Monday, November 29, 2010

Where Angels fear to tread

I don’t want to add fuel to the fire already ignited by the behavior of a group of super-angels here in Silicon Valley, or to further endorse Ron Conway’s excellent reprimand of that behavior – but, I do want to say that this behavior is rare in the valley – and in fact rather common where I come from. For some reason in other countries Angels, and VCs and PE investors are seen as competitors rather than key pieces of the value chain for startups and their growth. I was at an event in Australia recently, where it was proudly proclaimed that the angel network is so strong that "we don’t need the VCs anymore." As I dug further into this I discovered there is a deeply ingrained belief that Angels are in direct competition with VCs, and this was a big surprise ...

Furthermore, in places like Australia, or the mid-west US, where the VC ecosystem is fragile it's critical for groups to work together even if it is in the form of "coopetition."

At present this entire class of investments is being called into question and if there is to be growth in risk capital to support entrepreneurship all the parts need to work together. Where things get really screwed up, and this is typical of Australian deals, is when a private investor buys a large piece of the company for little cash and then will not allow the company to raise further rounds unless they are at major step ups in valuation. This forces the company to go to more naïve money, and get less and less help from their investors.

These companies become literally uninvestable in any traditional sense and while they often survive in purgatory for a long time, they don’t often give the founders what they had started a company for in the first place. It is not unusual to see a company where the investors own 80-90%, but have only carried the company halfway through the investment cycle. The solution should be simple, to raise more money, but this class of investor won’t stand for dilution and blames the management for their plight.

I have talked before about the numbers that enable venture investments to work--good Angels know these numbers well and make their investment synergistic with them in anticipation of a VC firm paying up for the deal, and taking the Angel along for the ride with the founders.

Typically Angel investments are simple convertible notes, no equity, until the A round gets priced and led by a VC. The Angel gets a substantial discount for taking the early stage risk, and more often than not gets asked to stay on or come onto the BoD because they usually have great domain knowledge that can really help the company. This is the other area where sugar cane farmers and mining millionaires can mess up tech companies because they often insist on BoD seats based on ego, despite bringing no value to the company. This is not to say that such people aren’t great at negotiating deals and selling companies or that they don’t have great business acumen, but the art of growing a tech startup is highly specialized and needs people who have done it before to help entrepreneurs who perhaps haven’t.

In the Internet deal, it's possible to get to success metrics with very little money--one side of this means an Angel or super Angel can fund the company entirely. But I don’t believe this is the right model or even a true model. What can and does happen well with Internet deals is a little bit of cash can quickly tell you if you have a successful idea or not. You can fail fast and cheap.

The failure I think of the Angel approach is not to bring in substantial capital to take advantage of the beachhead and own it before competition gets wind of your success. Some Internet deals can be entirely bootstrapped, yet regardless of the type of business web or traditional they always need money to support growth and strategic initiatives (see Atlassian) – this money comes from VCs or PE or IPO or credit cards ;-)

Monday, October 4, 2010

Every CEO needs to have carried a bag

Usually we CEO's spend most of our time carrying a can ... among other things, but it's really important for any CEO to have been a sales guy at least once in their life. Any entrepreneur is always in sales, selling simultaneously to team, customers, partners, investors and service providers. One of my favorite CEOs started life with a telephone book and cold calling to generate revenue--tough way to start, but what a great grounding in human nature and the importance of making numbers. The idea of meeting a quota is central to the needs of a startup, especially a bootstrapped one that is always months, weeks, or days away from Chapter 11. I know of one CEO who carried his bag all the way to Las Vegas, because he couldn't make payroll, and put what money he had on 11, and made payroll for the year ;-) Not what I mean, of course!

A classic founder situation happens when the investors come into the company and drive hiring of new executives with more experience than the founder to go out and carry his bag from him. Often, this does not work because the founder has an evolved DNA for selling exactly this product and deeply understands and has earned the trust of these customers. The experienced sales people, as good as they may have been elsewhere, just can't deliver the level of customer intimacy that selling to feed your family for years has instilled in the founder. Sometimes, this simply doesn't scale. Now it should be possible to teach this skill to the experienced sales experts, providing of course that they can get over their ego and let the founder help them learn, but of course this is the opposite of what the investors wanted to happen and may not sit so well with them and their egos ;-)

The other great thing about carrying a bag is that it gets you in front of your customers. If you are the founder you are likely to be more strategic than the typical sales person, and this gives you the ability to do that magic that the managers of really great sales people dream of--the strategic upsell. Because you are deeply involved in your customers' problems you have the ability to see solutions where they see only problems. And because you have their trust from your history with them, they will listen to you when you patiently explain why they need to step back and see the entire problem, and while they may buy this one single component today to solve this week's problem, they will have you back in every month for the next two years to buy other components and after all that they will have the entire solution cobbled together from all these transactions and gee wouldn't it make more sense to take a little more time now and solve it all, so they can spend the next two years on making money?

To be sure, this is really hard to do, and it can easily slip into the Osbourne effect (where customers don't buy anything because they are always waiting for the next big innovation to solve all their problems). But, when it does work, the result moves from transactional selling in $10-50k chunks, to $1-2M sales with recurring revenue over multiple year commitments, and the business scales from these repeatable, upsold, presold deals.

What's really fascinating about this, is after the VCs have pulled the founder back from the road to let the professionals fix the messed up sales process, the founder invariably gets put back on the road to save the business and sure enough can reengage with their beloved customers and start bringing home the upsell deals again as those customers welcome him back with open arms and where have you been all this time? Invariably, the reward for this success is that the investors then start searching for a new professional CEO to manage the business so the founder can focus on what they do best--now was that selling the product, or saving the business ;-)

Monday, September 13, 2010

Entrepreneurs are like water

Entrepreneurs are like water: in Australia there is a great shortage of both--but that’s not what I mean. Entrepreneurs have the unique ability to flow around obstacles, and always find the way through to success. Many, many good business people are more like stone, and in many cases being stubborn and inflexible in a negotiation pays off--I know people who have listed their houses at outrageous prices, waiting three or four years for the bigger fool to come along and pay the price. However, that victory comes at a cost--time. Entrepreneurs know that time is the most precious resource (like water). Water will always find away around inflexibility, and in the end water will wear away the stone, but in the short term it will simply flow under, around or in between the cracks and get to its goal faster and with less hassle.

I am in the middle of a difficult negotiation with a large Chinese state-owned enterprise as I write this, and trying to help a startup do a deal with them. Imagine the cultural disconnect in every dimension--small vs. large, US vs China, swift, innovative, agile technology, working in a large slow to move industry, with a very large foreign company where failure is often very very costly.

So far, the entrepreneurs involved have blown up three times; each time we have found basic disconnects on communication and misunderstanding, or lack of knowledge as to how deals are structured differently between the jurisdictions, to be the culprit. Now, of course, the Chinese are the greatest capitalists on earth--extremely skillful negotiators, and known for difficult, long, complex deal structures that evolve many times even after they are agreed and signed. It’s always a fluid contract in China. Which is another reason why entrepreneurs need to be like water. This basic attribute of China, which is so against the grain of western culture is endemic to markets, new technology, and the financing climate--these three elements are the most fluid of all and if entrepreneurs can't adapt quickly, they fail.

In this negotiation, one of the founders is having heartburn with the Chinese style of renegotiation, and being a little like stone--as in stonewalling the deal. While it does not pay to be too flexible in dealing with highly skilled negotiators (i.e., if you bend a little, they grow to expect a lot, so you have to yield a series of decreasing concessions to signal a clear end to negotiation) a stonewall with the Chinese, like the Chinese wall, leads to the Mongol horde at your gates, or at least not a very satisfactory conclusion for either party.

The other way in which entrepreneurs are exactly water is their ability to foster and nurture a deal. Investors thinks it’s the money that waters the seed, which has some truth, but nothing has the ability to deliver growth, raise money, see an opportunity and go after it like an entrepreneur….

The one area where the water analogy fails is that, unlike entrepreneurs, water flows downhill, sinks to the lowest level, tends to stagnate there. Although this fate can befall some unfortunate entrepreneurs generally they are headed in quite a different direction ;-)

Tuesday, August 10, 2010


There is a little Aussie startup in Sydney that bootstrapped its way to north of $50M in revenue on $10,000 borrowed from the CEO’s dad--you can do this with software, really! They just scored a massive investment from Accel, not Peter Wagner whom many of you know from the telecom days but the later stage fund. You see, these guys took their first VC investment after already achieving profitability and success. An investment of $60M. Come on Aussie ;-)

This investment has caused a furor both here in the Valley, and in Australia. Every software VC I know here has been trying to invest in Atlassian since it broke out of startup mode and delivered some stellar viral growth and managed to make money at the same time--dollars instead of eyeballs, imagine that? The other fascinating thing about Atlassian is it managed to deliver a stellar employee experience in a place where there was little sharing of equity. No, they don’t have a red slide in the foyer, but they managed to re-create a lot of Silicon Valley’s karma and get their employees to invest themselves truly into their startup. Some of the younger employees don’t actually appreciate just how unique their experience is, locally.

Back to the furor. People in Australia are worried that this is another case of Australia’s best and brightest taking everything to the US, and leaving nothing behind. Local investors are asking why didn’t they get a chance to invest? After a few too many beers, the CEO let off a diatribe that at least shows his passion and commitment to his business, but was a little unkind to the local financial ecosystem and VCs ... but let’s face it, he is not alone there.

I have received emails from most of the local VCs saying they have never been pitched for money by this company, and wondering why? I’m sure that’s true; why would Atlassian want that? The company was able to bootstrap its way like most good software companies. To be sure, taking in early stage investment may have accelerated the eight years into perhaps four years, but it doesn’t look like they gave up any market lead, so trading time for equity was a fair deal--certainly they hit the market timing. Knowing VCs, if they had gotten in, there would have been sweaty palms after year three!

To raise $60M an entrepreneur certainly wouldn’t go to VCs on either side of the Pacific, it would be a growth fund like Accel’s, Sequoias’, Oak’s, or just a private equity fund. And there are a boat load of them in Australia and even more in Hong Kong, which is a lot more local than Silicon Valley. There is more than $1 trillion under management in Australia so there is no shortage of cash. Most startups in Oz would have listed on the ASX and raised their capital from mum’s and dad’s pension funds rather than professional investors. So why come here to a venture funds' growth fund?

I actually think this shows great (and sadly rare) foresight on behalf of an Aussie entrepreneur--most believe that it's just the cash that matters, not who you get it from. There is of course one other element of secret sauce in the deals, and that’s paying off the founders--to cement a private equity deal like this in a company with excellent profits, track record, and prospects of growth, you had better hope the founders believe that cash is the sincerest form of flattery. Let’s not forget, it's an entrepreneur’s job to deliver the highest value possible for the company’s stock, not to give investors a sweetheart deal.

Will Atlassian move to the US--sure, why not? In this type of web sales business it is less important where the company HQ is, but for growth, to be close to customers and market, and most importantly for exit, this is the place to be. Will the founders stay on? I hope not, after all wouldn’t it be great if they came here for a while, delivered the value they sold to Accel, and then went back to Australia to bootstrap another one? Perhaps even encourage other entrepreneurs to do the same?

It would be great if they took some local VC investment money, assuming that they could find local investors who could truly add value, maybe some former entrepreneurs who had built businesses like theirs, maybe some investment funds who had success in this space. Who knows, it might even help grow a local ecosystem. In the past 20 years, entrepreneurs from China and India have learned their trade here in the Valley, and then migrated back to replicate their success in their home countries. We need to nurture entrepreneurs, we need to create more of them, it's how economies grow--and if you want statistics--US VC-backed startups generate almost 3x Australia’s GDP. One can also argue that they are responsible for 100% of US job growth--but that’s for another time ...

Monday, July 19, 2010


This is a bit of a continuation of my previous post on exits. What VCs can do better than most, by virtue of seeing a lot of deals, is to spot an opportunity to merge two companies together to form something much stronger. So as an alternative exit, they can create a strongly investible company that will exit later but at much greater value. If two startups are really products or features, not companies (earlier Blog) then sometimes they can be combined so that 1 + 1 makes 3 ... or even five. This is usually very hard to do, and a sceptic might say putting two crappy companies together makes a really crappy company, but certain VCs really have a knack of pulling it off.

I never appreciated this until I started looking at lots of similar deals, and it really jumps out at you when you see two companies pursuing the same opportunity, and one has really differentiated technology but no "go to market" ability, and the other has a solid operational team but weak IP--or, one company that has survived waiting for a market to emerge because they have the best solution for that market, and another that has a completely different solution for the same market that together would be best of breed and actually make the market emerge by ability to feed an easy low cost solution and stimulate the market to grow, and then segment the market for the better solution later.

What usually kills these deals is the existing investors who may have carried the company for a long time and have very high expectations that are going to be dashed--also the management team has a hard time accepting, and especially having to tell their investors that there is another company out there that has a better solution than they do.

As the new investor trying to be a matchmaker you get the fun task of trying to set a realistic valuation for the combined companies and there usually isn’t enough in the deal for everyone to get a fair piece, especially if the existing investors are short on funds.

I've seen probably four of these in the past year, where you would have loved to combine the two companies to create something really significant and investible, but it was just impossible to negotiate with the existing VCs. As an entrepreneur this is very frustrating because you watch the market need continue to be unmet until another player steps up and creates the solution that could have been yours.

The better outcome happens when the existing VCs realize that there has to be a put-together and start actively looking for such a deal. During the last tech downturn, we saw many of these deals and unfortunately not too many good outcomes because these were mostly driven by need to exit rather than opportunity to create best of breed value.

Saturday, June 19, 2010

Done it vs. Read about it

I was having a drink with an old friend who is the best product marketing guy I know, he was also my BoD member and an excellent operating partner at Accel. We were discussing the difficulty in hiring the right VP Sales, VP Marketing, and hardest of all VP Product Management--also called Marketing, Sales and many other things. The product management vertical originated in communications companies, due to a natural need for a highly technical, project management oriented, closer to bridge the gap between sales and marketing. If you think traditionally of marketing as giving aircover so sales can go in and take the territory, then product management supplies recon, logistics, plans the opp, and is often the Seal team that goes in first (or if you prefer a less airforce oriented analogy, marketing sells to groups and can't close anything, sales to individuals and closes them, product management identifies the product, defines the spec, does the initial sales to get the recipe right, and manages the entire process.)

So its really hard to find good people in this role. Actually in any of the customer facing roles-–prior experience is something of an indication of future results, but not that dependable because every startup is unique. Ideally a venture-backed startup is attacking a white space and history doesn't help that much beyond pattern recognition.

One of the key things that a CEO gets shot for is making bad hires, or worse being afraid to hire better people than themselves to enhance the quality and success of the company. I was surprised when I met a young, now quite well known internet CEO and his card read “I’m the CEO .... bitch” – frankly, who cares?

But if being the CEO is so important to someone, then that same ego is going to get in the way of good decision making and great hiring. It's something that VCs look for in any CEO. So how does the CEO win? After all, if they recognize a bad hire, they have to fix it, their investors and BoD will armchair quarterback them and opine sagely that perhaps there is a problem with the CEO and not the new hire ... never mind that it was the same people who helped screen the new hire and approved them ;-)

The California resume, as it's referred to on the East coast, is famous for purporting remarkable achievements and experience, building of great companies, and spectacular exits, most remarkable of which is that they were all achieved either before the candidate left college, or during an internship. While these are easy to spot, the really good sales or marketing person is very hard to distinguish from the really good talker, often it takes until after they have been in the job for a few months.

There is so much excellent training now available, that sales, marketing, and product management roles can be described superbly after doing a few courses and learning key process. This sounds strange, but even seasoned operating guys, like my buddy, can get fooled by the right words. A guy who I worked with years ago, had a gift of remembering every key word his boss used in giving him a task, and then repeated those same key words back to the boss when giving his progress reports, and magically, regardless of progress which was rare in his case, the boss always thought he did a great job.

If and when I ever work out how to avoid making bad hires I promise to let you know, but in the meantime, as with everything else in startups, if you are going to fail fail fast and early, make a change and move on. Don’t procrastinate about reversing a decision already made and firing--its better for the company, it's better for the employee, and it's much better for the CEO.

Thursday, May 13, 2010

My comfort zone

I’ve discovered that most VCs have a fingerprint, for investment style. Now, we’ve all heard that venture investing is all about pattern recognition, but there is a certain comfort zone that each VC likes to be in or around. On the pattern recognition side, it might be seeing two founders, one a technical/engineering guru who can not only invent but also create the product, coupled with a second founder with strong marketing experience--ideally both of whom have deep domain expertise in the market they are going after. This is a pretty good pattern, or fingerprint, for an investment basis.

Some VCs like really cocky CEOs who think they know everything; others (like me) hate that, and prefer the quiet achiever who is passionate but knows what they don’t know and is therefore coachable.

Internet deals are usually binary; i.e., they will either be huge like Google or Facebook, or nothing, and if there is nothing, then there is nothing to salvage.

At the heart of the matter is risk-reward, as we all know when you do something really big with a potentially massive payoff, chances are you will fail--that's no reason not to try, but everyone must accept that the potential for failure is great, if you try to do great things. In some countries, failure is a curse, like the black plague and those who fail are ostracized just like plague victims.

The US, in general, is not like that, and the Valley in particular is the reverse of that. Some VCs even look for, say, one failure in an otherwise perfect track record to see that you know how to deal with failure. It's easy to succeed when the market is strong and growing, it's how we deal with failure that makes it true failure or success.

My comfort zone turns out to be more around companies with some sort of baseline business, on top of which they have a stellar growth opportunity that could be a fund maker, but is also high risk. The baseline business will be there no matter what. It's probably not even venture investable because it's unlikely to generate more than 2-3x return, but when you are facing oblivion, 2-3x is pretty attractive.

I have a love-hate relationship with “emerging markets” or paradigm shifts--these are visionary opportunities where the founder thinks he can see a market change before everyone else, and wants to be there to capitalize on it. If he’s right he wins massively, if wrong, you end up carrying the company for years until the market does emerge, at which time his technology is out of date, and a younger smarter competitor eats your lunch--it sucks!

Timing the market is hard, marketing people rarely can do it, which means probably nobody can do it well. In general VCs have little fear of funding technology development, provided the market need is clear--they believe that engineers can solve most technical problems (they don’t like science projects however), but they shy away from funding market development because no amount of cash can change the market (other than kill it as the over-investment did during the telecom bubble).

Many VCs insist on customers and revenue before investment. This seems a little too easy to me, after all, you’ve got to have a little faith in the entrepreneur’s vision and take some risk! It puts a high bar for the entrepreneur who would have to bootstrap his way to product and revenue, after which he hardly needs you as a VC to come help him. Customer calls indicating strong interest and need should be enough, provided the entrepreneur has domain experience in the space.

Like conservation of energy, the risk reward ratio seems to be an invariant ;-)

Monday, April 26, 2010

Confusing Marketing with Sales

Despite the vast array of typical MBA definitions of Marketing vs. Sales (i.e., Marketing is selling to groups, sales to individuals; or Marketing is strategic, Sales is tactical), few of us still really understand the difference.

But as a startup CEO it’s a critical difference that needs to be understood. Fortunately, many VCs disagree on the definition, and the need in early stage firms, which forgives a multitude of sins ;-) Many technology startups look more like an engineering team lead by a CEO who does sales and marketing … and often engineering too.

Most good entrepreneurs have a basic fear of letting go and prefer to handle leadership of these functions themselves, at least until the concept is proven. This lean approach is great for cashflow, but there is a point in time where you have to develop muscle tissue in order for the company to grow.

Most founder/CEOs have a pretty clear grasp of the market and a vision for where it will go. Ideally, they wouldn’t have been funded unless they had deep domain expertise in that market either as an engineer, sales or marketing person. It’s very likely that the founder has good sales skills otherwise they wouldn’t have been able to sell the deal and close the funding ;-) Often a founder is so technically brilliant that the VC will fall in love with the technology/founder and fund the deal anyway, knowing that the investors can gather the right team around the founder to make a business.

One of the common startup traps is the great technology, great team with many, many customers but not a whole lot of revenue. A strong sales person can really turn this around--the company has either been totally customer driven and opportunistic in taking whatever sales they can get, or (better) they’ve strategically targeted the key customers, focusing on quality not quantity of revenue, in order to validate their business. The professional sales leader can now come in and monetize all of those initial entrees into the market; they can mine each customer, and generate repeat business across multiple divisions of a large company.

The other case is when the market is emerging (very scary for VCs), so the sales person does not seem necessary. A great sales leader would say if the market hasn’t happened, then you’d better learn to close--genetically engineered sales leaders don’t need marketing or technology to close sales, though of course they had better be selling what we can make … another Blog here :-)

Sales by nature is tactical, all the great marketing in the world won’t help overcome the personality of a particular customer. In the laser business we can be forgiven for confusing sales with marketing because the market tends to be a mile wide but only an inch deep, so a strong sales person must stretch across multiple verticals and ferret out sales from a number of emerging markets. Would marketing be more useful in this scenario? Marketing works best when you have a group to market to--however, deep strategic vision of market is critical especially in this situation because it will enable the company to focus on the particular vertical that marketing feels has the best chance of providing growth. In the meantime, Sales can keep bringing in the orders to feed the company until the market emerges.

All too often success is about the luck of being in the right place at the right time, Sales can enable you to live long enough to get to the right time, and marketing can lead you to the right place ;-)

Tuesday, April 6, 2010

Value Added VCs?

One of the hardest things for me as a former CEO is to get used to the idea of not being the CEO anymore. As a VC I imagined working closely with CEOs of our portfolio companies to help them better manage their business and avoid the pitfalls and mistakes I had made (there were and still are a lot)--of course as any father soon realizes your son never listens, you are an idiot, and you gotta let him make his own mistakes.

Classically we want entrepreneurs who are coachable, so we can help them, but, like sons, we don’t want them to be too pliable. We like the vinegar of self worth, and ego, provided it's fueled by passion and true belief. So what do you do when the CEO won’t listen? With the disclaimer that I am an old-school entrepreneur, I think not listening is a major alarm bell--it usually means the CEO is letting his or her ego make decisions, and there is never a good outcome from this. Now the flip side is that the CEO is better than their VCs and likely more operationally experienced and therefore recognizes bad advice and inexperience and is not willing to do the wrong thing merely to placate the egos of their VCs ;-).

In this scenario, the CEO is actually still wrong; a good experienced CEO with their ego under control knows how to manage their BoD and deal with all types of advice and investors, bad and good. Generally there are nuggets of wisdom in the most unlikely places, and if you can thin slice through the chaff you can find those kernels. Having said this, how much value can an armchair quarterback really bring to a startup?

If you parachute in for a BoD meeting once a month, it's unlikely you will have many pearls of wisdom to impart, unless you have built that type of business before in that specific market with those specific customers, and your knowledge is current. It's true, VCs are great at pattern recognition and can spot a flawed business argument, but often a little knowledge is a dangerous thing. I think the error can go too far the other way as well, when the VC wants to micromanage the CEO, because no VC has the time to really add day-to-day value, and let’s face it, we are wrong as often as we are right, like everyone else.....

The best interaction for me is as an auxiliary brain for your CEO. Ideally they already have this partner in their management team who can fill this role day to day, but it really helps to have an outside view, uncluttered by the day to day management issues. VCs by virtue of looking at lots of deals and companies, can bring a unique perspective to the strategic planning process.

Investors must have a healthy respect for their CEOs, but it's surprising to me how some CEOs can allow themselves to get sideways with their VCs. If it's truly fueled by passion and not ego (or insecurity) then it's excusable occasionally, but I am stunned at the stupidity of any CEO who wants to fight with their investor. I have seen companies go down simply because of this, sadly driven by big egos on both sides--I once saw an entrepreneur so cleverly structure a deal through nested companies that he achieved the equivalent of antidilution over his investors. Even after it was explained step by step it was still hard to understand how it was accomplished. But then the investors stonewalled and refused funding, denying meeting milestones, and killed the company (and their investment)--what a stupid waste.

For any investor to do their job for their LPs, they need to have some degree of control over the company, to do this they need complete transparency from the team, and this enables trust in the CEO. Any CEO who refuses to listen, be coached, and leverage their investors is letting his insecurity drive the bus, likely over a cliff. Fortunately there is an easy solution to this problem ...

Saturday, March 13, 2010

Red Herring – Global?

I wrote this one in sunny San Diego at the Red Herring Global 100. I am trying to work out how to address the question “Can venture capital be truly global” in time for our presentation today ;-) The problem I'm having with this question is that I don’t think it’s the right question. To me venture capital is by definition local, not global--sure we want to invest in global companies, but we do our work locally on the ground and in the trenches alongside the companies we invest in. If we can't visit them on a daily or weekly basis then we shouldn’t be in the deal.

Does that mean we shouldn’t invest in foreign companies? Well no, but the only way I can think of to make that work is either to relocate part of the firm to the target market--i.e., have an office in China or wherever, manned by partners equal to those in the mother ship and who are part of that market and can actively source, manage, support and fundraise for their companies there the way VCs do everywhere; or to find a trusted partner firm that you can work with in that market assuming that the target company will have substantial operations in both places so both firms can add hands-on value.

There's a lot of passion around this issue--especially at Red Herring which comprises a large proportion of non-U.S. companies, and is truly global due to the passion and drive of the founders. It's frustrating for them that many valley VCs talk global but don’t act it. It's also frustrating for many Aussie entrepreneurs who come to the valley for a week, pitch 25 Sand Hill Rd VCs, fly home, and don’t get much followup from them. Sometimes they come back six months later to pitch again, but still don’t get much traction.

The trouble with the infamous driveby (not the LA kind) is that it leaves no positive lasting impression--rather like the Silicon Valley VCs deciding to spend a week in China to find an investment partner and expand their wealth creation model there. Clearly, neither of these work. To be global you must act local. If you want to invest in China then go live there, spend a few years building a trusted network, and then if you can partner up with people who really understand the ecosystem, maybe you can risk investing and be successful riding their coattails. I simply don’t believe the venture model is scalable in the way that private equity is. Once of the few good things about this downturn is, it will likely drive us back to old-school venture, where VCs actually spend time at their companies, and entrepreneurs chose their VCs not like a banker but through trusted relationships and expectation of real value add.

Clearly there is no monopoly on innovation, it happens everywhere; but everywhere is different. In Silicon Valley you have probably the world’s best developed ecosystem for commercializing innovation where every banker, lawyer, accountant, HR firm, patent attorney, and engineer think startup mode and form a formidable support network. There is an abandance of risk tolerant capital, and a well established exit market. Now Shanghai and Hong Kong provide excellent exit markets, but just because you understand Nasdaq, don’t assume the same of those markets; just because you understand commercialization, don’t assume it will work somewhere else where you don’t really understand the rules, the government, the taxes, the business environment ecosystem, nor have that crucial trusted network to leverage.

Partners can solve this, they can be great, or as Marriott once said, when you a take on a partner you take on trouble. In places like China and India you can't do it without partners, and believe me you can’t do that without trouble ;-)

Tuesday, February 9, 2010

IP Problems

A few years back we started a company by licensing some technology from Stanford--actually we did a few of these types of deals and it was always fascinating to work with an enlightened academic institution. Having written a lot of my own patents (because we couldn’t afford patent attorney fees) I have a great respect for IP, but also a healthy skepticism--patents are great shields but rarely swords. Now in many places IP is seen as the crown jewels of a company and sometimes it can be but more typically it’s just a start. Unfortunately this obsession with IP leads to the fatal "technology leading the market problem."

In my short stint as a professor (now there’s a story), I thought wouldn’t it be wonderful to create a new method of collaboration with industry where academics were not so IP obsessed and focused instead on creating long term value. The problem, as I discovered, was that in the mind of the inventor, and most academic institutions, the IP itself is the work product. As such it is seen as 80% of the value of an enterprise emerging from it. In many cases there is a non technology oriented adviser involved who wants to split the IP 26 ways to create a portfolio of companies ... well actually a series of separate transactions where the same IP can be sold over and over again ...

So in this startup that I am remembering, the technology founder cut a rather aggressive IP deal with Stanford and managed to secure an exclusive license (which they rarely do), and on pre-financing equity structure, which of course tilted significantly post financing ... there were a few other non transparent items that ultimately conspired to give Stanford very little in return for this license.

Now this type of "hey I tricked you fair and square deal" is not worth doing, ever, but it seems to be rife in certain geographies--in this case Stanford was in a position to help us considerably with the implementation of the technology and to continue to invent, develop, and otherwise drive the evolution forward and we wanted an ongoing relationship with them. So once the company was funded we went back and renegotiated the deal by giving them more. You might think that our black blooded VCs would have opposed this move, but no in fact they applauded it and it increased their level of trust. Now this is not business school 101 approach--it's your job to negotiate the best deal you can for your side and the other guy beware--but it's rare to have a negotiation without an ongoing relationship, and if you value people you had better reward them otherwise they won't waste time dealing with you again.

So can you get to a stage where institutions will work with you in good faith, knowing that you will take care of them if they deliver real value?

I think so, but not easily. The converse problem is the licensing agreement where the institution gets so much royalty out of your sales that it hurts profits and you are no longer incented to pay it--in this vein we found Stanford to be extremely sympathetic to the practical realities of building a business and a simple sliding scale royalty that decreased when market forces reduced margins to ensure the company remained profitable and vibrant rather than weighed down by the weight of royalties.

Too often in IP deals, there is a focus on the lawyering of the agreements and parties lose sight of the objective, which should be the same for both--i.e. someone needs to commercialize the invention, and both need to profit from it. The vast majority of work will be done post invention and IP owners need to be realistic about this.

Exclusivity is the other issue--patents are legal monopolies for a time, so if the IP owner can pick a winner, it's better to let them run with the IP rather than try to be an arms dealer, and enable 20 competitors to slug it out in the market. As a worst case example think of the memory market and the cross licensing IP mess it is, which is largely at the heart of its distinct lack of profitability.

At the heart of the problem is that IP is a future value to be unlocked by a team of people, often not the inventor (and almost never the IP owner). For that future value to be realized, a team of people is needed--the IP creator needs to work with this team, roll over future inventions and value to that team if they are needed to ensure success, and bet on the success of that team--in the end, it's people, not patents that make startups work ;-)

Tuesday, January 26, 2010

The Chinese Incubator

I was at an Asian American institute meeting a while back and a prominent Chinese American web entrepreneur was explaining his revolutionary new incubator concept for entrepreneurs in China. He borrowed some parts of it from Google, and others from HP, and added a few unique twists of his own. Basically he is recognizing a wonderful trend–-in the past, successful expat entrepreneurs returned to China and brought the “American way” back with them. They were successful at raising money and often successful in business too ;-)

But Chinese people are, at their heart, some of the greatest capitalists on earth and the local team rapidly recognized the loosening rules of the government and moved to build their own home-grown wealth. The Chinese incubator concept is to combine the best idea with the best entrepreneur with the best team--and these three groups will be different people grinding out of an entrepreneur factory.

My problem with this approach is, having been an entrepreneur before the black blood of venture capital seeped into my system, I can't imagine wanting to go to some institute or incubator to be told my idea is great but they have someone better able to execute it; and in fact there is a whole separate team who will build the company around it.

I can't imagine any of those people would be particularly passionate or entrepreneurial because they will surely have their own ideas and won't need me to think for them, and certainly will be entrepreneurial enough to find a way to fund their ideas without the help of an incubator.

My fear of these approaches, one of which is being currently tried in Australia as well, is that they become jobs programs for consultants who also aren’t very entrepreneurial. Further, when the government knocks on your door because they are there to help you, many entrepreneurs (and probably all bankers) will be too rapidly heading out the back door to realize the benefit of government “help” … this wonderful entrepreneurial alchemy that enables transmutation of nothing into gold also enables entrepreneurs to conjure up the resources they need whether it be $, advice, leverage or …

In other countries, and frankly outside of Silicon Valley and Israel, culture is often the impediment--fear of failure (see previous BLOG), and societal scorn for entrepreneurial behavior are more often the place where change can really help. Most education systems are designed to create better employees, not employers; and frankly, given the nature of most people drawn to teach at university level (66% NP types if you follow personality types), it should be possible to find entrepreneurial traits but perhaps as a result of those systems the entrepreneurial professor that one finds so readily at Stanford, is hard to find elsewhere.

It's extremely hard to stimulate innovation and quite hard to “help” it – most entrepreneurs will tell you the best help they can have is $, the next best is deep domain market expertise preferably from someone who has built a similar business in the same space they are building--operative word is “built,” not someone who has read about it or studied it or consulted to a company about it, but actually done it. This is why some of the best angel investors are exactly that, a former entrepreneur/CEO … VCs can help too, really :-)

Tuesday, January 5, 2010

Valley of Death – Part III

Marketing is perhaps the rarest skill to find. Your customers rarely know what the market will do or what product they need. You can make all manner of calculated predictions but in the end markets are comprised of humans and competitors (some of them are human too) and they are fickle--it's why any good entrepreneur admits luck as the major factor ;-)

A big market opportunity forgives a multitude of sins because if you can identify a clear, large pain point you only have to worry about making your solution work, and work better than your competitors (who will be many if it's a big enough market).

But if it's all about big markets, where's the fun in being a VC? After all, we are supposed to be brilliant--so in deference to the classic laser markets, I would like to discuss the alternate model because it's more relevant to small markets, which are classic early adopter territory.

Let’s think about a component company (most laser businesses are exactly this). Selling a component (i.e., a laser, a laser system, anything that is not an end-user product in its own right) is fraught with challenges, not the least of which is focus--component plays always want to be all things to all people. The laser business is a mile wide but only an inch deep, so you are invariably going to have to sell into multiple vertical markets--the illusion that OEM is better because S&M cost is so much lower is obviated by the need to understand many different markets, customer bases, and evolve multiple sales approaches, which makes the classic recurring process and revenue really, really hard to achieve.

However, if a component is unique, with strong barriers to entry and compelling differentiated technology, chances are it can start to displace the incumbent technologies. There is a point at which the value proposition crystallizes for all customers, the sales process really starts to work, and revenue begins to ramp--grow the sales team and push the opportunity to sell before competition wakes up. No component can own the market for long, but this phase gives you the opportunity to move into much deeper relationships with your customers, and to start to integrate more of their product into your component so that before long you are selling a sub-system for which they are happy to pay more money because it saves them time and integration. You are designing yourself deeper and deeper into their product, making true barriers to entry beyond mere technology.

Unfortunately for most component (or non end-user) sales, its hard to ever become big (telecom bubble not withstanding, in which the whole value chain got turned on its head). At some point you have to break out to the end-user with a whole product solution, otherwise the next bright and shining technology will do to you what you did to the old technologies. This is a difficult transition, complicated by the fact you will invariably be competing with your immediate customer and thereby risking the lifeblood of your revenue.

Once of the best ways is in an adjacent market, in its early phases, where the customer actually needs your help to create the solution. Another way is when your customer pulls you up the stack, as big telco OEMs did when they wanted to get out of the transponder business and pulled their laser suppliers up to be Tx vendors. That was a bad example (telcos made no money on Tx, and neither did laser suppliers). The one you want is the customer who is making so much money elsewhere that they are happy for you to make money supplying their system--then everyone gets to eat.

My personal two favorite component plays are the disposable, and the small niche you can own for a long time. The former is obvious, but the latter often isn’t--take marine telco. SDL worked on that tiny market for years because it was so demanding and difficult, but their laser diode was the only product that could meet the final (lockout) spec, a lockout that they created, and once installed in submarine environment, nobody was going to change suppliers. Despite many, many cheaper competitive products, that SDL laser still dominated marine telco because it's simply too costly and risky to switch. If you can't find such a niche, or scale up to a system level product, then the other way is to keep selling components into as many verticals as possible until another telecom bubble comes along and components become king again--but I think that could mean a long, thirsty journey through the Valley of Death ...