When I left Australia in the late '80s, "entrepreneur" was a dirty word; it had all manner of negative connotations. In Silicon Valley, I became a serial entrepreneur, which is even worse, and after six tech startups with two IPOs and four successful trade sales, in 2007 I was asked by an Aussie fund manager what my problem was and why I couldn't keep a job! ;-)
I have run venture-backed startups through three recessions, and as many bubbles. For the past few years I have been an early-stage venture investor -- literally on the other side of the table from by entrepreneurial brethren. I don't like the term "cleantech"... Like the preceding bubbles, nanotech, telecom, Internet, laser, and the previous wave of solar in 1989 -- they are all just tech. Many were driven by government regulation or deregulation, and all were overdriven by excessive investment. These bubbles opened Pandora's box of technologies and created a new breed of entrepreneur, more like a showman or game show host to promote them -- rather like the perception of an entrepreneur I left in Australia 23 years ago.
VCs like entrepreneurs who are deep in the space, ideally those who tried to build their idea within their jobs but got so frustrated that they were forced to leave and go it alone. They may want to get rich, but more than that they want to change the way things are because they have a clear vision of a better way. Greed is OK, but it doesn't carry you through the tough times that plague any startup. Sergei & Brin had a great vision, ironically are only executing on that vision in the past 18 months, and after finally succeeding on Plan E, it wasn't greed that carried them through the near-shutdown of their yet-another-search-engine company...but it sure paid off. It's hard to find the diamonds among the showmen and promoters, but they are out there, especially in Australia and especially in deep tech organizations like CSIRO and NICTA.
A second fundamental tenet of venture is to find white space (more recently called "blue ocean"), and it's very hard to find white space in a bubble where 20 companies are funded to do essentially the same thing. One or two will survive. Most of cleantech is ICT: Smartgrid is ICT; solar is optical and semi; wind is optical, mechanical, and ICT; bioFuels is biotech, materials, ICT-- there is a common theme here that is endemic to early-stage technology companies, and VCs are very good at making these bets work. We are not a cleantech fund; we are a typical early-stage tech venture fund, but if you look at our portfolio you will find we have a wireless company that provides near Gbit/s broadband for last mile and drops 80% of the cost and power from fiber solutions; a chip co that enables processors that consume 1/10 the power in data centers; a sensing company that measures flow in water, oil and gas, and wind to increase energy efficiency; a superconductor company that reduces power, increases range, and decreases the number of base stations needed for cellular phones; and a coatings company that increases the efficiency of solar panels.
Some of cleantech is energy generation -- it's an old established industry that moves slowly and is dramatically affected by government. Most of the projects in that space are infrastructure financing projects masquerading as early-stage ventures, meaning that instead of needing about $10M to carry a fund through three rounds of financing, you need $100M, as several of the recent "exits" in that space have shown. However, it is still possible to nibble around the edges of energy and leverage the second order effects like increased efficiency technologies that add a few percentage points to the total power output and translate to low-cost, high-return investments.
I think the key to success in the cleantech space is more related to geography than technology. Unlike the telecom bubble whose market driver faded as bandwidth needs were satisfied (saturated), the market driver for cleantech started as politics, then moved to public perception, and is not driven by genuine need. That need is not going away. The geography determines the politics and the need. If investors can really align with the politics and the genuine need of a geographic area, truly locally, then win-win deals can be made.
I have recently put my money where my mouth is, by raising a $200M clean energy fund partnering with Australia and China, two geographies with unique needs. So time will tell if I am right. Please feel welcome to make any suggestions or advice; we need all the help we can get!
Friday, January 6, 2012
Tuesday, November 15, 2011
Making Acquisitions
A really hard transition to make for most of us founders is the idea of paying some other entrepreneur our hard-earned cash or even tapping into the lifeblood of our equity in exchange for their inferior product that we could easy make ourselves, and do a better job of it, if we just had the time. This transition to building muscle tissue around the bare bones of a startup trips up most first-time CEOs. VCs often rely on their founders to be market and technical experts for diligencing their other dealflow, but it's often ingrained in the entrepreneur (and should be) that they have the best product and everyone else’s ideas are crap. ;-) This makes such diligence unreliable.
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.
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
The Troll
I've written before about the obsession with IP, and the feeling, especially among academic institutions that 90% of the value of a company is in the idea and related IP - having sweated bullets like most entrepreneurs in order to get an idea to market and scrape a few of them together to form a self-sustaining business, it’s a little frustrating to have someone tell you after the fact that it was all their brilliant idea.
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...
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
Go big or go home
This phrase was very popular in the Valley 10 years ago, and has recently surfaced again -- unfortunately with respect to cleantech deals masquerading as early stage ventures when they are in fact infrastructure financing nightmares waiting to happen. ;-) However, "go big or go home" has always been a mantra of Silicon Valley. When I first came to the US in the late 80s, I feared the inability to compete in this market, academically and business wise. I certainly thought of a company as a startup that made a few million dollars (well, one million was a lot to me), and dreamed of one day being able to pay myself a 100k salary...imagine that. The idea that a big company might like my inventions and products enough that they would consider buying the company was almost inconceivable to me, and if by some strange chance it happened... wouldn't that be wonderful? The first time you sell a company it's a wonderful elation: It's a validation of you, your business, your team, and your vision. It's also supposed to deliver real value to the acquirer and build a long term relationship between the two of you.
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.
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
Behavioral change deals
Patrick Boucousis posted a great comment last month, which stimulated this posting, so thanks for his insightful comments. Patrick said “Many of the new Apps will enable and in fact require fundamental behavioral change in how people work. The business (read investment) potential of these Apps won't be THAT obvious up front ... just like Facebook wasn't before it was invented.”
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 :-)
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
Skin in the game
A number of investors gain confidence and comfort from entrepreneurs who have invested their own money in their startup. So much so, that many entrepreneurs find unusual ways of claiming their investment--in some cases you hear of millions of dollars personally invested in a deal, where the cap table does not reflect that cash because it was in kind, or missed opportunity value, or perhaps just unpaid salary. Interestingly many more investors don’t like entrepreneurs to have their personal net worth at risk in a deal. I know many Sydney fund managers who would be laughing at this ignorance of clear alignment: it’s an example of how opposite Silicon Valley is to other places.
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.
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
The hardware equivalent of an Internet deal
I had a great lunch recently with a successful young Internet entrepreneur, and he posed the strong belief that universities should stop wasting time teaching hardware and focus only on software. Those of us who helped build the infrastructure that enabled the Internet will disagree with that position, but there is certainly a sentiment that the business model has fundamentally changed because you can build an Internet business on very little cash, and this deserves a new VC model.
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 ;-)
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 ;-)
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