Tuesday, November 15, 2011
Clearly, it is just not possible to scale at the rate demanded by modern markets through organic growth. Especially demanding is the Internet, where innovation is unrestricted by hardware and can rapidly replicate without fear of IP infringement. I recently sat next to the VP of business development of a large Internet rollup (on a 5 a.m. out of Austin :( ) that owns most of the vacation rental Web sites, including good-old Stayz, which was founded by three of the youngest entrepreneurs in our portfolio, but I guess being in their mid-20s makes them middle-aged for Internet entrepreneurs :). This company was formed entirely to acquire these Web sites and form a conglomerate--it had no IP of its own, and interestingly did little to change the companies it bought. These guys perfected a Web acquisition model and rolled up what turned out to be a large market segment. Their key was overpaying the founders and betting on scale to make it all work. It’s a bit like the supermarket chain buying up the sole proprietorships, except you don’t end up with crap fruit and veg afterwards...
As a startup CEO you don’t think rollups, you think disruption. If you can paint a vision that other entrepreneurs will share, then you have a change to bring them under your banner to fight your cause. A lot of entrepreneurs look for “deals,” distressed assets, or companies that can't get funded, and try to do predatory deals. These usually don’t work--whatever caused the problems for the target company usually permeates the acquirer as well. Unfortunately, you have to pay up to make things happen. Now there are a few examples of companies like Visx whose internal technology failed, but became extremely successful by acquiring the core technology from someone who could not raise money. But assuming you are a successful startup, you should be abel to make 1 & 1 = 5 deals by bolting on the right pieces of product to your existing offering, and integrating them together under the hood to make them more compelling than they were separately.
There is a lot of banker wisdom in this area and a lot of people to help you formulate a financial engineering strategy. There is a lot of wisdom in this area and these guys know what is selling, who is buying, and why so they can in principle help you engineer an exit by making you the prettiest company on the block, By all means hear them out, but remember, you got to this point by focusing on one thing that you do better than anyone else--you leveraged yourself into a niche with your unique technology and you are well on the way to owning and controlling the direction of that market. You had a vision and drove it through the strength of your convictions. If your vision is accurate, you above all others can predict the direction your niche will move, and so you can build or acquire the products and technologies needed to serve that evolution. No banker or advisor can do that for you. Finally, you got here by serving your customer better than the incumbents. Stay focused on them and the acquisition will take care of itself--your company will be bought or IPO’d, not sold.
Friday, September 23, 2011
Years ago I went to visit the patent office in Arlington, and walked into the examiners office with my little box containing laser, optical delivery system and power supply, turned it on and showed him how it worked (surprising that there weren’t metal detectors back then...). The examiner was so stunned, not so much at the invention, which I thought was pretty cool, but at the fact that it was the physical embodiment of what was described in my self-drafted patent application. He pulled out a few other patent wrappers to illustrate his point, on one there were 57 separate office actions, the front page was littered with rejections, but it kept coming back - this patent, he said, will eventually issue with severely limited claims but sadly the paper its written on is as close as it will come to any form of physical embodiment.
Now when I first started studying patents I distinctly remember one of the key requirements for something to be patentable was that it be reduced to practice but it seems this is no longer a priority in inventions which has become something more in the province of lawyers and accountants than engineers, scientists, and inventors. I know that this is largely how it has to be, but after doing a lot of business in China, there is a certain satisfaction in the Chinese attitude of who cares, let's just build it and sell it in China anyway, and not worry about the US patents. Innovation knows no borders, so hopefully as China continues to grow they will begin to value IP and level the playing field.
I actually think what is worse than the patent degradation of late, is the emergence of so many trolls - i.e., those who sit on a patent for years waiting for it to ripen so they can sue anyone and everyone who is using it. As with most things there are 2 sides to this story - CSIRO recently won a landmark patent lawsuit because they invented WiFi and others used it - to date they have won $200M in back royalties - the WiFi market just for chips was over $3B in 2008 - I would have preferred that a bunch of companies span out of CSIRO and they developed the products. Now it’s a lot harder to build a company than it is to have an idea, and for sure there is an economic model for patent licensing.
In the CSIRO case they tried to license, and in some cases did license, and then some of the companies stopped licensing. Personally, I don’t want to see more of this, I would much prefer to see entrepreneurs try to build companies. CSIRO at least is dedicated a portion of the win to starting a fund specifically for the purpose of spinning out high-risk high potential return ideas like WiFi.
The other side of course, is the Troll, who has no intention of developing anything but a bank balance, often a consortium of lawyers who buy up the IP of others and sit quietly on the until the stakes are highest to pounce on startups. To me these groups are as bad as litigation funds who band together to try and extract money from public companies by suing directors - sometimes it's legit, but most cases I have seen have been pure profiteering. These business practices do not create anything, rather they tear down what has been created or at least debilitate it like a parasitic organism we can't quite flush from the system.
There is of course yet another case - a little company in San Jose invented an optical interface which is exactly what is used in the Wii. Their patent predates anything Nintendo had by at least a year, and they honestly tried to commercialize it - in fact they created a wonderful interface for Media Center, which enables gestures to navigate the screen, zoom, pan, and twist all by hand movements. They sold a few thousand of these devices, and then Wii came out - they wrote a letter and sent copy of the patent, and were told to go pound sand. In this case, I would love to see these guys come out on top, assuming that the facts are all correct...
Friday, August 26, 2011
I invariably sold companies too early, for many reasons: difficult investors (VCs with fins in their backs among them), bad market conditions or changes, problems with co-founders, and occasionally because I felt it was a local maximum in value and feared the market changes I imagined were coming. To me the cardinal sin was losing the investors' money, which I managed never to do. However, Valley VCs view that as "lame" -- it's losing the opportunity that is the cardinal sin. Losing a $5M investment, to them, is nowhere near as bad as losing a $500M opportunity. This, by the way, is one of the reasons that skin in the game (founders having personal cash in a deal) is often not viewed positively by VCs.
I also sold companies too late, going from $1B in 2000 to $100M in 2001, then to 50M at the end of 2001. And anyone who has sold a company for stock knows that you sell the stock ASAP -- except often when you do, the stock goes up a lot after you sell it. In one case of mine, it was a factor of 10, which was inconceivable at the time, but I can assure you that losing that money I never made actually felt a lot worse and completely overshadowed the money I made in the transaction in the first place.
Most entrepreneurs sell their company too early simply because they are faced with the risk of growing a company to the next level, taking on new investors (or changing from bootstrapped self-funded to VC investors) and suffering dilution. Most startups don't scale big: Ironically it's relatively easy to do $1M in revenue (there are usually enough early adopters to fill a niche); it's really, really hard to turn that into $10M, and somewhat easier to turn that into $30M. Then you do a trade sale because you are not sure if you can do $100M! I am told that once you break $100M it's easier to do $500M, but I don't believe that.
There are multiple dimensions to this conundrum of when to sell, but another thorny aspect is the make vs. buy decision when a company like Google or Microsoft decides they like your product and want to buy you, provided the price is reasonable...
VCs don't want you to sell -- not yet. They want to make the company as big as it possibly can be, drive profits as high as they can possibly get, and then make an acquisition feel like passing a kidney stone, or open heart surgery for the acquirer.
Monday, June 6, 2011
So, at the risk of being too much of a hardware guy, and so 90s, or is it 00s ... I still don’t get the value of Facebook even though it is invented ;-) Actually was it invented, or something else?
Fundamental change is the stuff than Venture dreams are made of--think telecom deregulation and the optical communications bubble that resulted. Or for that matter, the crazy idea of a husband and wife from Stanford who built the first Cisco router.
Behavioral change can also be a great value creator, but beware that fundamental change in how people behave is hard to predict and very difficult to influence--being creatures of habit we don’t change that readily and it's not a problem money can solve (see earlier posting on throwing $ to try and create a market).
The fundamental change of shopping on the Internet, which some of us adopted very rapidly (because we hate shopping and love the ability of the Internet to give us access to all information needed to make an educated purchase at the best price, without a sales person getting in the way) took a lot longer for mass market adoption that I would ever have thought. Remember that first wave of Webvan? Safeway came in a few years later (with the Webvan assets) and slowly built out a small niche in online groceries. I believe part of the problem here is that a lot of people, really enjoy the shopping experience--it's social, and interactive in a way that the Internet isn’t ... yet.
Mobile payments are another area that's experiencing the 3rd or 4th re-try. This should be a great space, but there are a lot of the same issues that seem to come up every time we think this area is set to explode. Security is my biggest, simply because no one is incented to fix the problem, no one wants to own the problem, and no one wants to admit there is a problem. But beyond that, just the behavioral change is tricky. It works with a Starbucks card giving you a virtual bar code on your phone (and United letting you fly with one too, but don’t forget to charge your phone….). It's definitely quicker, you can order and pay in 3 seconds, instead of the 5 seconds it takes to pull out your credit card … maybe this matters? The phone company has been the other big problem, with customer service about as good as the IRS ... they aren’t well equipped to handle a bunch of micro-payments, and the additional customer service it requires.
The other classic behavioral change question is Cleantech--whether it's remembering to turn off the light, or pay >10x for a CFL (compact fluorescent light) that is five times more efficient, or get used to an electric car that needs to be recharged every 200 miles.
Suddenly something that was cheap and abundant is now getting expensive and politically important. A lot of money has been bet on various forms of clean energy in a way that for me is reminiscent of the telco bubble, albeit with far more resilient market pull. Will the auto industry shift to battery replacement at the gas station? Will someone invent capacitance gel that can exchange vast amounts of energy quickly like we do currently with gasoline? Will people adjust to change their cars at home each night, and perhaps at work during the day use them to feed energy into the grid?
Something that sobers me when thinking about these changes: I am told that its easy to drive to and from work and charge the car each night – and electric vehicles have promising specs to meet that simple need – so it just takes a small change to accommodate – right? But, I am told by others, that if you run the A/C or heat in an electric car, you may only get 30-40 miles ... so perhaps not such an easy accommodation after all. It's funny, because having grown up in Australia there was little A/C available and I’ve never really adjusted to it or broken from just winding down the window when its hot, or wearing a sweater when its cold :-)
Thursday, May 19, 2011
The problem is actually a simple one: when a venture capitalist makes an investment, they want to ensure the team is highly motivated by their equity to succeed, and that their reward is mainly in the return on value of this equity. When a founder has substantial personal cash at risk, they will make poor decisions regarding risk--it's human nature to try to save your money rather that put it at (venture) risk. Look at how most entrepreneurs invest their own money and you will be surprised just how conservative they are, simply because their day jobs are so risky.
If an entrepreneur starts playing conservatively with VC money, they are likely to deliver a pedestrian return but VCs want an all or nothing play, it’s how their portfolio management works. A company that makes cash flow breakeven but does not provide a stellar growth opportunity is almost as much a failure as a company that craters--it’s the chance of the big win that justifies the VC level investment.
In fact, we can go step further, I know many successful fund managers in China who over the past 10 years made a lot of money simply by buying up established companies from the state, and introducing western IT practices and other efficiencies, then took them public in Shanghai for venture scale returns. However, after nearly 10 years of this working well for a small number of fund managers, larger PE firms stepped in to make it scale.
At that point, the model changed, and the PE guys started buying out the founders in order to get into the deal. The guys who pioneered this model in China would simply not invest in a startup if the founders were taking cash out of the deal. However, this is a very common practice in later stage investments here in the Valley--when a fund has a lot of cash to put to work, they often have to get creative as to how they deploy it and get more into a deal by buying founders stock.
I personally don’t like this approach because investors and entrepreneurs should be exactly in the same boat with interests aligned--and I like founders to win big whey they win and stay focused on maximizing value of their equity, not taking cash off the table. But sometimes, the only way to get into a really good deal is to buy your way in--works well for later stage investors, but not so well for VC. Personally, I don’t want to be in a deal that’s driven by price, in any dimension ...
To close on the story in China, those PE guys who bought into deals learned after about three years why the pioneers weren’t playing that game--it wasn’t that they were old fashioned or slow (let’s face it they jumped on a plane and immersed themselves in emerging China 10 years before it was popular, so hardly risk averse). The Chinese are some of the greatest capitalists on earth, and are quick to change--once bought out and handing over their hard build companies to the bankers, they quietly went across the street (in many cases literally) and started competing companies that rapidly secured deals with large state owned enterprises, and attracted the best employees who had recently learned western style efficiencies and could improve the new business, and rather quickly generated nice IPO exits on the Shanghai exchange ;-)
P.S. Patrick thanks for the great and thoughtful comment. It merits its own blog, and I'm working on that now.
Friday, April 15, 2011
Rather than debate that one, I would rather show how old-school venture does hardware in a capital efficient way, rather like Internet deals ... and preferably without credit cards ;-)
I know two entrepreneurs who are in their 60s who recently gave a group of 20-something year old Internet entrepreneurs a run for their money in terms of drive, energy, and entrepreneurship. Now these guys do materials--in the laser industry, anytime someone mentioned a project that was good to go except for a slight materials problem, we figured it was 10-20 years from a product, so this is about as far an extreme as I can think of in hardware from the Internet. If you can remember when people first started extolling the virtues of vanadate (Nd:YVO4) as a laser crystal, heralded as the replacement for Nd:YAG, it took pretty close to 20 years to actually make a dent in the market.
Just to make matters worse, let's also recognize that these guys are attacking something slower to respond even than the telecom market, by trying to get the semiconductor market to make a change to their Fab process. I certainly can’t think of anything further from the Internet, with worse customers and more capital intensive, than the combination of semi Fabs and materials :-)
So how do they do it? Well, the theory of deep tech is pretty simple, you have something unique and so valuable to your potential customer, that they are willing to invest in it to get the unfair advantage it offers. They can't get it from anyone else, and while the pain of change will be costly and time consuming for them, the pain of not adapting could well be fatal.
So they set up a simple lab, and beg, borrow, or otherwise get whatever equipment they can, everyone works for equity, and they develop their material solution. Pretty much identical to an Internet deal, except fewer PCs and programmers, more white coats and lab gear. But sometimes late at night, they multiplay with their web peers on Warcraft.
Unlike the web deal, what they create here cannot be copied without running afoul of the patents, or deep knowledge of both the materials technology and the real customer needs. The equivalent burn of this team is about $50k/month, if they were paying salaries, which they are not, at least to start. When they do, it's still about $50k/month because their customers are supporting most of their growth in resources and facilities. If the value proposition is compelling enough, even those stodgy Fab customers will get enthused and throw internal resources at evaluating the material. They run wafers, put them through a raft of tests that would cost literally millions of dollars to do if you were contracting the work.
It's this customer validation, in the absence of revenue, which is a really long time off, that is the equivalent of users or subscribers or eyeballs on a web deal. Now to be sure, if the dedicated user count gets into the millions, then there is money to be made--and quickly--in the web deal, but the dark side of that is the lack of stickiness of those customers, who are easily lured away by the next shiny object. The Fab customers can be lured away, but the more time and money they spend on verifying the material, the harder it is to walk away from, and the more sticky the traction.
Where the web deal is really compelling of course, is in its ability to deliver meteoric rises in users, and possibly even revenue ;-) If it goes viral, web based products and services can rapidly rack up $100M in revenue. Often this is actually someone else's revenue and the web business is taking a 5% clip of it, but sometimes it's all theirs and the company is wildly successful.
In the materials business example, this is going to take a long time--could be as long as seven years to get through the entire Fab cycle, and certainly more than three years to wait for the adoption of the next node (design change). Now they do also have to share some of that revenue with distribution channels, and there is come COGS that limit gross margin to say 80% ... Of course if the material is accepted, then its about $100M per line, on the order of $500M per Fab, and depending on how many Fabs adopt it, it can quickly become serious money.
You won’t see it on Facebook, but it will be in the mobile device you are using to look at Facebook, in the wireless and optical network elements that are bringing you the data, and in the servers that host the web app--so I think they are pretty intimately connected.
Isn’t it wonderful to see the confused look on a 22 year old web entrepreneur’s face when he learns that 2 guys in their 60s are on their 10th successful startup ;-)
Thursday, March 31, 2011
Now I understand that the law is set up to penalize director incompetence, but in some places it’s set up to penalize failure despite directors and founder efforts to fix the problems. When things get tough everyone should be rolling up their sleeves to help fix the problem not the blame. We managed to turn this company around, but not without a few threats of greenmail and the usual legal "BS" to go along with it. In the process we learned a lot about the CEO and his team—and the CEO learned a lot about the merits of proper BoD selection ;-)
Most problems can be solved given the right team and enough runway.
I don’t actually believe there is such a thing as failure, it’s more how you handle things going wrong that determines true failure or character. After all, it’s an ill wind that blows no good for someone. Truly great entrepreneurs see failure as an opportunity–c.f. James B. Stockdale in a POW camp.
Remember in ’99 when the market was going crazy for Internet and telecom, and how easy it was to be successful then, contrasted by how impossible it was to achieve success in 2002? Many many companies went to the wall, but surprisingly, many others found a way to adapt and survive--technically they failed to deliver as promised, but to me they achieved stellar success in learning to navigate perhaps the worst market downturn any of us has ever seen--we hope ;-).
In Australia there is a well known company that is considered one of the true success stories of tech startups--it was acquired for several hundreds of millions of dollars and made founders wealthy. Some VCs there quote it as the deal of the decade but I would argue it was a shame they didn’t take it public and build a sustaining company with a market cap beyond a billion. In the tech bubble time it was easy to sell companies for inflated prices. Selling too soon is something we are all guilty of as entrepreneurs--in contrast, building something sustaining is more risky but is better in every sense if it can be done.
Now in some countries failure is considered a curse, and those who fail are penalized severely--by English law there is no Chapter 11, so if a company cannot pay its debts the directors could end up in jail. In the startup world, failed entrepreneurs get ostracized like the unclean--many VCs I know like to see at least one failure in an entrepreneurs record because it gives an opportunity to see what that person is really made of, and how they dealt with a bad situation--it’s a great opportunity to shine and turn bad luck into good.
In the tech downturn you were a hero if you were able to sell your company for any price, even nothing, as long as the acquirer carried the liabilities--companies with $50-60 million invested capital typically sold for $1.5 million in stock, regardless of their revenue--it was as crazy and lopsided as it was on the way up leading to the crash.
One well known CEO friend of mine burned a $200+ million hole in the ground--you may ask what does one do to walk away from a train wreck like that? Normally you would expect to spend a few years in the penalty box--maybe the rest of your life? But not him. When he found trouble raising VC money for his next gig, he decided to stick it to the VCs and become one--he raised a $200 million fund, and recently a $400 million fund--so failure is definitely in the eyes of the beholder ;-)
Friday, February 18, 2011
Why was that? Well, I had no idea how to raise money, I had never heard of venture capital, and I certainly had no idea what an investor would want to see to fund me. Actually, I also had no idea who would buy my product, but I was certain I had invented something revolutionary ... if I could just figure out who cared?
Now I wasn’t stupid, I had searched for and found a smart partner who understood the laser business and we co-founded the company. He dealt with all the business crap, and I focused on solving the technology and building the product. The problem is, that neither of us really understood what the market was for our product. So as the number of credit cards increased, and the credit card debt scaled up towards $250,000, I realized that the problems weren’t technical per se, but rather financial ;-)
We ended up selling stock to some friends and family, and that helped but also increased the stress and worry around not losing their money in addition to personal bankruptcy. As things were getting worse, we had a visit from Milton Chang, and he gave us an epiphany about our business.
He spent time in my basement in DC surrounded by used lab equipment and even more used furniture, and spent the day talking about what was missing in the business, which included the fact that we didn’t actually have a business. Milton saw several things he liked, and I came to learn that these were his classic tells for a good investment (Milton went on to invest in 27 companies, generating 5 IPOs, 10 great trade sales, and no losses – his stats are off the charts even compared to the best Silicon Valley VCs).
He saw a passionate engineer, focus on putting every available penny into making the product, cheap rent (my basement), no salaries (everyone worked for equity), and a genuinely revolutionary piece of technology in the solid-state green laser, or the "green diode" as we called it (because its beam quality was about as crappy as a diode).
It took Milton about a week to come back to me with an idea to merge our company with one in California called Iris Medical. It took a year, me taking over as CEO, a lot of stress and angst for a lot of people. But when we put great engineers and inventors together with great sales and marketing, we got a great result: Iridex and a NASDAQ IPO.
We literally went from bankruptcy to success (albeit over a couple more years), and the original investors in Light Solutions got their cash back and also kept their stock, so a nice double return. VISA and the other cards got their money back, plus interest, and everyone was happy.
So was VISA better than VC? Well, it certainly attracted Milton. He couldn’t believe we were committed enough (read stupid) to take this level of risk to back our idea but it clearly showed we believed in it passionately. He didn’t like our idea of skin in the game, because it was too distracting and made us make short term tactical decisions rather than strategic ones, but it wasn’t a bad place to start.
VISA gave some good advice: pay your bills on time or we’ll screw you--perhaps some similarities to VCs with respect to milestones ;-) What amazed me most about Milton was despite not really understanding our market specifically, he understood it well enough generally, and 80% of our issues were common to all startups and he understood those better than anyone I have ever met then or since. The power of a committed investor/partner who is aligned with you and willing to give you the time and advice you need is invaluable--it's worth far more than the money, which as you have seen can be gotten almost anywhere.
A lot of us worry about giving up too much equity for investment, but old school entrepreneurs worry about losing the money, and old school investors get their hands dirty standing shoulder to shoulder with the entrepreneurs to help them not only not lose the money, but to use it to make more. If you are worried about dilution, VISA is much better, no dilution, but for God's sake don’t lose the money ;-(
Wednesday, January 26, 2011
I was fortunate enough to be invited to present at the IEEE Forum recently at National Semiconductor in Santa Clara. What’s great about these presentations is that you learn so much from the questions entrepreneurs ask, and there is always a new perspective and ideas to share. Personally, I don’t like success talks, they are always too glib, and too often accompanied by super-sized ego. I prefer to talk about failure and learning, and if possible how the failure was recovered and turned into a modicum of success, maybe God forbid even making a little money along the way ;-)
I really enjoy giving my life by misadventure talk, which basically explains how one can stumble into success despite making a bunch of wrong decisions – if you think about just how many decisions a CEO makes in a day, it's not surprising that many of them turn out to be wrong. What's great about startups is that you can change your mind, and second guess decisions and quickly adapt to correct mistakes. When Mark Hurd decided to cut and consolidate design centers in HP, it took a year to formulate a plan, another year to execute, and believe it or not, there wasn’t much of a chance to change his mind along the way, and even if there was, it would have taken another two years to undo - some more recent things can't be undone and more's the pity ...
As entrepreneurs, we go down a lot of rabbit holes (and not a few ratholes as well) in our search for the right products, solutions, businesses, and opportunities. Many of the rabbit holes are dead ends, or lead to the madhatter’s tea party, rather than the magical growth elixir for which we originated the quest – those failed quests are what temper us for eventual success. I have sat through so many presentations by successful entrepreneurs who did everything right, were geniuses, and had market vision so profound that everything worked out exactly as they planned. I read Alice in Wonderland as a kid, so little need to hear more fairy tales now. Engineers are not afraid of failure, nor do they expect to have clairvoyance enough to see every mishap and engineer it out before it becomes a problem – they twist and turn and always have a backup plan because they know failure is an inevitable part of pushing the envelope.
The other epiphany I had while preparing the talk, is drawing on my Aussie entrepreneur’s talk, I realized if I replaced the words “Australian Entrepreneur” with “Laser Jock” then the talk worked for both groups. It's amazing the similarities with the little Aussie battler entrepreneur, and the US laser engineer. We tend to think with solution or technology looking for a problem, we worry about saving money to success, we don’t understand marketing, and we don’t get just how much harder it is to market and sell a product vs design and build it. On the positive side, the similarities are even ore striking. We never give up, always find a way around any problem, are very straightforward in our dealings (and this is not the case with many other types of entrepreneurs), know how to deliver, can create a lot with a little, and are fueled with the passion of belief in what we are doing that transcends all obstacles.