Let Us Begin with the Beginning

And so, in conclusion, we project that our exit will occur on July 30, 2019.

Perhaps the only aspect of your business’s future that is less certain than your 3rd year EBITDA, is the financial exit that you and your investors will experience.  But that doesn’t prevent nearly every funding application summary from asking the question “What is your exit strategy”?  I’ve come to the conclusion that this is quite possibly the most useless early due diligence question that is routinely asked.  And yet, I continue to hear the question at venture fairs, in online investor solicitation forms and in private investor meetings.  I believe I audibly sighed the last time I heard it.  Which was rude, but heartfelt.

To begin with, founders that have no revenue and are trying to raise their initial funding round haven’t thought seriously one iota about their exit “strategy”.  They’ve thought a lot about getting rich from their venture, but they haven’t formulated a strategy for it.  They are looking for the on-ramp and you’re asking about the exit 3,000 miles away?  If you ask this question during the formative years of the venture, you aren’t focused on the correct things.

Besides, there are basically only 4 types of exits in all reality.  1) IPO; 2) Be acquired; 3) Pass on to your children, and; 4) Go bankrupt.  The only credible answer from among these 4 is to be acquired.  The investor knows that and so you, founder, should know it too.  Suggesting an IPO makes you sound, to me anyway, naive.  Suggesting passing the business on to your children makes you sound “lifestyle”.  Suggesting bankruptcy makes you sound, well, sarcastic.  I personally find sarcasm to be endearing, but I’ve discovered first-hand that many others, sadly, do not.  So to be clear, however tempting, don’t answer “bankruptcy” to a question about exit strategy.

I do not mean to say that having an exit strategy is not a good idea in general.  There is a time and a place for such a discussion.  Perhaps after 3 years of operating with revenue growth of more than 100% per year, and in a dedicated board meeting when a new round of funding is being considered, some serious thought and discussion should occur around the potential exit paths and multiples. That is generally the time that a strategy for exiting can and should be discussed.  Until the company has developed at least some operating history and product line evolution and customer buying patterns, it is nigh on impossible to discern what companies out there might make the best strategic acquirer. Oh, there will be frequent brief discussions about exit opportunities, but serious thought about strategically positioning your company for exit will not occur until you’ve built something of value.

Besides, shouldn’t we all be much more interested in your entrance strategy? Well before we talk exits, I want you to tell me about how you’re going to acquire your first customer and increase that to the 10th customer.  How are you going to  generate positive cash flow.  Tell me about your gross margins.  How do you get from $0 revenue to $100,000 revenue to $1 million and beyond.  Let’s both worry about your exit…later.

Unfortunately, you’ll find that many investors will ask the question.  If the question does come up for you, and if I’m in the room when it does, I would stand up and applaud if you answer something like this: “We’ll exit through strategic buyout.  But first, we plan to build a fast-growing and cash-flow positive business that fills a market niche that about a dozen Fortune 500-sized businesses do not currently address.  When we’ve built that value, and are of a size that is of interest to one of those companies, we’ll explore our options to get the best value for our shareholders in some sort of strategic buyout.  For now, though, we’re just getting started.”

Posted in Entrepreneurial Advice, Tech Based Economic Development, Uncategorized | Tagged , , , , | 2 Comments

The Secret Energy of Entrepreneurs

Will she have “it”?

I disagree with those who believe that people can be trained to be entrepreneurs.

Scores of scholarly pieces have been written that claim that entrepreneurs are not born, but instead are trained to be good entrepreneurs.  In fact I’d say that most of the pieces I’ve read on the question tend to side with nurture over nature when it comes to entrepreneurial success.   After more than 20 years of working with entrepreneurs of all types, I’m coming to the conclusion that there are three layers of capabilities required to be successful: 1) business skills capabilities; 2) entrepreneurial empowerment beliefs and 3) the secret entrepreneurial energy.  The last one is by far the most important of these.

Those who argue that smart people can become successful entrepreneurs by learning important entrepreneurial skills aren’t necessarily wrong, but they have things in the wrong order.  Business skills such as learning how to manage a sales process, how to select good employees and how to create financial projections are important for running a business, but not for the cliff-leap of STARTING one.  If you don’t first start one, your business skills won’t matter…except for supporting someone else’s venture.  If you do start one, but don’t learn advanced business skills (or don’t hire someone with advanced business skills), your likelihood of success is diminished but not eliminated.  As review: good business skills are important, but the secret energy of entrepreneurs is imperative.  Moving on.

After many years on this planet, I’ve come to the conclusion that no one amounts to anything unless someone teaches them that they can amount to something.  Countless, countless, countless people on planet earth have instincts, smarts and guts enough to become anything they want to become.  However, if there is no one around you to tell you that you CAN do it, even though you’re a little afraid, you will never do it.  People who are taught that “Failure might happen, but you can recover” or “Failure can happen, but you can try again” are the only ones who are NOT afraid to fail.   I’ve made a lot of dinner-table speeches to my kids helping them understand how they can become whatever they want to become.  They know it takes hard work to succeed at what they pursue.  They’ve seen us sacrifice today for the things tomorrow brings.  And I’ve seen some of their friends who, I believe, have never been taught that success is an option.   If Mother/Father make it ok to be an entrepreneur…and allow what they teach…the business founder who has heard that message has a much greater chance of succeeding.  I haven’t quite figured out how to work this into my due diligence when evaluating a client.  But I’ve learned to look for it…and after several months, I know it is there or it is not.

Posession of business skills and the notion that entrepreneurial success is an option are important.  But, possessing the secret entrepreneurial energy is the imperative, seminal ingredient. The secret entrepreneurial ingredient cannot be discovered under questioning alone.  If I ask an entrepreneur the question “after 14 months of $0 sales when you expected $1.2 million in sales, can you continue to look your spouse in the eye”, I will not learn if that entrepreneur has “it” from his answer.   I cannot expect an accurate answer in June, 2012 “if your business still has no investors in October, 2014, even though you will have 2nd-mortgaged your house, will you be tempted to take another job?”  I could try a more direct question…”If you discover that your master plan sucks two years after you thought you’d retire, will you still battle on?”  Or this: “How many “No’s” will you accept before a “Yes”?  Or this: “Son, as your father, I beg you to give up this false hope and take the job with Uncle Joe.”  How do you test for that?  Exactly what “nature v. nurture” scholarly piece do you ascribe to that makes this an obvious investment decision? What answer will indicate “winner”? What answer will indicate “loser”?

I do not wish to leave my precious reader in suspense.  My answer is that you cannot determine whether your prospect has the secret entrepreneurial energy from questioning alone.  No southern-Cali-successful 12 week accelerator can successfully separate winner entrepreneurs from loser entrepreneurs.  You have NOT uncovered the nature of the entrepreneur.  The founder might give a wicked-awesome investor presentation on “Pitch Day”.  The founder might have the perfect B-School pedigree-pitch-deck.  The founder might believe he is the chosen-one, possibly fulfilling the two least important successful-entrepreneur characteristics.  But will she dig deep?  Will he sacrifice beyond reasonable American limits?  Will the founder be selective in taking advice instead of chasing every suggestion that comes her way?  Will that founder sacrifice when sacrifice seems ridiculous?  If you are a seed stage investor with an Accelerator, Incubator, State Fund, Local Fund, Family Office, Angel Group or Venture Fund, and after a few months you observe the secret energy…please, please, please invest in that person.  Put yourself out there with the founder.  Be one with the energy that built this country and together, rebuild it.

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Ohhhhh. I Get It Now. You Said Valuation…I Thought You Said Value.

I am obviously slower than I thought I was.  And I’m certainly slower than the capital aggregators known as Silicon Valley venture capital.  They understood long before I did that early stage company investing is NOT about the value of the company.  It’s about the valuation.

ColorLabs was the poster child for this.  Instagram, of course, is the current poster child for this.  And now perhaps Viddy is the future.

When very large amounts of cash are concentrated in a relatively very few hands, as we have right now in the Venture Capital industry and on corporate American balance sheets, ever bigger deals are required to get the attention of investors.  If BIG VC has an $800 million fund and soaked up cash from LP’s who decided to NOT spread their investment into 10 smaller funds, that could mean that 10 $80 million funds might not get started.  Does this matter to anyone?  It certainly doesn’t matter to those with the $800 million.  They can now invest $10-$15 million at a time in companies whose valuations can double to $100 million and redouble to $200 million in a matter of months as hot companies start speeding up the valuation chain.  This is great news when you live in the land of Google and Facebook and other giants whose cash-laden balance sheets will always make them the potential last stop on the valuation express.

Good news for Viddy A Round investors who put in $6 million in February, 2012…another $30 million from a bevy of Hollywood stars and institutional VC’s have loaded up the company’s balance sheet with enough cash to…well, to do little more than appreciate in value.  The company has a nifty 15-second video sharing platform that will seemingly have a trillion users and a $100 trillion market cap in a few weeks.  Might even have a little revenue.  Battery Ventures and Greylock that put up cash for Viddy, and Sequoia and Khosla and others who put up for other social media rocket ships are comprised of damned smart people.  If Viddy doesn’t make them a boatload of cash, one of the other dozens of social media companies will do so.

America’s capitalist history is replete with successful investors in whom wealth became concentrated over time.  And it is good.  However, those investors invested in businesses of value that increased in valuation.  Vanderbilt, Hilton, Ford, Schwab, Morgan, Jobs and other icons built companies of value and the valuation followed.  Their businesses employed 100’s of thousands of people, usually Americans, and the country flourished from sea to sea.  What value is there in a photo sharing service?  A service that will make your picture look like it came out of your grandfathers Kodak?  It builds wealth but little lasting value.  The businesses like these don’t make us smarter or healthier or more self-sufficient or better able to defend ourselves in times of war.  There is very little value in being able to share the picture of my funny cat; there can be tremendous valuation.

These social media businesses are not “worthless”.  Advertising businesses have been around for decades.  And I don’t know whether 10 funds with $80 million each, making $500,000 to $3 million investments in companies with few if any paying customers would build this country better than 1 fund with $800 million making $10-15 million bets on companies with few if any paying customers!  But I do know from economics that when BIG Government invests heavily in expansionary policies, something called “crowding out” occurs.  Government spending soaks up private investment dollars in government bonds and, therefore, in their investments as interest rates rise to attract that capital, thus crowding out private sector investments.  This is happening in Silicon Valley right now.  The interest rate increase is replaced with rampant valuation increases, thus soaking up limited partner cash and crowding out investments in companies with value…but not hyper inflationary valuations.

We need more seed stage investors in a wide variety of businesses, but no investor is going to care as long as the valuation machine keeps ringing up huge increases.  Today’s climate in early stage investing forces smart people to think extremely short term, and why not?  They are being rewarded for it. I just hope that the short-term thinking isn’t successful a whole lot longer.  We’ve got a lot of problems in this country that can only be fixed with long term thinking…let me know if you want to know what they are.  I’ll tweet you a picture.

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VentureTips…Make Your Business About Your Customers, Not About Your Technology

A founder came to see me yesterday to give me an update on how 2011 went and to bounce some ideas off of me for where to take the company next.  The company is a small business that is approaching $500,000 in revenue.  Their software serves a very narrow market niche currently and has generally been an installed piece of software until the last 12 months or so when they offered up a web-based version.  In looking at their market and segments within it, we figured they’d probably landed about 10% of the target customers.  And they’ve sold the boxed version of the software to about 3,000 customers and the online version has now been sold to about 200 more. 

Their software application, with a bit of investment and a new hire or two, could be adapted to a couple of other niche industries.  And the founders love their little application.  Their potential new market niches seemed to get the founders pretty excited and they had basically defined their fundraising needs so that they could build the new product and start marketing it to the new customer base.

I asked him why he would want to do that.  He said it was because “the application is just so darned flexible.”  I told him that I thought his 3,000+ customers deserve more from him than that, and so do the next 3,000 customers!

Now I’ll be honest.  Many of the clients I work with have, well, zero clients.  So my rather dull eyes immediately focused on all those shiny customers.  I felt it was obvious that he was in danger of ignoring the most important asset his business had accumulated over the years…his customers!  The first version of the software he built was built on an ancient platform and very difficult to use, as evidenced by the support document which was a 500 page, photocopied, ring-bound tome. And this unsophisticated mess was released not 20 years ago, but in 2003!  And guess what…?  People were buying it!  And now he has managed to begin converting his customer base to the online version of the site, which they’ll have to visit every single day their businesses are open.  He landed one of the largest companies in the industry as a client at the end of 2011.  And yet, somehow, he was fixated on the software and not the customers.

There are certainly opportunities to pursue the development of other market applications with their platform.  However, these should be opportunistic at best and will not likely involve his company directly, but perhaps through some licensed version of the code.  Without a doubt, for some other companies, pursuing new niches is a good idea strategically…especially when your current niche ain’t buyin’.  So every company is different.  But when you’re having the kind of success mining a mountain that this company is having, and you’ve only mined 10% of the gems, why would you go looking for a new mountain?

The end of the story is a long way off.  But my advice to him was to build a financing plan that focused on 1) landing the next 3,000 customers and 2) begin exploring additional products and services to sell to the growing, fairly homogeneous customer base.  Not only will it require less capital (he was asking for a lot, I think), but the money he does raise can immediately be used to buy additional share in what I think is an increasingly easy market for him to mine.

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Q. Why Did the Chicken Cross the Road? A. To Get to a Real Incubator.

Yesterday I received an email from an entrepreneur who wrote: “I am launching a startup in the mobile/social media/sales & e-payments/arts & networking arena this summer and am looking to get into an accelerator.”  Rather than try to figure out what that type of business this might be, I basically responded “Thanks for reaching out Ben Franklin TechVentures.  I’m sorry, but we are an incubator, not an accelerator.”  It was perhaps a bit sarcastic, but it is how I feel and with that response, and this blog post, I’m formally registering a complaint to the people in charge of word usage.  The word “incubator” has been hijacked by many people, most of whom are from southern California and even more perniciously, I suspect, belong to the 1%!  These people, for the second time in just over a decade mind you, have taken the good word “incubator” and have begun mixing it, as if synonymous with, the word “accelerator”.  And now, the people from that world, are declaring that there are too many incubators!  There are NOT too many incubators…there ARE too many accelerators and have been since there were more than 2 of them.

Late in the first Dot.Com era, many venture capital firms carved out some office space and a shared conference room in their buildings and called them “incubators”.  “Bootcamps” were provided where unqualified entrepreneurs “ideated” every conceivable web-based interpretation of standard businesses known to man.  They were taught about raising venture capital from VC’s (talk about the vultures watching the incubator!).  This is happening again, late as we are in the second Dot.Com era.  Y Combinator leads this pack and there are now calls that there are too many incubators and that the concept has been watered down.  Here is one example of an outstanding blog post/rant on the topic by @littleidea on his Blog, StochasticResonance.  I’ve asked the author to do a “search/replace” of “incubator” for “accelerator”.  Probably not fair to ask, but it is the start of my campaign.

I would very much like to draw a sharp difference between an incubator and an accelerator.

Accelerator programs tend to obtain equity stakes in conceptual companies.  In exchange for the ownership stake, the founders get access to a network of people and brainstorming sessions that craft an actual business idea around the concept…like the one from the guy who emailed me.  The goal of the accelerator is to have the founders present these only partially baked concepts to a “deal day” where lots of attendees tweet out about all the great deals they’re seeing.  Many receive investment and the whole thing is declared a victorious and noble exercise.  The problem for us is that obtaining finance is the measurement of success.  Three months of networking and hacking and logo creation does not create a sustainable business!  It creates a hyped, auction-like environment where the buzz in the room gets ahead of actual value.  These unviable concepts spend their invested dollars trying to lure non-paying customers to their applications until it is obvious that they don’t have companies at all, but merely “features” that are sold to Google or Microsoft or a few others who have enough cash to overpay for features, and the founders either start another concept or become investors themselves.

I’m bearish on the accelerator business model and I hope it disappears soon but I’m worried about the damage its demise will have on actual incubator programs.  After Dot.Com crash #1, government support for and private sector respect for true incubators waned.  Somehow, my old-school incubator program that had created a few public companies and few multi-100 employee companies was equated to the flameout ridiculousness of Pets.com and the like.  The best argument I could use was that real incubators invest  in people and businesses that will build long term value while the accelerators invested in short term financial opportunities.  Real incubators also don’t have the luxury on focusing only on things described as “mobile/social/sales…whatever”.  We focus on sustainable companies in life sciences, electronics, advanced materials and more.  These companies require a more sustained effort and can’t be built in 3 months.  It is an important distinction to make and I’m unhappy that we’re going to have to try to make it again.

The eye-popping, but arguably overinflated, values of companies like GroupOn and Facebook are beginning to be tempered as Zynga’s tepid reception may be showing.  This is overdue.  A weakness in our capitalist system is our inability to stay focused on true value when shiny returns blaze through the sky.  I’m not sure how to measure it, but my economics training tells me that the money flowing into accelerator-supported type ventures has come at the expense of incubator-supported type ventures.  Perhaps it has been a phenomenon of desperation in a crappy economy.  Perhaps a rising overall economic tide will once again make it ok to invest in companies that seek profit rather than freemium growth.  Perhaps the word incubator can once again describe a place where businesses are warmed instead of super-heated and the focus is again on the business of chickens and not just the eggs.

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Every Top 10 List Deserves a Few Cautions

Martin Zwilling’s recent post discussing “10 Clues That It May Be Time To Start Your Own Business”  is only partly useful.  It provides a checklist of feelings or observations that, if you experience them, may help you recognize that you may be a candidate to start your own business.  I’d argue that nearly everyone could look down that list and say “Aha! I should start my own business!”  And perhaps you should.  It would re-start the American economy like never before.  However, in order to avoid a stampede to your local lawyer’s office to create your  Newco, I’d like to add a few things to additionally consider.  Like the sign, this blog post is merely a caution to keep you off the rocks of life.

1.  Are you in the right place in your life?  Dozens of entrepreneurs who’ve never started a company before in their lives show up in my office every year.  After many years doing this, I can get a sense in a few minutes whether I think the founder may or may not have the pieces together to get started.  One of the questions I often ask of those I’m on the fence with is “Are you in the right place in your life to do this?”  In that question I’m digging into the financial and emotional support that will be necessary to carry the founder through the usually-difficult first dozen or more months of launching a technology company.  You should ask yourself the same question.  Do you have a spouse with a job sufficient to carry the homefront expenses reasonably?  Or, do you have a pool of capital you can use to pay for the homefront expenses.  Do you have 3 kids in college…or are you about to?  Do you have three kids in elementary school who need to be taxi’d everywhere every day of the week?  Have you explained to your spouse, honestly, the difficulty of starting a venture like this?  Is he or she supportive?  Does he or she understand that progress–real progress– in the business still may not produce a paycheck for you?

This line of questioning can be discouraging.  But I, and other investors, need to know that you’re in it for the long haul.  We need to believe, and you should too, that the pressure at the business won’t be overshadowed by the pressure at home.  That work-life balance we hear so much about will need to be way out of balance in the beginning.

2.  Get yourself an unrelated partner.  There are two reasons why I tend to stay away from investing in one-person technology ventures.  The first reason is that one person, yes even you, does not know enough to succeed.  You need to find a business partner who has a different base of experience and knowledge than you.  Note that this should not be a person you met at a trade conference last week and you “really hit it off and see eye-to-eye on business ideas”.  It needs to be someone you’ve known for quite a while and best, have worked with under fire in the past.  Unfortunately for many people, this leads them to partnering with their spouse. Or sibling.  Or other person they are likely to eat Thanksgiving dinner with for the next 20 years.  Investors don’t want to invest in family led teams for a very good reason: they bring a lot of baggage.  No…find a partner from work-world.

The second reason you need a partner, in addition to nearly doubling your knowledge is that it doubles your time.  The extra brain, working on solving the challenges of the business and being able to have your company present in two places at once is critical.  So many entrepreneurs tell me about all the “sweat equity” they’ve invested…and often try to quantify if dollar terms.  Time is like money only if you use it effectively.  A smart partner helps you double this investment of time.

3.  Are you resilient and resourceful?  Think about times that you’ve struggled or failed at something.  How did you overcome the problem? I’m telling you to look and think deeply about it.  Starting this venture you’re contemplating will NOT be as easy as you’re projecting it to be.  Investors want to know that you are always problem-solving.  The trick to success in starting high-tech ventures is being able to find Plan B, Plan C, etc.  The current term for this is “pivot”, but it is not a new concept.  Are you always finding 2 and 3 ways to solve a problem?  They won’t be optimal solutions, but you need some sort of options when things go wrong.  You’ll need sources of emotional and intellectual support when things do go wrong…see #1 and #2 above.

So take a look at the 10 clues list prepared by Zwilling.  Think about taking the first step on what will undoubtedly be the most professionally and intellectually big adventure of your life.  Just be sure you and those around you are prepared for all the “one step backwards” that tend to follow all the “two steps forwards”.

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The Difference between “Should Do” and “Have To”

Those of us not directly involved with the incidents surrounding Penn State this week will never truly know what happened.  We won’t know who all knew what.  We won’t know who told who what and when.  We won’t know who really was a coward and who really was a hero.  All of that occurred in closed offices, private meetings and in the world that Jerry Sandusky created in order to carry on his horrible, detestable acts.

But like during the filming of a movie, and the director says “Cut”, the house lights are now on. From here on we’ll be able to clearly see who the actors are and how they behave without the benefit of shadowy props to hide behind.   Brings a little real reality to the world of contrived reality that our culture seems to have devolved into.

The first scene under those bright house lights played out when the Penn State Board of Trustees announced the dismissals of the University President and the beloved head football coach.  The explanation I’ve heard most observers give for why Penn State fired them was that they “had to”.  They “had to” fire them to protect their program.  They “had to” fire them to show they were cleaning house.  They “had to” fire them for legal reasons.  If this sounds familiar, that’s because it is.  I’ve come to the conclusion that I think it is all too familiar.  What I’d like to hear more from boards of trustees, from boards of directors at for- and non-profit companies and, Heaven knows, from the halls of government is “What we should do…”

I may be making to much of semantics.  I do it all the time.  But for me, the phrase “We had to do…” carries with it an implied pronouncement of guilt.  It says to me that “At one time we knew the right thing to do, but we didn’t do it.  So now we feel as though we have to do this other thing because we screwed up so badly before.”  There is an admission of guilt cleverly hidden inside the phrasing.  “We had to do…” is really saying “We are only doing this now because we need to look like we are taking some action.”  It is often followed by phrases like, “in the best interest of…” and  “we regret any offense you may have taken as a result…”  As if it is your fault somehow, but certainly not ours.

The system we’ve contrived for protecting financial assets are to blame for “we had to…” It turns out that lawyers and media outlets are the things lurking in the shadows of those movie sets.  Lawyers and media stand to gain when our organizations and leaders use the phrase “we had to…”  Big and small institutions have had to develop complicated employee manuals that require specific steps be taken (and specific language be used) in times of crisis.  Most of the rules lead back to the lawyers, of course.  And to long processes which, usually to avoid the media, lead back into the shadows.  And private offices.  And settlement agreements with aggrieved victims, worded as carefully as the public statements that are later made which usually begin with “We regret that we had to…”

What we’re missing too often is the phrase “should do”.  In the case of Penn State, it might have been used in this manner in 1998, when the actions of this cretin Sandusky first came to light: “We should fire his ass right this instant and tell everyone within shouting distance what a despicable miscreant he is.”  I mean where are we, as a civilization in a long history  of civilizations, when we do not have a reward structure in place to use the phrase “should do”.  Unfortunately, I’m guessing we are right where all civilizations have stood when they have a lot to lose.  More defensive than offensive.  More hunkered down than opened up.  More willing to work in the contrived lighting of a controlled scene than to use a moral compass to point us into the house lighted theater of what we should do.

As I said, those of us outside the room will never know what really happened and who knew what when in the case of Penn State.  What I do know is that Penn State had something to lose in 1998 by using the phrase “What we should do is…” and instead of taking the high ground of “should do” they allowed unknown amounts of pain and suffering, and now they’re left to the consequences, and the shadows, of “have to”.

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We Better Define Success Before Declaring It

Ten years ago, in my office, I was fortunate to have observed an “A-HA!” moment that pops back into my head more than once in a while.  In my office was a very well known and successful venture capitalist and an entrepreneur who was about 3 years into his second start-up.  His first start-up had grown to about 30 employees and almost $10 million in revenue.  He then sold that company to a Fortune 500, worked through his earnout period and made a tidy sum (that company, by the way, became a division of the larger company eventually generating $700 million in revenue for the Fortune 500 company…how do you quantify the impact of that?).  The venture capitalist did not invest in that company, but the two men mutually respected each other a great deal.  When the entrepreneur started his second company, he didn’t seek any outside capital.

In the chance meeting in my office the two greeted each other warmly with the “How’ve you been’s?” and “How’s your family’s?”  When the VC asked the entrepreneur about his second venture, the moment of truth had come.  In answer to the VC question “How’s the business?”, my entrepreneur said “Well, I think we’ve done it again!”.  The VC exclaimed “That’s awesome…who did you sell the company to this time?!”.  The entrepreneur was a bit surprised by the question and rather sheepishly responded with the answer that in fact he hadn’t found a buyer for his company, but rather had reached profitability on $1 million in revenue.

Venture capitalists are required to think about the end game and the exit as one of the first considerations.  They are being paid, most often, for managing other people’s money and have made certain promises to those people about their expected performance.  It gets ingrained in them to define success as an exit…their livelihood depends on it.  This has not really changed, nor will it.  I’ve gotten to know this particular VC very well over the past 10 years and, it should be said, he thinks quite differently than this under the surface.  But at that moment of truth, his professional mindset popped out, and it was all about the success of the exit and not at all about the success of the business.

I’m probably overstating this…ok, I’m sure I’m overstating this… but I think a problem in the technology economy of the US lately has been that too many entrepreneurs are thinking like VC’s.  Programs like TechStars, YCombinator and the like have taught the entrepreneur, I think, that success is to be defined as a funding event.  Building a business with paying customers and profit is no longer valued by too many VC’s or entrepreneurs.  See “GroupOn”.

There is too much emphasis on building companies for the short-term.  Recently there has been a lot of investment in “features” rather than companies.  As we saw in the dot.com era, there were a lot of “companies” funded and created to sell a specific line of products.  It turns out we didn’t really need these.  We needed more of a department store where all things are sold.  Amazon survives to evolve and Sockpuppets.com disappears.  The focus was on growth in eyeballs and profit comes later.  We don’t need to build a sustainable business model since we’ll sell it long before that matters.

Entrepreneurs should be patient for growth but impatient for profit.  That formula seems to be reversed these days, and I think it is better for the country if it turns back around soon.  There is some good in the fact that investors and founders are “aligned”, but a little balance is probably good for us.  There should be a little passion by the founder to want to “build a sustainable business” rather than “build toward an exit”.  Sometimes they win the argument and sustainable businesses are built.  When entrepreneurs think too much like investors, we get too much of a unanimous “flip” mentality that creates less regard for customers, partners and employees.

Posted in Entrepreneurial Advice, Seed/Venture Capital, Uncategorized | Tagged , , , | Leave a comment

What Erich Brenn Can Teach Us About Funding of Start-Ups

Who remembers Erich Brenn?  In these blog posts, I’ve occasionally tried to understand, and explain, the business world I see by comparing it to famous people you’ve probably never heard of.  We’ve previously talked about Don Ho and Jim Riggleman.  And today, an even more obscure celebrity helps me explain why the venture economy would work better with a bit more help from the government.

If you don’t remember Erich Brenn…it’s ok.  You are not alone and in fact, you are in the majority.  He was an occasional guest of the Ed Sullivan Show, but does not have his own Wikipedia page.  If you’ve never seen the guy do his schtick, the only decent video I could find was in this promotional spot which shows the performer in a 1969 apearance. 

I’ll wait while you watch it.  It is only 3:14

Take a look at about the 3:00  mark.  All the plates are spinning on the table and on top of the poles.  I don’t know how entertaining it really is, but for me, that moment is the perfect representation of a perfectly balanced venture economy.  All the companies, er plates, are spinning along…well funded and well supported by the well-heeled venture capital community.

But I want you to also look back to the 1 minute mark in the video.  Mr. Brenn appears to be a bit more harried in his actions.  Racing from one end of the table to the other, he needs to get all the plates up and running in order to achieve the perfection at the 3 minute mark.  In your opinion, does the 1:00 minute mark or the 3:00 minute mark look most like the American economy of today?

I’ll wait while you think about that.  Should take you less than 4 seconds.

Correct.  Our economy today looks more like the 1:00 mark of the video.  That is where TechonomicMan and dozens, probably hundreds, of government-backed technology start up investors come in.  Dr. Josh Lerner, in his poorly-argued book “Boulevard of Broken Dreams” argues that government programs to stimulate the technology economy do not work (a blog-rant to come on this in the near future).  Others have said that government efforts to stimulate the technology economy should be legislatively scheduled to disappear in a given, short period of time.  The argument goes that if the private sector hasn’t stepped in to make seed-stage investments within 5 years in a given region, the program is a failure at creating opportunity.  And if the private sector HAS stepped in…well, the program should disappear in favor of the private sector.  I say that the work of a well-conceived, business-oriented but government-funded seed stage investment program is critical to keeping the flow of plates coming in our economy.

Many say that the slow down in venture investing, and the fact that VC’s are tending to only invest ever-larger amounts of money in more established companies, is evidence that there are only crappy seed-stage deals out there.  No good companies to invest in and, therefore, why should the government “waste” taxpayer money to invest in early stage tech companies?  Well excuse me, but as Mr. Brenn’s video clearly shows, companies will ALWAYS look crappy when they’re not spinning!  I would argue that if the strategy of reduced government funding for seed stage tech companies continues, only a small handful of overvalued companies will get any support from the Bessemers, Andreesens, etc. of the world! 

My experience with true seed-stage companies (ie., 2-3 people, little to no revenue, prototype almost done, etc.) is that they are ahead of their time.  Too far ahead often.  Certainly too far ahead for even angel investors to have a serious look.  The private investors do not have the patience to limp along for 3 or 4 years while the company bootstraps its way into the market.  I’ve seen it happen numerous times.  In fairness, most of our companies are not social media/mobile app companies that can follow the “lean startup” methodology.  Advanced materials, medical devices and even enterprise software take more time from concept to commercialization…it’s like the difference between lean and starving-to-death, or like the first minute of the plate-spinning video.  This is the abyss into which reasonably sized investments by the government can help keep the entire venture economy in happy-spinning harmony.  I’m not talking about one-time $535 million investments…I’m talking about $250,000 investments in hundreds of companies a year.

Like the spin of the plates on the poles, the speed of the economy comes and goes.  The spinning slows and deals begin to look crappy.  I feel that government funding of seed stage ventures is like the segment of the video covering 0:01 until about 2:00.  The job every day for the government-funded programs like mine, and many others like it, is to try to get the plates up and spinning.  We need to get them spinning and work constantly to find partners, usually in the form of angel and venture capital, to pick up where we leave off. 

So Erich may not have been the Beatles or Elvis Presley.  But, as Ed Sullivan occasionally said of the up and coming stars on his show, and as we seed-stage investors realize on a daily basis, “Of such extraordinary doings are champions made.”

Posted in Economic Development Policy, Just Kidding, Seed/Venture Capital, Tech Based Economic Development | Tagged , , , , , , | Leave a comment

Should VC’s Be More Like Lumberjacks?

VC Industry? Don't just take all the big ones!

According to this Small Business Trends post, only 10% of all VC investment goes into seed and early stage companies.  That is up from only about 5% in the mid-2000’s, but well below the 15-25% range that existed between 1980 and 2000.  As everyone knows, this means that institutional VC’s have moved up market to become growth stage investors.  Some have moved absurdly far up market…like Greylock and Kleiner and Andressen and Battery and others who invested $950 million in GroupOn in January valuing the company at $4.5 billion.  Up in the thin air of multi-billion valuations on non-profitable companies, the only hope for financial happiness is an IPO.

And in January, 2011, IPO’s were starting to happen and it briefly appeared as if we were poised for the salvation of the public markets to begin lubricating the great venture capital funding mechanism. VC’s began bidding up the price of privately held companies and a stampede occurred. The greater-fool theory was at work when those big VC names began piling into these companies and a social media bubble was rapidly inflating as the public was soon going to have access to some of the most hyped companies that Silicon Valley could come up with.   It looked like it was only going to be 6 months until they were out among the masses.  I don’t know how much these investors thought they could get in return, but I’m sure they thought they could get it quick.  Heck, the investment they made in January was a mere bridge loan.

If you don’t remember seeing the press release on the GroupOn funding, here is the most hyper-ventilated quote I’ve seen in a while.  “In the last year, Groupon has been called “the fastest growing company ever” by Forbes Magazine and “America’s best website” by one of Groupon’s television commercials.  Two things wrong here. 

First of all, their press release cited their own commercials to be declared America’s best web site? That’s funny, right? 

The other thing wrong here is the focus on fast growth and not on profitability.  In one of my June posts, I was explaining that a company with no profit model was not sustainable.  This article by Rob Wheeler, though, says it so much better.  Among the gems in his article is this: “The best way to manage a fledgling business is for managers to be impatient for profit but patient for growth.”  I’m putting that quote on my office whiteboard. 

Well, the true colors of this economy were revealed by mid-summer as the market froth flattened and taking a big, but unprofitable company public no longer looked like a good investment.  The big VC’s are certainly  big enough to miss a couple of IPO windows.  But they’ve got to be wondering what those big bets are worth now.  If I sound sarcastically pleased by this, I’m not.  If I thought the experience would chane the industry, then I would be pleased.  But I’m sure this wasn’t a big enough lesson to fix my concern with how the VC industry funds the growth of America.

My biggest concern is that all this cash is now being burned up sending me GroupOn emails that I’ll never see as my spam filter silently completes its mission.  Companies that raise too much cash, find ways to spend it and in the social media world, they spend it on getting big instead of profitable.  I can’t help but believe that this country of ours would be much better off had that $950 million been spent on 100 or 150 companies instead of one.  And, thus, I finally get to my real point.

As the 1980s became the 1990s and became 2000, the percentage of VC money that went into SEED stage companies declined.  Several VC’s reaped a huge harvest as the dot.com era ended. And that huge harvest, in my opinion, became an albatross around the neck of American venture investing.  “Big fast” instead of “profitable first” became the driver.  Big funds got huge and no longer looked at the small deals.  Small funds either got big or began to disappear trying to get big.  These big funds became the safest place for big LP’s to put their money and as the 2000s wore on, the big stuff crowded out the small stuff.   It set in motion all sorts of other maneuvers and politics that began to change the legal and political landscape to support the big stuff at the expense of the little stuff.  Patent law in this country is a good example.

The lumber companies learned decades ago that they live in a renewable business.  When you cut down big trees, you plant new ones.  The new ones are small and need more attention than the big ones.  The VC industry needs to get oriented this way.  Place your big bets.  Harvest the old growth.  But don’t tell me that making small investments costs you as much as making big investments.  I am quite sure you can find ways to reduce your costs to make 10 $3 million investments instead of a single $30 million investment.  I believe the soil is fertile and capable of building companies that are profitable first and big second.  

We just need to nurture the seeds.

Posted in Entrepreneurial Advice, Seed/Venture Capital, Tech Based Economic Development | Tagged , , , , , , | Leave a comment