foggy messaging, bad pricing or business model, picking the wrong target customer, building a big sales channel or opening too many markets before working out the bugs in your process. All of these are mistakes where the impact can be minimized if you identify them early and pivot fast. That means tempering the natural extreme optimism of the successful start-up mentality with a dose of skepticism.

Infrastructure is also a place where big expensive errors occur. Hiring too many people too fast, investing ERP or accounting infrastructure ahead of the need are expensive in both dollars and company time. Alternatively, hiring too slowly or not buying the tech and systems you need to achieve the milestones set for the business can be big mistakes as well. Always be evaluating your people and processes, are the really delivering the needed results.

Watch for critical milestone misses, know your risks and build contingency plans and mitigations. Question whether any expensive endeavor is truly a smart move that adds value and return on investment. Make mistakes but be vigilant, don't let the little mistakes get big. Three strikes and you are out, but you can hit fouls forever.

The third rule of threes is the one that keeps you in business, and allows the company to grow out of the start-up stage.

The three rules of threes for building a venture business:

  1. Venture Capitalists invest in large market opportunities, proprietary differentiated product, and the team to deliver on the promise

  2. Always have three shots on goal – focus on three strategies to achieve your growth target

  3. You only get three big expensive mistakes – then it is someone else’s turn

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