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, February 9, 2010
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 :-)
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 ...
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 ...
Monday, December 7, 2009
Valley of Death – Part II
So how do you cross the Valley of Death?
Well it sure helps to have some other people to guide you who have personally made the journey and worked out where the hidden wells are along the way. A key element to carry you is risk capital – but the businesses that are really great to invest in are often the ones that don’t want the money – usually they need it, but they often don’t want it because they don’t want to deal with the crap that comes with it.
Software companies are a great example of how bootstrapping can work really well, and a new idea can be tested and validated, and even sold, well before significant amounts of money are needed. There is still a valley of death for these businesses, because just selling product and having happy customers can make you complacent and fail to recognize that these early adopters are not the whole market, and you have to grow or die. The day you launch your product you start the clock on competition, if in fact they haven’t already got something similar cooking and ready to release already. First mover advantage is a two edged sword and often instead of creating and then owning a market, you simply create it for a competitor to go take it from you. The curse of software is the ease with which it can be replicated by competitors and lack of patent protection. You have to understand how to really scale your business, and differentiate from competitors, and have a clear and focused strategy around that growth to leverage your limited resources for maximum result. Money is a fulcrum--who gives it to you can be the lever, depending on the depth of their experience, personal networks, and commitment as an investor.
For many hardware businesses, it's not possible to boostrap without capital – even if there isn’t money to be had, entrepreneurs have a gift for finding it – a customer who is a real believer in your product is often a great source of needed capital whether it's NRE or advance payment
This applies primarily to deep tech, rather than Internet or execution plays. Early adopters validate your product, fine tune it and provide premium price because they value the unfair advantage you give them – if they are not willing to pay that premium then it's just about price and you shouldn’t play in that game. A good test of the compelling advantage of your technology is to try and raise money by getting a customer to fund your company in exchange for exclusivity (you can limit the term later). Too many companies delude themselves into their value only to find their customer walks them into the purchasing department who has no interest in value other than to get as much of it for as little as possible ;-)
Early adopters let you under the hood of their company engine, and with that inside knowledge you gain deep customer intimacy that begets understanding of their real pain point, which when coupled with your deep technology understanding creates a unique solution that neither of you ever would have thought of alone. The pioneering customers help you prove your value proposition, and later will help evangelize your virtues and enable sales to the broader market where price will become an issue, but armed with the proven business case of your early adopters you can win those sales.
Once you have your clear value proposition and product that supplies it, you need to iterate your sales process many, many times, until you find the right repeatable model that secures recurring revenue. It has always amazed me what happens when a career sales person is brought in to replace the peer-to-peer selling of engineers – don’t underestimate the value of peer-to-peer, it’s the secret sauce of selling to early adopters, but there is an inflection point where the domain experienced sales person can turn up the heat for broader market acceptance and really start to ramp sales. This is the other element of risk capital; its hard to judge when to increase burn in order to capture the market – if you are bootsrapping, you will often miss this point and grow organically, trading time for money. This is usually a bad trade because you can’t win back time – there are many, many bet-the-company decisions an entrepreneur is faced with, it’s a lot easier to seize the opportunity if there is a financial buffer, and ideally people who have made these decisions before for their own businesses.
So if it's so easy, why do we so rarely succeed? (see Part III next time)
Well it sure helps to have some other people to guide you who have personally made the journey and worked out where the hidden wells are along the way. A key element to carry you is risk capital – but the businesses that are really great to invest in are often the ones that don’t want the money – usually they need it, but they often don’t want it because they don’t want to deal with the crap that comes with it.
Software companies are a great example of how bootstrapping can work really well, and a new idea can be tested and validated, and even sold, well before significant amounts of money are needed. There is still a valley of death for these businesses, because just selling product and having happy customers can make you complacent and fail to recognize that these early adopters are not the whole market, and you have to grow or die. The day you launch your product you start the clock on competition, if in fact they haven’t already got something similar cooking and ready to release already. First mover advantage is a two edged sword and often instead of creating and then owning a market, you simply create it for a competitor to go take it from you. The curse of software is the ease with which it can be replicated by competitors and lack of patent protection. You have to understand how to really scale your business, and differentiate from competitors, and have a clear and focused strategy around that growth to leverage your limited resources for maximum result. Money is a fulcrum--who gives it to you can be the lever, depending on the depth of their experience, personal networks, and commitment as an investor.
For many hardware businesses, it's not possible to boostrap without capital – even if there isn’t money to be had, entrepreneurs have a gift for finding it – a customer who is a real believer in your product is often a great source of needed capital whether it's NRE or advance payment
This applies primarily to deep tech, rather than Internet or execution plays. Early adopters validate your product, fine tune it and provide premium price because they value the unfair advantage you give them – if they are not willing to pay that premium then it's just about price and you shouldn’t play in that game. A good test of the compelling advantage of your technology is to try and raise money by getting a customer to fund your company in exchange for exclusivity (you can limit the term later). Too many companies delude themselves into their value only to find their customer walks them into the purchasing department who has no interest in value other than to get as much of it for as little as possible ;-)
Early adopters let you under the hood of their company engine, and with that inside knowledge you gain deep customer intimacy that begets understanding of their real pain point, which when coupled with your deep technology understanding creates a unique solution that neither of you ever would have thought of alone. The pioneering customers help you prove your value proposition, and later will help evangelize your virtues and enable sales to the broader market where price will become an issue, but armed with the proven business case of your early adopters you can win those sales.
Once you have your clear value proposition and product that supplies it, you need to iterate your sales process many, many times, until you find the right repeatable model that secures recurring revenue. It has always amazed me what happens when a career sales person is brought in to replace the peer-to-peer selling of engineers – don’t underestimate the value of peer-to-peer, it’s the secret sauce of selling to early adopters, but there is an inflection point where the domain experienced sales person can turn up the heat for broader market acceptance and really start to ramp sales. This is the other element of risk capital; its hard to judge when to increase burn in order to capture the market – if you are bootsrapping, you will often miss this point and grow organically, trading time for money. This is usually a bad trade because you can’t win back time – there are many, many bet-the-company decisions an entrepreneur is faced with, it’s a lot easier to seize the opportunity if there is a financial buffer, and ideally people who have made these decisions before for their own businesses.
So if it's so easy, why do we so rarely succeed? (see Part III next time)
Thursday, November 12, 2009
Valley of Death
I am involved in a government thing at present, trying to help innovation in another country. There is a bunch of money available to help startups be successful and to try and solve the “commercialization problem.” I am looking at materials around how that process will work and can't help concluding it’s a jobs program for domestic consultants rather than a fix for startup success. There are lots and lost of inputs and activity, lots of boxes to check--consultants who can handle your taxes, legal, IP, and ugg Marketing--well not real marketing in the sense that an entrepreneur thinks about it, but more marcom or branding.
The problem is that good entrepreneurs self-select out of these programs. They don’t need the government to solve these problems for them. If they did they would have little hope of solving the really hard problems of the marketplace, which is of course where they really need the help. Domestic consultants in that country are ill equipped to navigate a foreign ecosystem because they are living in it currently. Like the entrepreneurs, the entrepreneurial service providers, patent attorneys, lawyers, accountants, real estate brokers, etc who all work for equity here in the Valley, don’t do so in other ecosystems and wouldn’t naturally migrate to a government program because they are entrepreneurial enough to do it themselves.
It's not lack of basic business advice that kills startups, it’s the valley of death, that gulf that separates the first early adopter customers and the mass market that propels a company to revenue growth, scaling and success. Many, many companies survive in purgatory for years, without achieving success, but government programs might label them as successful because they didn’t fail ... in other cultures there's a great fear of failing--but as with skiing, if you don’t fall down, chances are you won’t learn to ski!
The power of networking is an awesome thing to behold, and no one uses it better than a great entrepreneur.
So you have a great technology idea for a laser sheep shearing machine and you want to get it funded; you talk to a few friends, and one of them knows an angel or a VC; they set a meeting. That investor doesn’t like the deal but he knows someone else who does, he makes a call, you meet for a coffee and sketch the business model on a napkin. The second investor laughs and you go through five iterations together, and he sends you away with three more names to vet it out. Next day, you meet those three people, one is a domain market expert who has worked in the sheep shearing market for 15 years. The other is a laser expert, who vets your technology, and the third is a former entrepreneur who has never seen a sheep but built five successful laser companies.
After your business plan has been torn down and rebuilt seven more times, you have a fairly invested group, and a solid plan and you can go back to the VC. You also have the names of three other VCs who invest in laser technologies (which means you have the worldwide market for laser investors ;-) ).
One of those VCs tells the former entrepreneur, looks great idea but there are five of those deals going around the Valley now, and I’m pretty sure X funded one of them--better check it out. The sheep shearing guy knows the customers and verifies, yes in fact VC X did fund them, so we’ll cross that VC off the list--is there an angle here to partner, compete, or should we give up this idea? We still have time to put together a new plan, and it isn’t even the weekend yet …
No cash changed hands in these interactions, no commitments were made. If the company had been funded, chances are some of the people who helped would become advisors or BoD members, maybe the seasoned entrepreneur would have ultimately stepped in as CEO. The people involved will stay connected, the entrepreneur who came up with the idea, will try to find ways to help those who helped him, and pay it forward. Value gets rewarded, any good entrepreneur knows this, and knows how to reward and nurture those who help.
One way to deal with the valley of death is simply to avoid it--when pitching an idea to a VC the second best answer you can get is NO, but with sound reasons. It's awful to spend years trying to build a business, languishing in the valley of death, it's far better to avoid it all together and do something else.
If you are Evil Knievel, then you may be able to jump the valley of death. So how do you cross the valley of death?
The problem is that good entrepreneurs self-select out of these programs. They don’t need the government to solve these problems for them. If they did they would have little hope of solving the really hard problems of the marketplace, which is of course where they really need the help. Domestic consultants in that country are ill equipped to navigate a foreign ecosystem because they are living in it currently. Like the entrepreneurs, the entrepreneurial service providers, patent attorneys, lawyers, accountants, real estate brokers, etc who all work for equity here in the Valley, don’t do so in other ecosystems and wouldn’t naturally migrate to a government program because they are entrepreneurial enough to do it themselves.
It's not lack of basic business advice that kills startups, it’s the valley of death, that gulf that separates the first early adopter customers and the mass market that propels a company to revenue growth, scaling and success. Many, many companies survive in purgatory for years, without achieving success, but government programs might label them as successful because they didn’t fail ... in other cultures there's a great fear of failing--but as with skiing, if you don’t fall down, chances are you won’t learn to ski!
The power of networking is an awesome thing to behold, and no one uses it better than a great entrepreneur.
So you have a great technology idea for a laser sheep shearing machine and you want to get it funded; you talk to a few friends, and one of them knows an angel or a VC; they set a meeting. That investor doesn’t like the deal but he knows someone else who does, he makes a call, you meet for a coffee and sketch the business model on a napkin. The second investor laughs and you go through five iterations together, and he sends you away with three more names to vet it out. Next day, you meet those three people, one is a domain market expert who has worked in the sheep shearing market for 15 years. The other is a laser expert, who vets your technology, and the third is a former entrepreneur who has never seen a sheep but built five successful laser companies.
After your business plan has been torn down and rebuilt seven more times, you have a fairly invested group, and a solid plan and you can go back to the VC. You also have the names of three other VCs who invest in laser technologies (which means you have the worldwide market for laser investors ;-) ).
One of those VCs tells the former entrepreneur, looks great idea but there are five of those deals going around the Valley now, and I’m pretty sure X funded one of them--better check it out. The sheep shearing guy knows the customers and verifies, yes in fact VC X did fund them, so we’ll cross that VC off the list--is there an angle here to partner, compete, or should we give up this idea? We still have time to put together a new plan, and it isn’t even the weekend yet …
No cash changed hands in these interactions, no commitments were made. If the company had been funded, chances are some of the people who helped would become advisors or BoD members, maybe the seasoned entrepreneur would have ultimately stepped in as CEO. The people involved will stay connected, the entrepreneur who came up with the idea, will try to find ways to help those who helped him, and pay it forward. Value gets rewarded, any good entrepreneur knows this, and knows how to reward and nurture those who help.
One way to deal with the valley of death is simply to avoid it--when pitching an idea to a VC the second best answer you can get is NO, but with sound reasons. It's awful to spend years trying to build a business, languishing in the valley of death, it's far better to avoid it all together and do something else.
If you are Evil Knievel, then you may be able to jump the valley of death. So how do you cross the valley of death?
Monday, October 26, 2009
Why do you do Hardware?
I was asked this question by a young VC analyst replete with Stanford Biz school education, attitude, and three months of on-the-job experience. It struck me that perhaps the industry has passed me by and Hardware is so 80s ... so I thought it was time to soul search as follows: the rivalry between hardware and software is akin to that between physicists and chemists. Many would say that when you know what you are doing you do it in hardware and if you don’t [know what you're doing] you chose software ;-)
At Iridex I was stunned at the power of software, particularly with the advent of the touch screen. Suddenly we could change the bezel with code only, we didn’t need to retool or repaint the knobs. It was also incredibly more resilient in nasty places like the OR (well it wasn’t at first but it eventually got there). The difference from the hardware guys is that you can afford to get it wrong because it's easy to fix (compared to messing up the mould for the bezel or display, which could take months to fix). However, to hardware guys, the software is always the gating item in a project because it's always late, and never works properly--in fairness the software can’t be done until the hardware is complete so it’s a shared responsibility for being late.
The logic of doing software deals is that the recipe is fairly well defined. Because there is no manufacturing you can usually see the product or a prototype before you invest, talk with beta customers and a have a clear understanding of the value proposition--but where is the fun in that ;-) In hardware, it's rare to have the product, particularly if it’s a chip, so you have to rely on market vision, trends, and team. The capital expense is much higher in hardware and if you get it wrong it's really hard to recover. On the positive side, hardware begets a lot of IP and if managed properly you will always have a residual value to your investment even if the market fails. This IP barrier is the critical missing piece for me in software deals, unless there are legitimate ways to protect algorithms (like crypto, sequencing, expert systems, etc.). They tend to become execution plays, with tender hearted companies like Microsoft and Google looking over your shoulder ready to step in with a mediocre purchase price based on a make/buy decision. Of course if you can execute, very large companies can be built, which is why there are so many software-centric VCs.
In contrast chip investors seem to be a dying breed--partly because VCs don’t have the firepower to fund $100M deals ... well, unless it's in Cleantech ;-) Yet in medical device or biotech these $ amounts are fairly typical, so what's going on there?
In the medical space, in addition to wonderful IP barriers, you also have the FDA as a blessing and a curse. On the bad side it can take five years to get approval from scratch, but the value of that asset is immense, almost regardless of revenue metrics. To a large company like Medtronic or J&J, it's well worth paying $100M for a “failed” device company that has the platinum of FDA approval--often failed deals turn into great successes when big pharma puts its marketing muscle behind them.
Virtualization and cloud computing are strong trends and important ones--but as a hardware guy I worry about the security of these connections, and the power of software to effectively secure these open network systems.
I have seen a new breed of software guys who make software hook into the silicon itself, which turns out to be a wonderful way to get chip guys who don’t do software to appreciate it, and leverage the hardware to work in concert with the software to make a secure device. I think this is probably a theme.
I guess in the final analysis no matter how virtualized you are, at some point you have to touch the real world so software is pretty useless without the hardware that manifests it, so to me at least they are inextricably linked in a timeless symbiosis ;-)
Responses to comments:
David Wright - Larry - I have had a few successes and one deemed a failure. To me it is beyond doubt that you "can" learn a lot more from a failure than successes - how far can you push yourself, your team what are the warning signs etc but I don't think many will count the scenario you presented as a failure. Timing also is an issue. In my case - I am a better CEO because of my company failure and what I learnt to get it to the heights achieved but this was permanent - the company folded so a genuine failure. Until this happens the scoreboard is still running - will this person still consider it a failure if that company turns up again. If not they should tell Mr Murdoch how much of a failure he is :)
David--Thanks for your thoughts. We invariably learn more from our failures than successes--and how we react when things don’t go as planned really teaches ourselves and others about the quality of our character. Sounds to me like you will have continued success despite some setbacks.
At Iridex I was stunned at the power of software, particularly with the advent of the touch screen. Suddenly we could change the bezel with code only, we didn’t need to retool or repaint the knobs. It was also incredibly more resilient in nasty places like the OR (well it wasn’t at first but it eventually got there). The difference from the hardware guys is that you can afford to get it wrong because it's easy to fix (compared to messing up the mould for the bezel or display, which could take months to fix). However, to hardware guys, the software is always the gating item in a project because it's always late, and never works properly--in fairness the software can’t be done until the hardware is complete so it’s a shared responsibility for being late.
The logic of doing software deals is that the recipe is fairly well defined. Because there is no manufacturing you can usually see the product or a prototype before you invest, talk with beta customers and a have a clear understanding of the value proposition--but where is the fun in that ;-) In hardware, it's rare to have the product, particularly if it’s a chip, so you have to rely on market vision, trends, and team. The capital expense is much higher in hardware and if you get it wrong it's really hard to recover. On the positive side, hardware begets a lot of IP and if managed properly you will always have a residual value to your investment even if the market fails. This IP barrier is the critical missing piece for me in software deals, unless there are legitimate ways to protect algorithms (like crypto, sequencing, expert systems, etc.). They tend to become execution plays, with tender hearted companies like Microsoft and Google looking over your shoulder ready to step in with a mediocre purchase price based on a make/buy decision. Of course if you can execute, very large companies can be built, which is why there are so many software-centric VCs.
In contrast chip investors seem to be a dying breed--partly because VCs don’t have the firepower to fund $100M deals ... well, unless it's in Cleantech ;-) Yet in medical device or biotech these $ amounts are fairly typical, so what's going on there?
In the medical space, in addition to wonderful IP barriers, you also have the FDA as a blessing and a curse. On the bad side it can take five years to get approval from scratch, but the value of that asset is immense, almost regardless of revenue metrics. To a large company like Medtronic or J&J, it's well worth paying $100M for a “failed” device company that has the platinum of FDA approval--often failed deals turn into great successes when big pharma puts its marketing muscle behind them.
Virtualization and cloud computing are strong trends and important ones--but as a hardware guy I worry about the security of these connections, and the power of software to effectively secure these open network systems.
I have seen a new breed of software guys who make software hook into the silicon itself, which turns out to be a wonderful way to get chip guys who don’t do software to appreciate it, and leverage the hardware to work in concert with the software to make a secure device. I think this is probably a theme.
I guess in the final analysis no matter how virtualized you are, at some point you have to touch the real world so software is pretty useless without the hardware that manifests it, so to me at least they are inextricably linked in a timeless symbiosis ;-)
Responses to comments:
David Wright - Larry - I have had a few successes and one deemed a failure. To me it is beyond doubt that you "can" learn a lot more from a failure than successes - how far can you push yourself, your team what are the warning signs etc but I don't think many will count the scenario you presented as a failure. Timing also is an issue. In my case - I am a better CEO because of my company failure and what I learnt to get it to the heights achieved but this was permanent - the company folded so a genuine failure. Until this happens the scoreboard is still running - will this person still consider it a failure if that company turns up again. If not they should tell Mr Murdoch how much of a failure he is :)
David--Thanks for your thoughts. We invariably learn more from our failures than successes--and how we react when things don’t go as planned really teaches ourselves and others about the quality of our character. Sounds to me like you will have continued success despite some setbacks.
Tuesday, September 22, 2009
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 the CEOs of our portfolio companies to help them better manage their business and avoid the pitfalls and mistakes that 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 their 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 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 have to 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 its 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 ...
Responses to comments:
Peg has left a new comment on your post "Success or failure":
Thank you for this; you remind me to buck up and try again. My self-funded company failed last year after a bad car accident left me hospitalized for several months followed by five more months of being bed-bound at home. The corp. did not make it with me out of the picture, and at the same time, unable to add more capital to get them through it, though the staff tried valiantly to keep going for the 10 months immediately after the accident. I learned the importance of key man--not only insurance, but to have a person and a plan in place. Thanks for the reminder that failure is a step one would rather not take, but once taken, can be a path to another venture. At times in the last 18 months, I have forgotten that. I'll avidly follow your new blog. Thanks!
Peg – getting up and trying again is what it's all about, anytime you try to create something great the chances of failure are high, but the real failures are the ones that don’t try but criticize those that do, and end with an I told you so ... good luck!
Anonymous has left a new comment on your post "Success or failure":
Larry, By your definition, a Ponzi scheme would be a "successful" business. The true definition of a "success" is a company that creates wealth, rather than simply redistributing it. Was wealth created in your case or only redistributed? R.
R – Perhaps you should re-read – we were defining failure, not success; fear of failure stops too many of us from trying to change our world – failure is where we learn our most valuable lessons – success is great but it doesn’t teach us much – in the case I discussed wealth was created by the company and redistributed to the investors
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 their 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 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 have to 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 its 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 ...
Responses to comments:
Peg has left a new comment on your post "Success or failure":
Thank you for this; you remind me to buck up and try again. My self-funded company failed last year after a bad car accident left me hospitalized for several months followed by five more months of being bed-bound at home. The corp. did not make it with me out of the picture, and at the same time, unable to add more capital to get them through it, though the staff tried valiantly to keep going for the 10 months immediately after the accident. I learned the importance of key man--not only insurance, but to have a person and a plan in place. Thanks for the reminder that failure is a step one would rather not take, but once taken, can be a path to another venture. At times in the last 18 months, I have forgotten that. I'll avidly follow your new blog. Thanks!
Peg – getting up and trying again is what it's all about, anytime you try to create something great the chances of failure are high, but the real failures are the ones that don’t try but criticize those that do, and end with an I told you so ... good luck!
Anonymous has left a new comment on your post "Success or failure":
Larry, By your definition, a Ponzi scheme would be a "successful" business. The true definition of a "success" is a company that creates wealth, rather than simply redistributing it. Was wealth created in your case or only redistributed? R.
R – Perhaps you should re-read – we were defining failure, not success; fear of failure stops too many of us from trying to change our world – failure is where we learn our most valuable lessons – success is great but it doesn’t teach us much – in the case I discussed wealth was created by the company and redistributed to the investors
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