Silicon Insider: Making a Smart Exit

March 29, 2007 — -- I'm an optimistic guy, and this column usually reflects it. But today I want to write about failing and quitting.

In an optimistic way, of course.

There's a new book out by Charles Koch, CEO of Koch Industries, entitled, appropriately enough, "The Science of Success: How Market-Based Management Built the World's Largest Company." The book was brought to my attention by Nick Schulz, who wrote a fine little essay on it at the Web site Tech Central Station.

While Schulz likes the whole book, his attention is particularly drawn to the section where Koch discusses not the businesses in which his company was successful, but where it failed and bailed out.

As Koch writes: "Progress, whether in business, an economy or science, comes through experimentation and failure. Given that a market economy is an experimental discovery process, business failures are inevitable, and any attempt to eliminate them only ensures overall failure."

That's a profound thought -- you can't succeed in the big stuff unless you occasionally fail in the small -- and it got me thinking once again about failure and the power of a smart exit.

Before Big Reward Comes Big Risk

Tom Peters, in one of his books, credits me with saying, "People think Silicon Valley is all about success, but it is really all about failure." In fact, I was paraphrasing, a bit too facilely, the great marketer (National Semiconductor, Intel, Apple) Regis McKenna.

What Regis always said was that when you are looking to work with, or invest in, a new company, always look for people who have known failure, who have lost their fear of it, and thus are willing to take the kinds of business risks that might court failure again.

I heard that again a decade later from the Valley's most famous venture capitalist, John Doerr. I was interviewing him for an article on what he looked for in an entrepreneurial team that made it worth investing in. Crucial among the factors, he said, was a "good" failure in their past -- that is, a company that failed for any one of a number of right reasons, including being ahead of the market, being unable to create a successful follow-up product, getting crushed by a giant competitor, etc.

I find it telling that this little interview, written for Fast Company magazine in 1997, is, among the thousands of newspaper and magazine articles and columns I've written over the years, the single most linked and downloaded (and presumably, read) piece of my career.

Whenever I run into Doerr, he always gives me a hard time about it, as it is still regularly the No. 1 Google search result for his name -- and the source of endless letters and pitches to his office. Just last week I got an e-mail from a college student from somewhere on the other side of the world congratulating me on the article -- which he assumed was new, having recently read it in class -- and asking advice on starting a new company.

Mind you, this is 10 years after I wrote the thing.

Seeing the Big Picture

Despite my complaining, I do take a certain comfort in the enduring nature of both the Doerr interview and the Peters' quote. It means that there's a sizable number of budding entrepreneurs out there who have at least been warned to look past the myth of overnight success in tech. They're more aware of the reality of a 90-plus percent failure rate in new start-up companies, and the crucial role those dead companies play in both the ecology of places like Silicon Valley and in their own professional career development.

You've got to kiss a lot of frogs before you find a prince, and by the same token you are probably going to bust your butt in a half-dozen or more doomed start-ups before you find "overnight" fame and riches in high-tech. Along the way, you are going to make a ton of mistakes, many of them in the public eye. And some of those mistakes will destroy your business and perhaps even make enemies of your friends and business partners.

That's the underlying message of Charles Koch's quote. Here's the CEO of the most successful private company on the planet, and he readily -- even proudly -- admits to having taken his company into a whole series of new businesses, only to admit defeat and abandon them.

I found the same attitude a few years back, when interviewing for a public television series some of the most famous executives -- Gates, Ellison, Moore, Siebel, McNeely, among others -- in electronics. Every one of them, when asked about the worst failure in his or her career, responded quickly, even enthusiastically, describing disasters that would have sent the rest of us into hiding for years. And to a person, every one of these famous execs explained to me how they had used that disastrous experience to learn how to do it right the next time -- the next time that made them billionaires and industry titans.

Plotting the Exit Strategy

The corollary to learning from defeat is learning when to get out. According to Schulz at TCS, Koch spends a lot of the book explaining not just how his company went into wrong markets, but more importantly, how and why they exited those markets. It turns out that Koch has very specific benchmarks -- profit margins, particularly -- to determine whether the company is sufficiently successful in that business to stay there.

If that sounds pedestrian, you are exactly wrong, dear reader. Indeed, having been part of a dozen start-up companies (six dead, one on hold, two moderately successful, one sold for a billion bucks, one legendary), I can say with all of my heart that knowing when to get into a hot tech company is only the second hardest thing to do in this industry. The hardest is knowing when to get out.

I'll bet that I've met 5,000 paper multimillionaires in my life, and maybe 100 paper billionaires. Some of them are close friends. But the number who actually were able to convert that paper wealth into real wealth could hold a cocktail party in my living room.

Why do all of the others, all at least as brilliant and talented as the winners, fail in this final and crucial step of getting the payoff for their labors? Because entrepreneurship is as much about the heart as the head.

You don't get into entrepreneurship, suffer the long hours and face the nearly impossible odds because you calculated the ROI of this career move… you did so because you are driven by ambition and the need to control your destiny, and you are obsessed with creating an enterprise. And that is why it is so hard to let go, to get above your emotions and to make a true economic decision when it comes to your company, your products and your customers.

Holding Out for 10 Percent

The most common mistake entrepreneurs (and early stage employees) make is to hold out for the last 10 percent. This happens all the time, especially on the reverse slope of industry booms…like right now.

It works like this: You have a chunk of stock options that you exercise for $2 per share when the market price hits $20 per share. That's good money. But you don't sell, figuring that the price is still skyrocketing and your shares can make you rich. You then hang onto the stock until the shares are worth millions -- proving, in your mind, that you really are a genius. You even extrapolated the growth curve of your shares and mentally set the price at which you plan to sell them -- let's say $100.

Now, the stock hits $90 and starts to falter. Keep in mind, you are already $88 per share ahead, but you have your heart set on that hundred buck target. Then, as the boom ends and the market falls, your shares drop to $75 per share. Now, in reality, you are still $73 per share ahead. But in your heart you have just lost $13 (or worse, $25 from your dream price) per share. So you decide to hold on. It's just a temporary blip, you tell yourself, the stock will come roaring back.

The next thing you know (remember 2000-2001?) the stock is $30 per share. You can't sell now because you were a millionaire a week ago, and now all you've got is a couple of years' worth of wages. You're not the genius you thought you were. Now you're just praying the stock will momentarily rebound. Just get back to $50 and I'll sell, you tell yourself. Instead it hits $10. Your shares are now officially underwater.

Resigned, you finally sell… and that's when your tax accountant tells you that you still have to pay capital gains on those same shares at the $20 price you paid to exercise the option. Two weeks ago you were rich, a week ago you had a tidy little bonus, now you are a couple hundred thousand dollars in debt. And all because you just had to get that last 10 percent of money you never really had.There at least a dozen other ways to miss your exit. You can fail to notice that the key players in the company are leaving. Or exhibit loyalty to an indifferent employer when you should be jumping to a hotter competitor. Or sticking around too long after your entrepreneurial personality has become a handicap in your maturing company -- instead of handing off your work to a corporate type who will do a better job of protecting your stock. Or letting the investors decide when you can sell your shares (the notorious founder "lockout"). Or, worst of all, believing your own press clippings.

As I'm sure Mr. Koch would tell you, never fall in love with your products, your markets or your workmates. Plan your exit strategy even as you enter. Risk failure, but never embrace it. And save your dreams for your career, not your portfolio.

TAD'S TAB: Ever regretted not saying hi to that cute girl or guy that caught your eye at the gym or the coffee joint? That's why there's kizmeet.com, designed especially so you can list a description of your brief encounter at 24-hour Fitness or Starbucks and hope that your hopefully significant other will read it and contact you. Think of it as the online version of the old newspaper personal pages, with a lot more information and cross-referencing. Right now kizmeet.com is only available for major cities, but it's too good of an idea not to grow. After all, how often in life, love and flirting do we get a second chance?

Michael S. Malone's new book, "Bill & Dave: How Hewlett and Packard Built the World's Greatest Company," has just been published by Portfolio/Penguin. Said Jim Collins, "I hope it inspires a whole new generation of entrepreneurs to rise to the standards set by these two remarkable leaders." You can find "Bill & Dave" online at all major booksellers.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Michael S. Malone, once called the Boswell of Silicon Valley, is one of the nation's best-known technology writers. He has covered Silicon Valley and high-tech for more than 25 years, beginning with the San Jose Mercury News, as the nation's first daily high-tech reporter. His articles and editorials have appeared in such publications as The Wall Street Journal, the Economist and Fortune, and for two years he was a columnist for The New York Times. He was editor of Forbes ASAP, the world's largest-circulation business-tech magazine, at the height of the dot-com boom. Malone is best-known as the author or co-author of a dozen books, notably the best-selling "Virtual Corporation." Malone has also hosted three public television interview series, and most recently co-produced the celebrated PBS miniseries on social entrepreneurs, "The New Heroes." He has been the ABCNEWS.com "Silicon Insider" columnist since 2000.