Water deals

It's been said that water is the new gasoline--I hope not, it will be hard to drink. ;-) I am a big believer in water investments; in the US we pay a fraction of a penny per gallon of water, while in the rest of the world it is priced by market forces--many times higher than here. As it did in telecom, deregulation will hit this industry and fortunes will be lost and made. In my real estate investments I have a partner who has been in bottled water for years, and is seeing a disproportionate escalation of water-related real estate values (i.e., land with springs and no waterfront). About 10 years ago I helped a friend with a European water bottling outfit differentiate his product using laser marking--there’s a stretch of technology. ;-)

In China and India, clean water is on the top-10 list of key infrastructure needs for the future. Coming from Australia, which is almost always in drought, I have a keen appreciation of how critical water is. Israel is a source of exceptional water-related technologies because, as with most things, need drives solutions. So far I have seen quite a few water deals, but I am having trouble finding the killer app/technology. There are membrane technologies that filter the water, specialty plumbing systems that recycle gray water and use it for non-potable applications, and there are software suites that model and optimize flow. It's a really large and fragmented industry; it's hard to make sales and they are usually consultative and long, with slow-moving technology adoption. Sound familiar?

So we laser jocks or telecom experts should be good at this area…maybe.

So many of the areas we plan in have this same characteristic, but the water industry exacerbates all the usual obstacles to selling for a startup: you are small and they take a long time to make a decision (you may burn through two rounds of financing before they put you in a field trial). If you win the field trial, then you have to support it, and if you get a design win, then you have to convince them you can supply and you'll burn through a third round of funding just doing that. But then you can ride the wave. :-)

There are some great, venture-investible technologies that help the water ecosystem, despite its fragmentation and selling difficulties. Acoustic leak detection systems using sonar, fiber-optic pipeline monitoring, unique algaes and chemicals that simplify and improve water purification, and also new electrolytes and electrode materials that make electrolysis easier to separate H₂ out of water driven by solar energy. As with Palm Oil, water may be seriously undervalued--but we had better hope people don’t start turning it into energy for fear of making life's vital quantity-priced like gasoline...

Course correction

One of the key gifts of a great entrepreneur is their ability to execute real-time course correction in response to market changes, team changes, morale changes, and investor and customer sentiment. :)

As a hardware guy, it's fascinating for me to observe the truly real-time nature of management of Internet companies, and the amenability of the data to real-time analysis. For example, a retail web business continually tweaks its Web site -- everything from background color to placement of the buttons and core code -- but they do it in an endless series of micro tweaks, then measure the changes in site metrics to determine whether it was the right tweak or not. I saw the extrapolation of this metrics-based management in a company that sells specialty products to women when they tested a series of "hardware" initiatives in the same way they would test Web. In this case, they tried selling their product through real-world parties with interested women customers and measured the effects of different party structures and formats across multiple events to determine the optimum. When I heard the results and analysis and ultimate conclusions, I was struck with the simple question of "why not just ask someone who has done Tupperware parties or Avon, how they do it, and why?" Especially when some of the conclusions on the formats that didn't work were based on fairly obvious problems like, "if the women in the group didn't know each other, we didn't sell as much…" Fairly obvious, even to a non-Avon user.

Contrasting Internet, software, and hardware highlights to me a fundamental difference and issue in the area of product management, which is always the Achilles' heel of startups. Despite the experiences of VCs, most startups still suffer badly from poor product management -- it's not a well understood discipline, and confused with marketing and sales as much as marcomm is confused with true marketing. Being one of the classic failure points, I am always surprised when investors don't want to spend $ on a solid product management expert before "developing the technology" -- how on earth will you know what to develop? In any hardware company -- take your pick from semi to medical device -- the product is always late because the software isn’t finished. :) The software guys can't really test until the hardware is done. For the hardware guys, the product management and vision had better be perfect. Otherwise, the chip that took over a year to design, tape out, and FAB may work great but have the wrong interface or attributes, or control software that simply doesn't suit the customer -- and another spin takes at least 6 months more. :) These issues are somewhat amenable to analysis (not as in a consumer Web site), but largely the work of a very thoughtful and usually somewhat visionary product manager who understands the customer, the technology, the market, and the likely changes. Good startup CEOs know the fatal error of asking the customer what they want and building the product based solely on that (you get the same product you have today, but at a lower price with more features).

Let's face it, software might be trying to eat the world but if you really know what you are doing, you do it in hardware. :)

Don’t get discouraged

So the pitch went great, lots of good discussion and Q&A, but still no $...what happens now? Firstly, don’t be put off by a VC not investing in your idea--there are many, many reasons why this happens. Please don’t assume your idea sucks; at the same time, also don’t assume they don’t get it--the fact is, you can’t kiss every girl. VCs (should) only invest in things they can really add value to--so if they don’t understand your technology or haven’t personally built a business in that space, chances are they wont want to fund it because they cant add anything beyond mere $.

A little known fact, VCs love to learn--why did they listen to your pitch if they didn’t really understand the space? Because you can teach them--in return, they will teach you. They will spend some time with you helping you find the right VC through their network, if you seem to have a solid idea. Furthermore, if they do understand the space generally, they will often spend a long period of time helping you iron out the kinks in your plan. I know of one company that Dado spent almost 18 months with before ultimately funding. Some companies take a lot of work before they are investible. This is a really good piece of the ecosystem--now, many entrepreneurs from other places don’t realize or believe how much time a valley VC may be willing to spend to nurture a potentially great idea. So, here is a story--some chip guys came up with a very high risk concept pushing the chip performance envelope almost to its theoretical limits. They were pretty well qualified to do so but while their chip design knowledge was great, their market knowledge was poor. So a very well known chip investor spent about 9 months working with the team, almost turning them into EIRs and letting them work closely with the rest of his team to flesh out their concept. The company was probably 3 months away from being investible, but at that point they secured a term sheet from one of the top 3 firms on Sandhill rd, not well known for syndication of deals--they took the money & ran (per good advice ;-) but failed to get the original VC dialed into the deal--very, very bad...). One of my own companies in the optical space had a similar history where one of the founders had leveraged actually 3 different, small VC firms for almost a year before getting funded. I found out about the history about a year after that and set about mending fences, but hard as it is to believe entrepreneurs are stupid enough to leverage this help and then dump the VCs in favor of another, the emotion is a lot likely being dumped for a prettier girl, and it leaves pretty nasty scars, too. Now, this ususually is a byproduct of heady times of rapid market growth--in poor economic climates, it's far more common for VCs to band together and prefer more people at the table to share the risk.

Getting turned down isn't the end of the world--in fact, let's turn it around to the VC getting jilted by the entrepreneur. In the case of the chip company, the dumped VC now had a very clear perspective of the space and knew what he felt was wrong with the team’s original idea, so was in a great position to evaluate the next 4 groups that pitched him for the same concept and thereby selected the optimal competitor who is now making the original team’s life hell...fun, isn’t it. Every no from a VC is an opportunity to learn. Make sure you ask for a debrief--VCs are optimists and they live by relationships. They want to invest the $ they have; they will work with you to make you investible if you are patient, honest, and have fundamentally a good idea. The more honest they are the more it can hurt, but make it easy for them to be honest; otherwise, all you’ll get is “love the deal, but we are not doing any more in this space.”

Life is too short

Larry Ellison has known this for years, as he tries to extend his years ;-), but also in the sense, I mean. I had breakfast with a friend at Kleiner last week and he was bemoaning wasting 3 months on a deal and having to drop it. He was doing a deal with a foreign company in a region known for tough negotiations--and great falafels. So he had done all his diligence, reworked the plan with the team 5 times, secured his tier 1 co-investor (yes, even Kleiner likes to have a co sometimes), and had signed the term sheet. But there was a slight problem: There was a local angel investor who wanted to renegotiate the deal. He wanted blocking rights, veto rights, and the more they talked, the worse it got. Worse, the CEO clearly couldn’t manage the negotiation, and my friend had been negotiating with the wrong person and quickly decided 3 things:

1. If the CEO couldn’t manage his investor, then he couldn’t run the company.
2. The angel investor added no value to the company, and would jeopardize its success.
3. Life is just too short; he had seen this movie before and knew the ending.

There are very few negotiations you will do in your life that are transactions without some form or ongoing relationship. Even when you buy a car--a negotiation that is very adversarial complete with appeal to authority, missing man scenario, even ignoratio allenchi, and all 7 of the classic gambits--there is still a relationship to worry about post-transaction: Someone has to service your car and deal with your warranty.

Someone who takes a transactional approach to a deal with you is a great example of life’s too short--you should politely bow out and forget the deal, no matter how good it seems. Entrepeneurs have been often been advised to tell the VC that they don’t need or want the money--don’t play this game--you will get "great, then come see me when you do." If it's going to be all about price, go to a bank, a strategic investor, or an angel--the price will inevitably be better, but the value-add will likewise be less. And if it's just a transaction, why would you expect any value after the transaction?

Another classic tell is assignment of blame--in its worst form, the entrepreneur blames you when things go wrong, but generally it's their team or the economy, or the weather. Life is simply too short to work with anyone who won't accept personal responsibility for what they do. This tell usually comes out in the first Q&A session.

First impressions from engineers are difficult because they are almost always geeky--a good friend here in the valley created the first impression with some foreign investors that he would make a lousy CEO. Too much of a techie and a geek--kind of a gangly, dorky guy. Now, he is that, but if you have ever worked with, say, Intel, you will find that they are all a bit that way, but if you listen to what they are saying, you will quickly realize that they are really exceptional business people as well. The culture of semi people is quite unique--to be good, they have to be quirky, and only the paranoid survive. :-) So, I am not talking about superficial first impression--you have to see deeper than that. As dorky as my friend can be, his integrity is without question and his dedication focus and passion for what he does are compelling. He also built 4 tech companies and turned a zero-revenue tech acquisition into a division on Intel generating 100s of millions in revenue--so his business skills aren’t too shabby, either.

A young guy in Sydney caught my admiration dramtically when he argued passionately on a panel of older, more experienced investors, a very controversial point--but he showed passion and belief, and some serious cojones to take the position he did. (And, by the way, against my point of view as well--yet as a first impression--I’ve gotta find a way to work with this guy!)

It's really hard to practice what you preach in this regard. I am working on a project at present where we are literally founding the company around the entrepreneur--which any good VC should do. In this case, it’s the opposite of the first impression--my first impression was "there is something here; this guy is good, but he needs a lot of help." In working with him I have since seen many red flags, but can't get past my first impression--we’ll see if it works out. :-)

What kills tech startups

I have heard visionary or highly technical founders blamed repeatedly for the failure of a company because the technology didn't work--in some countries, they are blacklisted for life for this "failure." I don't believe I have ever seen a company fail because of bad technology (although I have seen one where the founder simply but unintentionally fooled himself). The visionary ideas are the hardest--new materials that will "fix" the memory industry, a new device that will make solar profitable again, or an electric car that will break all the paradigms. These big, bold ideas often represent new platforms or are category-defining companies--technologists love platforms because they can sell their technology to multiple markets and that makes the TAM much bigger than anyone focused on a single vertical. Now some VCs also love platforms, or at least those that can be truly category-creating--but startups should try to sell into multiple verticals. It's too damn hard.

Investors want to find these deals that will change the world, but the perennial problem for tech is finding someone to pay for that change--to do that we need someone who cares, ideally a customer. The company can raise some seed money to flesh out their idea, maybe do some engineering prototypes or simulations to show it "can" work. Then, they will take these to a group of potential customers to try and find the visionary who can share their vision. The investors will go talk to these potential customers and get excited about what could be, but it needs a little more work--it will change the world, but it needs some more cash to get a prototype together and validate it. OK, great--so, Mr. Customer, how much are you willing to pay to be the first to have access to this revolutionary technology? Er...well, we don't do that sort of thing...

Now, there are some big, brassy, bold investors out there who will happily forge ahead and fund these revolutions; you find them a lot on cleantech, healthcare, and semi. Often, it's the only way that these things will change because customers are so terribly conservative and slow to change that they can't see the future until they are thrust into it. But even these investors have a recipe to de-risk these swing-for-the-fences deals.

There is an old adage in physics that to solve a problem you have to turn the problem against itself--put another way, all physics students know in multiple choice the answer that seems least likely is usually the right one. Two companies I co-founded ran into fundamental technology problems where basically the technology didn't work. In one, the material died at any practical operating temperature, so we had to change to a market that was comfortable with high-temperature stuff; in fact, that needed products that could withstand those temperatures. In the other the technology worked, but it required so much unique manufacturing equipment that it could never be practically deployed--the solution there was to sell the company to someone who was awesome at manufacturing so they could get it "inside," and they did about 7 years later. Death for a startup, but just a single design cycle for them. :-)

Elon Musk made the electric car revolution work by partnering with everyone who was best-of-breed in making the critical elements he needed--Panasonic for batteries, Toyota for engines and their parts chain, etc. He also had them write the big checks to finance the idea --so a crazy (who in their right mind would try to compete with Detroit? Japan...) idea became a stellar IPO. Of course, you don't hear about the other 5 startups that preceded Tesla and failed...

Ideas are Cheap

I know the guys that invented the Internet--no really, and he wasn’t even the Vice President--but seriously, in 1980 a good friend made the observation that the intranet at our university should be the basis of a global communication system. After a few more beers, he had painted a vision of IP telephony, e-commerce, and many of the other innovations we now take for granted. He had a brilliant vision, but limited ability to execute on it; in fact, no real desire to do the work necessary to execute on it. Not to criticize Dave; after all, I was renowned in my University days for always saying "Just shut up and do it"--imagine if I'd bothered to TM that. ;-)

I also spent a lot of time in my first company writing my own patents because I couldn't afford to pay an attorney--I highly value IP, but it's a love-hate relationship because IP fools you into thinking you have invented something. To me, invention, or rather innovation, is all about executing on the vision and delivering the change. Now, clearly, there are instances where someone invents something clever, tries to commercialize it, and another company does it better and a IP lawsuit results. Ultimately, products must be born of innovation, but unfortunately IP is more often used by Trolls to stifle innovation and competition. Sure, there are times when a company refuses a fair license agreement and get what they deserve as a result, but as an investor it's rare to find an inventor, especially in a university that has a realistic perspective on the value of an idea. If you have ever negotiated with a university to license IP, you will likely share this feeling about IP.

I had an interesting experience recently with a university outside the valley; the meeting started with reading the riot act about what the university wouldn't put up with, and then went into a diatribe around knowing all about how VCs operate. Now I admit my brethren in other countries to operate quite differently to those in the valley, and there is probably justification for considerable negativity. Anyway, it was an interesting opening negotiating position. It stemmed from a bunch of things--but recognizing that I had already spent a lot of time with the inventors and worked with them in arranging investor meetings, customer meetings, diligence, getting market data, and creating the plan, the assumption was that I was already half-pregnant so I had a lot to lose.

The problem with this adversarial approach, aside from the fact that life is just too short (see earlier blog), is that early-stage investing is a partnership--if it's being done right, the VC is part of the founding team and gets their hands dirty in the trenches alongside the founders. When someone starts trying to use the work you did to help them against you, it's indicative of a zero-sum gain mindset--clearly, it's one form of business leverage, but it's a transactional view that burns the relationship for short-term gain. You don't ever want to work with people like that--even if you are just doing a transaction. Many, many people live and thrive in zero-sum gain ecosystems, but they rarely create anything, so why bother?

Having walked away from the deal I had helped create, I then experienced the irony of having a series of players from the original investors, independent BoD members, and some of the founders come back over the next year and pitch me my idea It still sounded pretty good, but they were so busy competing with each other to steal the idea that none of them actually delivered it. Lawsuits were threatened, sabers rattled, and ultimately everyone walked and the original company died. Which is the other problem with a zero-sum gain mindset--there isn’t anything left to go around. :-)

Steve (for Wick)

Many years ago, I had the great pleasure of showing Steve Jobs a laser projector prototype in our suite at a major tradeshow. When I brought him into the room wearing the customary jeans and T-shirt, my chairman tried to tell him it was a private suite, and who was he and why wasn’t he wearing a suit like everyone else? Interestingly, none of this seemed to bother him, as he was obsessing on the projection system at the time.

I had met Steve 3 times in 23 years and while I doubt he ever remembered me, I was always stunned by his perception, vision, and imagination tempered by ability to focus (obsess) on core over context. He lived next door to a fellow CEO Wick Goodspeed near downtown Palo Alto for many years, and because he didn’t have a pool (his yard was an orchard) he and his family often used Wick's. Wick was a wonderful friend to many people, a role model, and he is sadly missed. I asked Steve once if he was left- or right-handed (so many of the original Apple team were lefties)--and without missing a beat he said ambidextrous. :)

Now, while many people will tell you the stores are all true, I would observe that all visionaries can be difficult because they are obsessed--I'm sure Gandhi was a pain at weddings, too. My limited observations of him were augmented by working with a lot of his close co-workers and meeting a lot of the classic Apple alumni, including one of my portfolio CEOs and my current business partner Scull, who had the dubious pleasure of channeling go-to market strategies to Steve’s ideas...you can imagine!

My final meeting with him was a few years back, still related to the cell phone projector idea--I was in big trouble with my family because it was my birthday and the only time I could meet him was at night, so I was missing my cake. I waited in the lobby for quite a while, and since no one was there I started playing the Bosendorfer piano, which surprisingly wasn't locked (normally in the US, playing the piano in a big hotel gets the "may I help you?" and dirty look), so I figured this might accelerate my meeting so I could get back to my birthday cake. After another 10 minutes or so I realized he was listening, so I stopped and figured I was in big trouble, but apparently not. I discovered later that he loved art and artists--he wasn't artistic himself, at least not in the traditional sense, but that made art even more important to him, as evidenced in Apple's designs.

Apple, even with Steve's vision, is impossible for a startup to do business with--they pay well, they have massive volumes, and they value performance and quality over price, but they are relentless in their pursuit of excellence. And startups beware--they will suck you dry like any big company, only worse. So, excited as I was, I really didn't want to get into bed with them, but I wanted to see if the idea really had legs or was crazy. What intrigued Steve was not the projector or the laser or the cool tech, but the key issue that a laser is always in focus, so when you project a beam the image is always in focus, even if its on an irregular surface like a sphere, cylinder, or someone's T-shirt. He immediately leapt to the idea of projecting clothes onto people, and structural drawings on old buildings and at least 20 other "apps." The other amazing thing about him, was his willingness to take a big bet early on--he bought the little startup that invented the multi-touch technology, ploughed years of resources and cash into it, and made it the key selling point of the iPhone. He did the same thing many years before with a crazy idea completely computer animated movies buying the property from George Lucas after Lucas' financial advisors insisted he sell the dog that was draining his cash--10 years of pouring money into it made Steve CEO of 2 public companies simultaneously.

Love him, hate him (and the same people did both), he was truly a national treasure, and an inspiration to us hardware guys who struggle for attention against the white noise of the Internet. In my final meeting, I made the mistake of answering his "how important are we to you" question by saying "I’m giving up my birthday with my family to be here with you at night, isn’t that a good start?"--he ignored that and moved on. I found out later that it was his birthday, too--oops….

Aussie 'Gold Rush' in SV?

Aussies have been coming to the States for 30 years -- actually, longer if you think about Ugg and others, but for sure Peter Farel founding Resmed.

There's a misconception that if you come here, everything is solved and the streets are paved with gold. It's a little like the scientist I started out to be saying naively it's such great technology; build it and they will come.

I think the real story is Aussies who are building these companies back home; that's really new. I think Atlassian, Stayz, Bislr, Freelancer, Spreets, 99 designs, OzForex, and the prior generation Seek and Looksmart are the real heroes because they proved it could be done on shore in Oz [Editor's note: Australia]. Dave Skellern and Neil Weste went against all odds and proved you could build a big semi company in Oz with the first Wi-Fi chip company, despite the absence of any domestic chip market. Dave made a massive exit to Cisco.

What's also new is that the current generation got US private equity firms (not VCs, yet) to do later stage deals domestically. It would be great if local PE firms would get into these deals. I would much rather see Aussie funds supporting Aussie companies -- there is over a trillion dollars under management in Oz and it's a shame that most of the tech money goes into US tech.

Web deals are inexpensive to start and to fund -- so easy to bootstrap, and less constrained by geography. But they still need serious dollars if they start to get traction, because competition is so fierce they need to market like crazy and that costs big money. Sometimes they get lucky and go viral, but it's rare. With hardware deals, you need to have money to build the prototypes to get started; this is the area that Aussie entrepreneurs really need help with. It's also the area where the most sustainable and value-creating companies can be built. According to the World Economic Forum, Australian startups are strongest in the new to region category, not new to market or new to world -- this means we are good at copying successful ideas from overseas and exiting them in Oz. That's not sustainable. The same is true of many, many, other countries, and in general mercenaries make money far more easily than missionaries.

On the invention side Australia is disproportionately strong; there is massive government support of research -- we invented Wi-Fi, the photocopier, plastic money :) ...but we are weak on the rest of the innovation value chain. We are also more often visionary or missionary entrepreneurs when we do technology, rather than mercenary. Atlassian had a vision of collaboration rather than e-mail. Resmed proved the existence of a lethal disease no one ever knew existed but affected many, many people, then built a multibillion dollar company to cure it.

Another generational change: In the prior generations, there were few serial entrepreneurs in Oz; mostly they win once then go into something easier like property development. If they invest in tech, they tend to be pretty tough on terms like the older generation of family offices. Rather like toughened school boys, they do to the new kids what was done to them and it becomes self-perpetuating. The new generation are more accepting of risk, I think, because they tended to make money faster and easier through the evolution of the web. This is a really good thing for the country because they are willing to re-invest both in themselves (repeat entrepreneurs) and in each other. That's smart money and it's ecosystem creating; with that catalyst we could see a real tech investment ecosystem form Down Under….there certainly is enough beach for a silicon something. :)

Cleantech

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!

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.

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...

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.

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 :-)

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 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 ;-)

Why failure is good

History is a great teacher. Of all life’s experiences, failure is the best teacher of all. Most good VCs look for at least one failure in an entrepreneur’s track record. Failure, like adversity, generally reveals true character. I was on a BoD where things got rough, and there was concern over solvency (this is a bad thing for personal liability)--one of the directors resigned immediately. To me this is chicken#$%#!

Now I understand that the law is set up to penalize director incompetence, but in some places it’s set up to penalize failure despite directors and founder efforts to fix the problems. When things get tough everyone should be rolling up their sleeves to help fix the problem not the blame. We managed to turn this company around, but not without a few threats of greenmail and the usual legal "BS" to go along with it. In the process we learned a lot about the CEO and his team—and the CEO learned a lot about the merits of proper BoD selection ;-)

Most problems can be solved given the right team and enough runway.

I don’t actually believe there is such a thing as failure, it’s more how you handle things going wrong that determines true failure or character. After all, it’s an ill wind that blows no good for someone. Truly great entrepreneurs see failure as an opportunity–c.f. James B. Stockdale in a POW camp.

Remember in ’99 when the market was going crazy for Internet and telecom, and how easy it was to be successful then, contrasted by how impossible it was to achieve success in 2002? Many many companies went to the wall, but surprisingly, many others found a way to adapt and survive--technically they failed to deliver as promised, but to me they achieved stellar success in learning to navigate perhaps the worst market downturn any of us has ever seen--we hope ;-).

In Australia there is a well known company that is considered one of the true success stories of tech startups--it was acquired for several hundreds of millions of dollars and made founders wealthy. Some VCs there quote it as the deal of the decade but I would argue it was a shame they didn’t take it public and build a sustaining company with a market cap beyond a billion. In the tech bubble time it was easy to sell companies for inflated prices. Selling too soon is something we are all guilty of as entrepreneurs--in contrast, building something sustaining is more risky but is better in every sense if it can be done.

Now in some countries failure is considered a curse, and those who fail are penalized severely--by English law there is no Chapter 11, so if a company cannot pay its debts the directors could end up in jail. In the startup world, failed entrepreneurs get ostracized like the unclean--many VCs I know like to see at least one failure in an entrepreneurs record because it gives an opportunity to see what that person is really made of, and how they dealt with a bad situation--it’s a great opportunity to shine and turn bad luck into good.

In the tech downturn you were a hero if you were able to sell your company for any price, even nothing, as long as the acquirer carried the liabilities--companies with $50-60 million invested capital typically sold for $1.5 million in stock, regardless of their revenue--it was as crazy and lopsided as it was on the way up leading to the crash.

One well known CEO friend of mine burned a $200+ million hole in the ground--you may ask what does one do to walk away from a train wreck like that? Normally you would expect to spend a few years in the penalty box--maybe the rest of your life? But not him. When he found trouble raising VC money for his next gig, he decided to stick it to the VCs and become one--he raised a $200 million fund, and recently a $400 million fund--so failure is definitely in the eyes of the beholder ;-)

Is venture capital better than VISA?

My first company had phenomenal investors--VISA, Mastercard, Bank of America ... Actually 37 credit cards in all, and it was great because you got sweetheart rates for 6 months as you swapped balances ... no really ;-)

Why was that? Well, I had no idea how to raise money, I had never heard of venture capital, and I certainly had no idea what an investor would want to see to fund me. Actually, I also had no idea who would buy my product, but I was certain I had invented something revolutionary ... if I could just figure out who cared?

Now I wasn’t stupid, I had searched for and found a smart partner who understood the laser business and we co-founded the company. He dealt with all the business crap, and I focused on solving the technology and building the product. The problem is, that neither of us really understood what the market was for our product. So as the number of credit cards increased, and the credit card debt scaled up towards $250,000, I realized that the problems weren’t technical per se, but rather financial ;-)

We ended up selling stock to some friends and family, and that helped but also increased the stress and worry around not losing their money in addition to personal bankruptcy. As things were getting worse, we had a visit from Milton Chang, and he gave us an epiphany about our business.

He spent time in my basement in DC surrounded by used lab equipment and even more used furniture, and spent the day talking about what was missing in the business, which included the fact that we didn’t actually have a business. Milton saw several things he liked, and I came to learn that these were his classic tells for a good investment (Milton went on to invest in 27 companies, generating 5 IPOs, 10 great trade sales, and no losses – his stats are off the charts even compared to the best Silicon Valley VCs).

He saw a passionate engineer, focus on putting every available penny into making the product, cheap rent (my basement), no salaries (everyone worked for equity), and a genuinely revolutionary piece of technology in the solid-state green laser, or the "green diode" as we called it (because its beam quality was about as crappy as a diode).

It took Milton about a week to come back to me with an idea to merge our company with one in California called Iris Medical. It took a year, me taking over as CEO, a lot of stress and angst for a lot of people. But when we put great engineers and inventors together with great sales and marketing, we got a great result: Iridex and a NASDAQ IPO.

We literally went from bankruptcy to success (albeit over a couple more years), and the original investors in Light Solutions got their cash back and also kept their stock, so a nice double return. VISA and the other cards got their money back, plus interest, and everyone was happy.

So was VISA better than VC? Well, it certainly attracted Milton. He couldn’t believe we were committed enough (read stupid) to take this level of risk to back our idea but it clearly showed we believed in it passionately. He didn’t like our idea of skin in the game, because it was too distracting and made us make short term tactical decisions rather than strategic ones, but it wasn’t a bad place to start.

VISA gave some good advice: pay your bills on time or we’ll screw you--perhaps some similarities to VCs with respect to milestones ;-) What amazed me most about Milton was despite not really understanding our market specifically, he understood it well enough generally, and 80% of our issues were common to all startups and he understood those better than anyone I have ever met then or since. The power of a committed investor/partner who is aligned with you and willing to give you the time and advice you need is invaluable--it's worth far more than the money, which as you have seen can be gotten almost anywhere.

A lot of us worry about giving up too much equity for investment, but old school entrepreneurs worry about losing the money, and old school investors get their hands dirty standing shoulder to shoulder with the entrepreneurs to help them not only not lose the money, but to use it to make more. If you are worried about dilution, VISA is much better, no dilution, but for God's sake don’t lose the money ;-(

IEEE Entrepreneurs talk

I was fortunate enough to be invited to present at the IEEE Forum recently at National Semiconductor in Santa Clara. What’s great about these presentations is that you learn so much from the questions entrepreneurs ask, and there is always a new perspective and ideas to share. Personally, I don’t like success talks, they are always too glib, and too often accompanied by super-sized ego. I prefer to talk about failure and learning, and if possible how the failure was recovered and turned into a modicum of success, maybe God forbid even making a little money along the way ;-)

I really enjoy giving my life by misadventure talk, which basically explains how one can stumble into success despite making a bunch of wrong decisions – if you think about just how many decisions a CEO makes in a day, it's not surprising that many of them turn out to be wrong. What's great about startups is that you can change your mind, and second guess decisions and quickly adapt to correct mistakes. When Mark Hurd decided to cut and consolidate design centers in HP, it took a year to formulate a plan, another year to execute, and believe it or not, there wasn’t much of a chance to change his mind along the way, and even if there was, it would have taken another two years to undo - some more recent things can't be undone and more's the pity ...

As entrepreneurs, we go down a lot of rabbit holes (and not a few ratholes as well) in our search for the right products, solutions, businesses, and opportunities. Many of the rabbit holes are dead ends, or lead to the madhatter’s tea party, rather than the magical growth elixir for which we originated the quest – those failed quests are what temper us for eventual success. I have sat through so many presentations by successful entrepreneurs who did everything right, were geniuses, and had market vision so profound that everything worked out exactly as they planned. I read Alice in Wonderland as a kid, so little need to hear more fairy tales now. Engineers are not afraid of failure, nor do they expect to have clairvoyance enough to see every mishap and engineer it out before it becomes a problem – they twist and turn and always have a backup plan because they know failure is an inevitable part of pushing the envelope.

The other epiphany I had while preparing the talk, is drawing on my Aussie entrepreneur’s talk, I realized if I replaced the words “Australian Entrepreneur” with “Laser Jock” then the talk worked for both groups. It's amazing the similarities with the little Aussie battler entrepreneur, and the US laser engineer. We tend to think with solution or technology looking for a problem, we worry about saving money to success, we don’t understand marketing, and we don’t get just how much harder it is to market and sell a product vs design and build it. On the positive side, the similarities are even ore striking. We never give up, always find a way around any problem, are very straightforward in our dealings (and this is not the case with many other types of entrepreneurs), know how to deliver, can create a lot with a little, and are fueled with the passion of belief in what we are doing that transcends all obstacles.

Where Angels fear to tread

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

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

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

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

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

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

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

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

Every CEO needs to have carried a bag

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

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

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

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

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