Never having been one to shy away from a complicated deal structure, I am starting to learn why term sheets and VC deal structures are so vanilla--it’s a little frustrating ;-)
If I put my entrepreneur’s hat on, it seems to me that every entrepreneur wants the chance to raise as much money for as little dilution as possible. So why not structure deals that give the entrepreneur the chance to win by doing a lot for a little, but at the same time, give the VC a win if they don’t--i.e., underwrite the entire round, but put half the money in at the VC’s target pre-$ , and have a tranche and a milestone that if triggered pulls in the other half as a convertible into the next round (probably with a discount for risk); but if the milestone is missed the second half goes in at the same pre$. If the entrepreneur does a lot for a little, then more power to them! After floating this concept past several valley VCs, and wiping the vomit off my shoes, I think I am beginning to understand the problem ... so let’s see:
VCs worry a lot about alignment with the team. Often, especially in other places, you see deals where too little money is put in, and the team is basically set up to fail, but they got the deal done and are then at the mercy of the VCs when they run out of money. Clearly there's a fundamental misalignment here, and not a good working relationship.
A good investor will always want to fund the company with whatever it needs to reach the next valuation inflection, plus a buffer in case things go wrong. If the company does everything right but the market shifts, the VCs will still likely put more money in, and convert into the next round--if the company does not, they will likely put money in too, but at the same terms as the previous round--pretty simple, right?
The misalignment in the first structure is that the VCs will be hoping that the company misses the milestone so they can get to the valuation they need to make their fund economics work--when, instead, they should be cheering the company on to do as much as possible with as little as possible, to get the best valuation on the next round. They are also misaligned on the next round, because if they don’t get the percentage they need on the first round, they will want the new lead to set a lower valuation so they can buy up their percentage to reach their original target. The valuation sensitivity of the company and desire for funky structures also tells the VCs that in the next round, the company will be inclined to take the highest valuation regardless of where it comes from--letting finance dictate strategy, rather than making the best strategic decision to build long term value.
If the VCs don’t get their target percentage, then they will be spending a full partner on working with the company, but only getting a fraction of the reward for it--a good firm will simply not do the deal, a lesser firm might, but basically won’t give the company much time, so why do the deal anyway?
The other argument is, yes, but if you can put in less money you have less at risk, and if the company trips, you will still have an opportunity to buy more. The problem with this, is twofold--most early stage firms are in the business of putting 10M to work, putting 1M in a deal wont move the needle on the fund even if it is a 10x; second, if the company trips the VCs have to take a writedown which their limited partnerss hate ...
I would greatly welcome comment and debate around this issue, especially if someone has a great idea for a deal structure that resolves these issues so we could stop arguing about valuation, and get on with building great companies ;-)
If you prefer not to post, please email me at larrymarshall@sxvp.com and put BLOG in the subject.
Sunday, September 28, 2008
Sunday, September 14, 2008
Chip companies and why they are hard
At present its very, very hard to fund a chip company. Firms that would previously have been very bullish on the space have backed off completely, and one very well known firm for chip deals has done only one deal this year in that space. VCs have always been careful on fabless semi, because it typically takes $50M to build a chip-company--not for the weak of heart!
However, the economics and scale of the chip business keeps luring investors back. For example a GPS chip that might go into a cell phone, or a laser that might make a cell phone display ,get investors excited because of that wonderful "billion" prefix to the number of phones sold--even when multiplied by an ASP of only say $5 that turns into a very very large number.
Chips have large gross margins because they are hard to build and can have great IP barriers to entry. The downside is just about every design decision you make is fraught with risk and quickly followed by a $5M price tag on making your first serious chip run. The level of design team you need to get to tape out the chip means a million a month level burn rates, and pretty quickly your cash is gone.
If your market materializes and you are first in, then chances are you can be the Intel of that market and enjoy 80% share for a long time to come; but if you miss and your competitor gets in first, then you are fighting with the others for the scraps. The worst case is when the market does not take off when you thought--like femto cells, or RFID. Then you are stuck waiting for the market to happen and all your technological lead becomes worthless because your competitors have plenty of time to catch up while you are waiting. VCs get scared off by the lack of a market, and the company is in real trouble.
Volume is key to the chip-co; remember when DSP was first thrown at optical for dispersion compensation? It was like black magic for its ability to solve aberrations occurring in transit with DSP at the receiver. There was a massive wave of investment in that area because the technology offered such a compelling value proposition. Unfortunately, the volumes couldn’t support the chip economics, even in a high volume optical application like telcom (which for laser jocks is like consumer electronics is to PC people), you were still only selling say 50,000 transponders that needed EDC which simply couldn’t support the economics of a single chip-co let alone a flurry of them.
On the positive side, they are great because chips have the unique ability to integrate functionality on a scale never seen before. Remember how wireless started on a card or a USB plug-in and ended up as a feature on an Intel chip?
So once you are in, you can retain your gross margin and ASP simply by adding more and more functionality to your chip through integration of other hardware and software functions elsewhere in your customer’s product. From the customer perspective you are taking cost out of their product and driving up their gross margin, and at the same time you are supporting yours, albeit by eating someone else’s lunch ;-(.
There is a particularly interesting connection between CMOS and optical, at least for me, because the parallel processing potential of optics is so great, and the DSP capability of CMOS offers the ability to solve tough optical problems. The combination of the two often leads to great technologies, at least when there aren’t 20 companies funded at once to do it (circa 2000). Hey, maybe this is a good time to do a chip deal ;-)
Responses to Comments:
To Life Saving Beverage Maker:
It's true that at acquisition time many investors don’t seem to value the team, but I think it's all about Team--and a good investor should be part of that team, otherwise, sure, put the money in the bank instead. Man, we’ve met a few VCs who acted a lot more like bankers when it came to risk haven’t we?
To BJ:
Mate, I was actually thinking of Lightbit when I wrote this one; the CEO or Chairman should answer your question, but if you shoot me an email, I will forward to them. From the VC’s perspective it was a top quartile success, and 3x return in the year after IPO is great – but you’ve given me a great idea for a future blog, thanks.
However, the economics and scale of the chip business keeps luring investors back. For example a GPS chip that might go into a cell phone, or a laser that might make a cell phone display ,get investors excited because of that wonderful "billion" prefix to the number of phones sold--even when multiplied by an ASP of only say $5 that turns into a very very large number.
Chips have large gross margins because they are hard to build and can have great IP barriers to entry. The downside is just about every design decision you make is fraught with risk and quickly followed by a $5M price tag on making your first serious chip run. The level of design team you need to get to tape out the chip means a million a month level burn rates, and pretty quickly your cash is gone.
If your market materializes and you are first in, then chances are you can be the Intel of that market and enjoy 80% share for a long time to come; but if you miss and your competitor gets in first, then you are fighting with the others for the scraps. The worst case is when the market does not take off when you thought--like femto cells, or RFID. Then you are stuck waiting for the market to happen and all your technological lead becomes worthless because your competitors have plenty of time to catch up while you are waiting. VCs get scared off by the lack of a market, and the company is in real trouble.
Volume is key to the chip-co; remember when DSP was first thrown at optical for dispersion compensation? It was like black magic for its ability to solve aberrations occurring in transit with DSP at the receiver. There was a massive wave of investment in that area because the technology offered such a compelling value proposition. Unfortunately, the volumes couldn’t support the chip economics, even in a high volume optical application like telcom (which for laser jocks is like consumer electronics is to PC people), you were still only selling say 50,000 transponders that needed EDC which simply couldn’t support the economics of a single chip-co let alone a flurry of them.
On the positive side, they are great because chips have the unique ability to integrate functionality on a scale never seen before. Remember how wireless started on a card or a USB plug-in and ended up as a feature on an Intel chip?
So once you are in, you can retain your gross margin and ASP simply by adding more and more functionality to your chip through integration of other hardware and software functions elsewhere in your customer’s product. From the customer perspective you are taking cost out of their product and driving up their gross margin, and at the same time you are supporting yours, albeit by eating someone else’s lunch ;-(.
There is a particularly interesting connection between CMOS and optical, at least for me, because the parallel processing potential of optics is so great, and the DSP capability of CMOS offers the ability to solve tough optical problems. The combination of the two often leads to great technologies, at least when there aren’t 20 companies funded at once to do it (circa 2000). Hey, maybe this is a good time to do a chip deal ;-)
Responses to Comments:
To Life Saving Beverage Maker:
It's true that at acquisition time many investors don’t seem to value the team, but I think it's all about Team--and a good investor should be part of that team, otherwise, sure, put the money in the bank instead. Man, we’ve met a few VCs who acted a lot more like bankers when it came to risk haven’t we?
To BJ:
Mate, I was actually thinking of Lightbit when I wrote this one; the CEO or Chairman should answer your question, but if you shoot me an email, I will forward to them. From the VC’s perspective it was a top quartile success, and 3x return in the year after IPO is great – but you’ve given me a great idea for a future blog, thanks.
Tuesday, August 26, 2008
What really happens in an acquisition
Money is almost out, but there is light at the end of the tunnel. A last minute offer has come in to acquire the company and it looks like everyone will survive to fight another day.
Rewind 6 months to the painful realization that the company should not be funded again and needs to find a buyer. Should they engage a banker? (need another Blog on this). How many months did the investors & founders spend arguing over the liquidation preference and management carveout?
Typically, when the market is poor, management teams negotiate a carveout in the event of sale to overtake the liquidation preference of the investors and assure the team of some return. What’s interesting about this situation is how common it is and how it is reversing the urban myths of VCs reneging on deals. In this case management is reneging--they took the investor’s money and promised a return, agreed to preferences, probably participating preferred and liquidation, maybe anti-dilution to boot--so what’s going on here!?!
Do contracts mean nothing? Damn, sue them!!!
The only people I know who shout that are people who have never been involved in a lawsuit. Generally it's the battle cry of a fool. So the team gets a management carveout of typically 10%. I’ve seen many months wasted in this type of negotiation but it always seems to end up at 10%. I’ve also seen management argue that the investors shouldn’t get any of the earnout in the deal, unless the investors beat them to it with the argument that investors should get all their portion of the earnout up front since they have no control over the team’s ability to deliver the earnout ;-(
So let's look at what happens when the investors don’t negotiate an carveout--the acquirer has acquisition costs--the price he pays for the company, and the retention bonus for the team. If the acquirer can roll the latter into the deal price it’s a better position for them. Finisar did a number of acquisitions in the telecom downturn, and I can't think of one where they didn’t override the VC imposed carveout structure with something more suitable to the acquirer to reward the team. Earnouts rarely went to the investors, and new carveouts were imposed to reward the team and keep them in place. The counterpoint to this is obviously getting the deal done--in a competitive environment the buyer has much less chance to impose deal structures.
The upshot of all this is very simple--as an entrepreneur you can spend an inordinate amount of time negotiating complex deal structures and fretting valuation, and likewise the investors can impose all types of downside protections. But in the end value is generally rewarded. So despite liquidation preferences, anti-dilution, and a host of other issues that probably cost 6 months of painful negotiation, in the end the buyer decides who gets what.
The team is most of the value in a deal, and if they don’t get rewarded the deal doesn’t happen. So while all the power may seem to reside with the VCs because they have the money, in fact it resides with whomever delivers the value. At the time of initial funding the value is mostly the $, but once the company is established that power shifts ;-)
Rewind 6 months to the painful realization that the company should not be funded again and needs to find a buyer. Should they engage a banker? (need another Blog on this). How many months did the investors & founders spend arguing over the liquidation preference and management carveout?
Typically, when the market is poor, management teams negotiate a carveout in the event of sale to overtake the liquidation preference of the investors and assure the team of some return. What’s interesting about this situation is how common it is and how it is reversing the urban myths of VCs reneging on deals. In this case management is reneging--they took the investor’s money and promised a return, agreed to preferences, probably participating preferred and liquidation, maybe anti-dilution to boot--so what’s going on here!?!
Do contracts mean nothing? Damn, sue them!!!
The only people I know who shout that are people who have never been involved in a lawsuit. Generally it's the battle cry of a fool. So the team gets a management carveout of typically 10%. I’ve seen many months wasted in this type of negotiation but it always seems to end up at 10%. I’ve also seen management argue that the investors shouldn’t get any of the earnout in the deal, unless the investors beat them to it with the argument that investors should get all their portion of the earnout up front since they have no control over the team’s ability to deliver the earnout ;-(
So let's look at what happens when the investors don’t negotiate an carveout--the acquirer has acquisition costs--the price he pays for the company, and the retention bonus for the team. If the acquirer can roll the latter into the deal price it’s a better position for them. Finisar did a number of acquisitions in the telecom downturn, and I can't think of one where they didn’t override the VC imposed carveout structure with something more suitable to the acquirer to reward the team. Earnouts rarely went to the investors, and new carveouts were imposed to reward the team and keep them in place. The counterpoint to this is obviously getting the deal done--in a competitive environment the buyer has much less chance to impose deal structures.
The upshot of all this is very simple--as an entrepreneur you can spend an inordinate amount of time negotiating complex deal structures and fretting valuation, and likewise the investors can impose all types of downside protections. But in the end value is generally rewarded. So despite liquidation preferences, anti-dilution, and a host of other issues that probably cost 6 months of painful negotiation, in the end the buyer decides who gets what.
The team is most of the value in a deal, and if they don’t get rewarded the deal doesn’t happen. So while all the power may seem to reside with the VCs because they have the money, in fact it resides with whomever delivers the value. At the time of initial funding the value is mostly the $, but once the company is established that power shifts ;-)
Tuesday, August 12, 2008
Marketing Power
As engineers we tend to underestimate marketing--we don’t understand it well, and at a minimum we merge it with sales. Something that always surprises me about venture backed tech startups is how little they emphasise marketing. There is a lot of lip service, but look at the org chart of most tech startups going into their series B, and there will be a bloated engineering organization, one or two sales people, and no marketing. Now this can be good for burn rate; marketing can burn a frightening amount of cash, and often the CEO is the marketing person (showing at least that it’s a priority).
To give an example of the strength of marketing--Coherent, when they had a medical division, launched mixed gas lasers that made yellow light for ophthalmic applications. They could just as easily have made green lasers, but they realized that others could do that too. If you look at the absorption spectrum of hemoglobin there are two peaks in the visible, one in the yellow and a slightly smaller one in the green. From a theoretical perspective one would conclude that yellow is better--i.e., less power for more energy absorbed in same volume. So a great marketing campaign was launched to promote yellow as the magical wavelength for photocoagulation, and Coherent dominated the market.
Even more than 15 years later, most doctors, and surprisingly many engineers, still believe yellow is better and wont buy anything else--researchers still struggle with ways to create yellow, but in clinical applications the differences are barely distringuishable and from an economic perspective cost differences not justified. Just like Brand, it's an almost unbeatable argument based on belief. Whether nurtured from science or religion, the end result is additional value captured for years. To quote an oft misrepresented and misunderstood compay, dear to the hearts of all laser jocks--Novalux, making laser TV--what could be cooler than that!?!
As a quick aside to my “Is it a feature, product, or company?” Blog, Novalux could have been a company for sure, but they never managed to control the whole product solution. However, they did engineer the first ever TV solution with a hope of meeting the grinding wheels of consumer electronics (rather like CMOS, actually). They had the laser chip but they lacked the optical chip.
I am personalloy very proud of being able to acquire this company and merge it into the optical chip company to create the whole product solution. Novalux did a simply outstanding job of marketing, they convinced even the most cynical laser jocks (including me!) that laser TV was viable, they convinced the brands, and their OEMs, and darn it, they built the best looking TV I’ve ever seen. Classic marketing (not surprising for a group of ex Coherent guys ;-) ).
So at several Photonics Forum presentations I have predicted that laser TV will never happen. I am officially wrong as Mitsubishi is shipping these TVs. In fact, if Novalux could have gotten to market faster by say a year, I believe that several brands would be shipping these TVs now.
Novalux did a stellar job of marketing, which is why Arasor acquired them. The thing missing from Novalux was true partnership (see another Blog on this), which could have given them the missing piece to deliver a whole product solution to the market. The fundamental problem was they relied on third party OEMs who currently supplied the brands with product to manufacture the new laser TV product using a Novalux lisence. If Novalux could have gotten control of laser manufacture or a true partner to supply complete lasers, they could have driven the market.
Easy to say, much harder to do--one of the perks of being a VC ;-)
To give an example of the strength of marketing--Coherent, when they had a medical division, launched mixed gas lasers that made yellow light for ophthalmic applications. They could just as easily have made green lasers, but they realized that others could do that too. If you look at the absorption spectrum of hemoglobin there are two peaks in the visible, one in the yellow and a slightly smaller one in the green. From a theoretical perspective one would conclude that yellow is better--i.e., less power for more energy absorbed in same volume. So a great marketing campaign was launched to promote yellow as the magical wavelength for photocoagulation, and Coherent dominated the market.
Even more than 15 years later, most doctors, and surprisingly many engineers, still believe yellow is better and wont buy anything else--researchers still struggle with ways to create yellow, but in clinical applications the differences are barely distringuishable and from an economic perspective cost differences not justified. Just like Brand, it's an almost unbeatable argument based on belief. Whether nurtured from science or religion, the end result is additional value captured for years. To quote an oft misrepresented and misunderstood compay, dear to the hearts of all laser jocks--Novalux, making laser TV--what could be cooler than that!?!
As a quick aside to my “Is it a feature, product, or company?” Blog, Novalux could have been a company for sure, but they never managed to control the whole product solution. However, they did engineer the first ever TV solution with a hope of meeting the grinding wheels of consumer electronics (rather like CMOS, actually). They had the laser chip but they lacked the optical chip.
I am personalloy very proud of being able to acquire this company and merge it into the optical chip company to create the whole product solution. Novalux did a simply outstanding job of marketing, they convinced even the most cynical laser jocks (including me!) that laser TV was viable, they convinced the brands, and their OEMs, and darn it, they built the best looking TV I’ve ever seen. Classic marketing (not surprising for a group of ex Coherent guys ;-) ).
So at several Photonics Forum presentations I have predicted that laser TV will never happen. I am officially wrong as Mitsubishi is shipping these TVs. In fact, if Novalux could have gotten to market faster by say a year, I believe that several brands would be shipping these TVs now.
Novalux did a stellar job of marketing, which is why Arasor acquired them. The thing missing from Novalux was true partnership (see another Blog on this), which could have given them the missing piece to deliver a whole product solution to the market. The fundamental problem was they relied on third party OEMs who currently supplied the brands with product to manufacture the new laser TV product using a Novalux lisence. If Novalux could have gotten control of laser manufacture or a true partner to supply complete lasers, they could have driven the market.
Easy to say, much harder to do--one of the perks of being a VC ;-)
Monday, July 28, 2008
Is it a feature, product, or company?
This is one of the key questions a VC will ask themselves after hearing your pitch. Inside Intel (as opposed to Intel Inside), they talk about the Intel funnel--it’s a nasty piece of business engineering that takes what was a product, and turns it into a feature on a chip. In fact it can often take a company and turn it into a feature on an Intel chip (not so good for the company).
Remember when WiFi first came out, and we had those little PCMCIA cards that plugged into our laptops? Then we got USB plug ins. Then within about 28 months, WiFi was embedded on the Centrino chip. This is the way of the semiconductor--its why you never want to build a business in the way of CMOS, it will crush you--silicon always finds a way.
A corollary in lasers is, if there is any other way to solve a problem without using a laser ... then do it that way. Lasers generally only win in applications where there is no other option: ophthalmic lasers win because only they can get inside the eye non-invasively. Radio frequency (RF) or intense pulsed light (lamps) tend to beat lasers in most other applications because they are easier, lower tech, and less expensive.
Ironically, I’ve been run over by CMOS a couple of times. Worst case was EDC (electronic dispersion compensation) in telecom or optical silicon. By throwing DSP (digital signal processing) at dispersion compensation, a little Intel company called Intersymbol was able to negate the effects of dispersion and extend the reach of a variety of transponders, while the rest of us were selling optical solutions firmly convinced that this was the only and most elegant way to correct for dispersion. But take heart, the EDC company also turned out to be just another feature, and needed to use that to create a unique transponder to become a company ... but wait! That company needed to be acquired to be part of the larger ecosystem before the entire entourage of technologies could become a real company…..ugg…..
With optical silicon, Translucent created an optical gain medium trying to piggyback on CMOS and help solve the pin problem limiting speed of chip communications--again, the problem, even when you are trying to be part of the CMOS ecosystem, is it will always find a way to do it in silicon anyway. So as a startup, you may have a unique software algorithm that can accelerate chip communications, you may be able to do it faster than anyone else, and you’ve patented the hell out of it, but you are still at the mercy of a chip supplier to use your product and when they do it becomes a feature on their product and you have no company.
In contrast, you may be able to use this unique acceleration algorithm to create a new type of chip that you can supply to, for example, Cisco to make faster routers, and Apple to make a faster web interface on its I-phone. In this case you may just have a company (and some nice acquirers to boot ;-) ). The femtocell BLOG I wrote a while back is another good example. A large ecosystem has developed around femto, from carriers doing trials, to investors, femto vendors, and suppliers to those vendors. The femtocell makers are trying to sell to the carriers, the chip makers are trying to give the femto makers an unfair advantage, and everyone is trying to guess when the carriers will deploy, and the carriers are trying to drive down the ASP from $300 to $50 ... but promising massive volumes ... sound familiar?
Someone making a chip controls the heart of the femtocell, enabling the key characteristic valued by the carriers. That vendor is in a position of power while they can lead the adoption curve. Some cell maker recognized this early and leveraged that characteristic and is getting design wins--very likely, everyone else in the ecosystem is trying to tag along for the ride but will get crushed by the price erosion---sound like fun?
And by the way ... I’ve been getting quite a few emails with Q&As for the Blog, instead of postings here. So to make it fair for all feel free to send questions/comments to lmarshall@sxvp.com BUT, please use the subject header BLOG so I can filter them ;-)
Remember when WiFi first came out, and we had those little PCMCIA cards that plugged into our laptops? Then we got USB plug ins. Then within about 28 months, WiFi was embedded on the Centrino chip. This is the way of the semiconductor--its why you never want to build a business in the way of CMOS, it will crush you--silicon always finds a way.
A corollary in lasers is, if there is any other way to solve a problem without using a laser ... then do it that way. Lasers generally only win in applications where there is no other option: ophthalmic lasers win because only they can get inside the eye non-invasively. Radio frequency (RF) or intense pulsed light (lamps) tend to beat lasers in most other applications because they are easier, lower tech, and less expensive.
Ironically, I’ve been run over by CMOS a couple of times. Worst case was EDC (electronic dispersion compensation) in telecom or optical silicon. By throwing DSP (digital signal processing) at dispersion compensation, a little Intel company called Intersymbol was able to negate the effects of dispersion and extend the reach of a variety of transponders, while the rest of us were selling optical solutions firmly convinced that this was the only and most elegant way to correct for dispersion. But take heart, the EDC company also turned out to be just another feature, and needed to use that to create a unique transponder to become a company ... but wait! That company needed to be acquired to be part of the larger ecosystem before the entire entourage of technologies could become a real company…..ugg…..
With optical silicon, Translucent created an optical gain medium trying to piggyback on CMOS and help solve the pin problem limiting speed of chip communications--again, the problem, even when you are trying to be part of the CMOS ecosystem, is it will always find a way to do it in silicon anyway. So as a startup, you may have a unique software algorithm that can accelerate chip communications, you may be able to do it faster than anyone else, and you’ve patented the hell out of it, but you are still at the mercy of a chip supplier to use your product and when they do it becomes a feature on their product and you have no company.
In contrast, you may be able to use this unique acceleration algorithm to create a new type of chip that you can supply to, for example, Cisco to make faster routers, and Apple to make a faster web interface on its I-phone. In this case you may just have a company (and some nice acquirers to boot ;-) ). The femtocell BLOG I wrote a while back is another good example. A large ecosystem has developed around femto, from carriers doing trials, to investors, femto vendors, and suppliers to those vendors. The femtocell makers are trying to sell to the carriers, the chip makers are trying to give the femto makers an unfair advantage, and everyone is trying to guess when the carriers will deploy, and the carriers are trying to drive down the ASP from $300 to $50 ... but promising massive volumes ... sound familiar?
Someone making a chip controls the heart of the femtocell, enabling the key characteristic valued by the carriers. That vendor is in a position of power while they can lead the adoption curve. Some cell maker recognized this early and leveraged that characteristic and is getting design wins--very likely, everyone else in the ecosystem is trying to tag along for the ride but will get crushed by the price erosion---sound like fun?
And by the way ... I’ve been getting quite a few emails with Q&As for the Blog, instead of postings here. So to make it fair for all feel free to send questions/comments to lmarshall@sxvp.com BUT, please use the subject header BLOG so I can filter them ;-)
Friday, July 11, 2008
Just be yourself
I listened to a pitch the other day, by a PhD who had invented/designed a new type of chip and was looking for funding to take it to market. As we got about half way through, I noticed he kept saying “In this business you have to…” and “You should know, we are not here to do R and D…”, and “You have to understand that Customers care about results…..” – now, I don’t necessarily disagree with any of these statements, but considering the guy making them has never worked outside a University, I must question what qualifies him to make any of them.
As a former professor (hard to believe I know), albeit for a short time, I know we tend to pontificate, but its silly to try and be something you are not--worse, per Abraham Lincoln’s theory, please don’t open your mouth and confirm the fact.
When novice marketers, or engineers try to sound knowledgeable they say really dumb things and lose their credibility. In contrast, when an engineer says, “I don’t know anything about marketing, but its seems to me that customers wont care much about technology…..” there is a great ring of truth to it. VCs want to know that they can work with entrepreneurs--if you try to sound like an expert in something you are not, you will first make them think you are not an expert in anything (including the field you probably are an expert in), and second, scare them off the idea of trying to mentor you if they make the investment.
Another secret that some VCs and most really good sales people use is the Enneagram--it’s a personality typing methodology developed by the Jesuits several hundred years back to help them convert people to Catholicism. It's like x-ray glasses to read people’s personality and thereby manage them more effectively. A good sales person can rapidly asses whether you are a big picture dreamer, or a detailed oriented slow decision maker--or whatever. If you are a dreamer, the sales person will simply drop by your company and let you paint a grand picture of life with his product; if detailed oriented, he’ll write a formal proposal outlining the detailed benefits of his product and probably throw in analytics to boot--just dropping in and waffling would irritate the detail oriented person. So, what’s the point? Well, while the Enneagram is hard to use, spotting someone who is trying to be something they are not is very, very easy--so don’t do it.
Another pet peeve of mine is the prelude--“well, to be completely honest …” or, “to tell you the truth ...” – so you’ve been lying to me up to this point, right?
Now, it seems a number of readers prefer email to posting--so here are answers to their questions:
Larry what are your startup CEO Tips?
Always take the money, when they pass the hors d'oeuvres take two
Forget about dilution, focus on value creation and leverage
Never lead with price, lead with quality and value and charge a premium
Choose your investors like your wife, with luck they’ll last as long, or longer ;-)
Until the company has more than 100 people, interview every hire yourself – for the first 20 interview them first: You are creating a DNA, you have to nurture it
Feed your sales people, starve your engineers--use cash to reward sales, equity for engineering--use both for marketing
CEO job #1 is never run out of money
There is no EGO in CEO--when the company wins, credit the team, when it loses take it on the chin yourself
Be honest and open with customers, investors, and employees--if you always tell them the bad news, I guarantee it will be better than what they were thinking and you’ll focus them
Spend your dollars on what matters--investors and good customers look at furniture the opposite way lawyers do
Invest in and understand marketing--most people confuse marketing with marcom, and sales with marketing. Understand the difference--the right marketing VP combined with the right sales VP can make your company; the wrong one WILL break it, and you can rarely tell until its almost too late
How do you decide which technology to use to reach a goal?
In the laser market there’s an old adage, mine actually, that says if you can do it any other way without using a laser, then that will be successful. Example: Iridex made lasers work in ophthalmic because it’s the ONLY way to get inside the eye non invasively, so it worked well, otherwise simpler technologies will always win. So my answer is pick the simplest, that you can get to market fastest that gives the best result in the application--i.e., use just enough technology to make it work well not more and ensure its well protected
Should you be an earlier adopter of new technology or wait until things are proven?
Early adopters take the most risk, therefore get the best reward when they win, and suffer badly when they lose. Customers have the benefit of being able to back two or three startups to hedge their bets. If you want to be average, you will lose. Early adopters usually win.
How do you determine the outcome of applying technology in a new way?
You don’t, the market does it for you ;-)
Are their secrets to financing a digital business that are different to other forms of business?
Its cheaper to fail than ever before, so VCs are funding many more deals with smaller raises. Competition is fierce, try to pick someone who really understands your specific vertical, not just digital, but preferably someone who has built a company in the exact space (or invested in a few) who can really help you win. Probability of success is lower in digital than traditional, and sticky funding is as hard to get as sticky customers ..
As a former professor (hard to believe I know), albeit for a short time, I know we tend to pontificate, but its silly to try and be something you are not--worse, per Abraham Lincoln’s theory, please don’t open your mouth and confirm the fact.
When novice marketers, or engineers try to sound knowledgeable they say really dumb things and lose their credibility. In contrast, when an engineer says, “I don’t know anything about marketing, but its seems to me that customers wont care much about technology…..” there is a great ring of truth to it. VCs want to know that they can work with entrepreneurs--if you try to sound like an expert in something you are not, you will first make them think you are not an expert in anything (including the field you probably are an expert in), and second, scare them off the idea of trying to mentor you if they make the investment.
Another secret that some VCs and most really good sales people use is the Enneagram--it’s a personality typing methodology developed by the Jesuits several hundred years back to help them convert people to Catholicism. It's like x-ray glasses to read people’s personality and thereby manage them more effectively. A good sales person can rapidly asses whether you are a big picture dreamer, or a detailed oriented slow decision maker--or whatever. If you are a dreamer, the sales person will simply drop by your company and let you paint a grand picture of life with his product; if detailed oriented, he’ll write a formal proposal outlining the detailed benefits of his product and probably throw in analytics to boot--just dropping in and waffling would irritate the detail oriented person. So, what’s the point? Well, while the Enneagram is hard to use, spotting someone who is trying to be something they are not is very, very easy--so don’t do it.
Another pet peeve of mine is the prelude--“well, to be completely honest …” or, “to tell you the truth ...” – so you’ve been lying to me up to this point, right?
Now, it seems a number of readers prefer email to posting--so here are answers to their questions:
Larry what are your startup CEO Tips?
Always take the money, when they pass the hors d'oeuvres take two
Forget about dilution, focus on value creation and leverage
Never lead with price, lead with quality and value and charge a premium
Choose your investors like your wife, with luck they’ll last as long, or longer ;-)
Until the company has more than 100 people, interview every hire yourself – for the first 20 interview them first: You are creating a DNA, you have to nurture it
Feed your sales people, starve your engineers--use cash to reward sales, equity for engineering--use both for marketing
CEO job #1 is never run out of money
There is no EGO in CEO--when the company wins, credit the team, when it loses take it on the chin yourself
Be honest and open with customers, investors, and employees--if you always tell them the bad news, I guarantee it will be better than what they were thinking and you’ll focus them
Spend your dollars on what matters--investors and good customers look at furniture the opposite way lawyers do
Invest in and understand marketing--most people confuse marketing with marcom, and sales with marketing. Understand the difference--the right marketing VP combined with the right sales VP can make your company; the wrong one WILL break it, and you can rarely tell until its almost too late
How do you decide which technology to use to reach a goal?
In the laser market there’s an old adage, mine actually, that says if you can do it any other way without using a laser, then that will be successful. Example: Iridex made lasers work in ophthalmic because it’s the ONLY way to get inside the eye non invasively, so it worked well, otherwise simpler technologies will always win. So my answer is pick the simplest, that you can get to market fastest that gives the best result in the application--i.e., use just enough technology to make it work well not more and ensure its well protected
Should you be an earlier adopter of new technology or wait until things are proven?
Early adopters take the most risk, therefore get the best reward when they win, and suffer badly when they lose. Customers have the benefit of being able to back two or three startups to hedge their bets. If you want to be average, you will lose. Early adopters usually win.
How do you determine the outcome of applying technology in a new way?
You don’t, the market does it for you ;-)
Are their secrets to financing a digital business that are different to other forms of business?
Its cheaper to fail than ever before, so VCs are funding many more deals with smaller raises. Competition is fierce, try to pick someone who really understands your specific vertical, not just digital, but preferably someone who has built a company in the exact space (or invested in a few) who can really help you win. Probability of success is lower in digital than traditional, and sticky funding is as hard to get as sticky customers ..
Monday, June 30, 2008
When to let go
This is a cynical one--be warned. I just completed a really tough shareholder meeting for a company I took public where the CEO recently had to be replaced and the chairman didn’t show up for the meeting, so I had to stand in for them.
So, as an entrepreneur, you take great responsibility when you accept the first investor’s check. You get sleepless nights worrying about losing their money, and generally this means you don’t lose it. I remember the first check I ever got was from a retied DEC executive in Boston, and as he handed over the $100k check he looked me in the eye and said in all sincerity “I know you’ll make me money.” It’s a great feeling wining the check, but the sleepless nights aren’t far behind.
Fast forward to the successful exit, the major event that all your investors eagerly anticipated all those years ago when they invested in an idea. So you IPO the company and everyone gets liquid--it’s a Red Letter day! Now, problem, all the IPO investors have expectations of gaining great wealth, too, and you just accepted responsibility to them for this and you get more sleepless nights. Now the bankers should shoulder a lot of this responsibility too, since they diligence the company for the public investors, and underwrite the IPO, but too often they are onto the next deal.
As a founder, you leave the company to do the next startup, and the company goes on, grows and generates maybe a 3-4x return for the IPO investors--this is a stellar result, after all, the VCs expect to get a 10x return on 1 in 10 companies, and a base hit 3-4x on the rest that don’t fail. So imagine your shock when you start hearing the public shareholders talking about a 10x – after the company is public!?! Talk about sleepless nights …
So there I am, up at the podium facing a rabble of angry shareholders, actually I am one too, the difference is I spent years building the company, and making the shares valuable enough to IPO in the first place, and unlike the public shareholders, most of us have a two-year escrow and can’t realize any gain. Just to make it more interesting, the company secretary grabs me just before I go on, and redlines 50% of my speech because “you aren’t allowed to say that.”
So there I am, I was loaded for bear, but not I’m barely loaded for squirrels--and they are hungry ... looking into the eyes of retirees, stock brokers, institutional investors, and, ah yes …. that guy in the front is definitely a lawyer. Funny how there is always a lawyer around when the share price falls, wanting to take a piece, but when it rises, no one is giving you a piece ….
So what’s the point of this Blog? Well, there really is no exit. What you consider liquidity, someone else considers a great investment and unfortunately you carry the responsibility for all those investors going forward, and in some places, you will be blamed for many years after you exit, if things go south. Conversely when things go well, no one will remember your name--success has a hundred generals, failure only you. This is actually the hallmark of a great CEO. The oft misquoted lesson from the Godfather--it's not personal, it's strictly business--is of course opposite to the book’s intention, which was that the Godfather was great because he took everything personally and carried personal responsibility. Great CEOs stand up and take the hit when things go wrong, no matter who caused them--when Kevin Kalkhoven tried to buy Iridex and we were unable to convince the board that we should sell (I’ll cry if I tell you how much money this would have made), it was actually our fault for not being persuasive enough, not the board's for making what was in fact the wrong decision.
As a startup CEO, you are going to turn over a lot of rocks, and often you’ll find wriggly things underneath that you don’t like. Make sure you take the time to scrape them off before putting the rock back in place. Great CEOs shoulder blame personally, and as a result, they tend to fix problems before they result in blame. They also fix the problem, not the blame, in that they never blame their team. But when things go well, the team gets all the credit and this is exactly how it should be. Nothing engenders loyalty in a team as much as knowing they will be allowed to shine.
So, as an entrepreneur, you take great responsibility when you accept the first investor’s check. You get sleepless nights worrying about losing their money, and generally this means you don’t lose it. I remember the first check I ever got was from a retied DEC executive in Boston, and as he handed over the $100k check he looked me in the eye and said in all sincerity “I know you’ll make me money.” It’s a great feeling wining the check, but the sleepless nights aren’t far behind.
Fast forward to the successful exit, the major event that all your investors eagerly anticipated all those years ago when they invested in an idea. So you IPO the company and everyone gets liquid--it’s a Red Letter day! Now, problem, all the IPO investors have expectations of gaining great wealth, too, and you just accepted responsibility to them for this and you get more sleepless nights. Now the bankers should shoulder a lot of this responsibility too, since they diligence the company for the public investors, and underwrite the IPO, but too often they are onto the next deal.
As a founder, you leave the company to do the next startup, and the company goes on, grows and generates maybe a 3-4x return for the IPO investors--this is a stellar result, after all, the VCs expect to get a 10x return on 1 in 10 companies, and a base hit 3-4x on the rest that don’t fail. So imagine your shock when you start hearing the public shareholders talking about a 10x – after the company is public!?! Talk about sleepless nights …
So there I am, up at the podium facing a rabble of angry shareholders, actually I am one too, the difference is I spent years building the company, and making the shares valuable enough to IPO in the first place, and unlike the public shareholders, most of us have a two-year escrow and can’t realize any gain. Just to make it more interesting, the company secretary grabs me just before I go on, and redlines 50% of my speech because “you aren’t allowed to say that.”
So there I am, I was loaded for bear, but not I’m barely loaded for squirrels--and they are hungry ... looking into the eyes of retirees, stock brokers, institutional investors, and, ah yes …. that guy in the front is definitely a lawyer. Funny how there is always a lawyer around when the share price falls, wanting to take a piece, but when it rises, no one is giving you a piece ….
So what’s the point of this Blog? Well, there really is no exit. What you consider liquidity, someone else considers a great investment and unfortunately you carry the responsibility for all those investors going forward, and in some places, you will be blamed for many years after you exit, if things go south. Conversely when things go well, no one will remember your name--success has a hundred generals, failure only you. This is actually the hallmark of a great CEO. The oft misquoted lesson from the Godfather--it's not personal, it's strictly business--is of course opposite to the book’s intention, which was that the Godfather was great because he took everything personally and carried personal responsibility. Great CEOs stand up and take the hit when things go wrong, no matter who caused them--when Kevin Kalkhoven tried to buy Iridex and we were unable to convince the board that we should sell (I’ll cry if I tell you how much money this would have made), it was actually our fault for not being persuasive enough, not the board's for making what was in fact the wrong decision.
As a startup CEO, you are going to turn over a lot of rocks, and often you’ll find wriggly things underneath that you don’t like. Make sure you take the time to scrape them off before putting the rock back in place. Great CEOs shoulder blame personally, and as a result, they tend to fix problems before they result in blame. They also fix the problem, not the blame, in that they never blame their team. But when things go well, the team gets all the credit and this is exactly how it should be. Nothing engenders loyalty in a team as much as knowing they will be allowed to shine.
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