I wrote this one in sunny San Diego at the Red Herring Global 100. I am trying to work out how to address the question “Can venture capital be truly global” in time for our presentation today ;-) The problem I'm having with this question is that I don’t think it’s the right question. To me venture capital is by definition local, not global--sure we want to invest in global companies, but we do our work locally on the ground and in the trenches alongside the companies we invest in. If we can't visit them on a daily or weekly basis then we shouldn’t be in the deal.
Does that mean we shouldn’t invest in foreign companies? Well no, but the only way I can think of to make that work is either to relocate part of the firm to the target market--i.e., have an office in China or wherever, manned by partners equal to those in the mother ship and who are part of that market and can actively source, manage, support and fundraise for their companies there the way VCs do everywhere; or to find a trusted partner firm that you can work with in that market assuming that the target company will have substantial operations in both places so both firms can add hands-on value.
There's a lot of passion around this issue--especially at Red Herring which comprises a large proportion of non-U.S. companies, and is truly global due to the passion and drive of the founders. It's frustrating for them that many valley VCs talk global but don’t act it. It's also frustrating for many Aussie entrepreneurs who come to the valley for a week, pitch 25 Sand Hill Rd VCs, fly home, and don’t get much followup from them. Sometimes they come back six months later to pitch again, but still don’t get much traction.
The trouble with the infamous driveby (not the LA kind) is that it leaves no positive lasting impression--rather like the Silicon Valley VCs deciding to spend a week in China to find an investment partner and expand their wealth creation model there. Clearly, neither of these work. To be global you must act local. If you want to invest in China then go live there, spend a few years building a trusted network, and then if you can partner up with people who really understand the ecosystem, maybe you can risk investing and be successful riding their coattails. I simply don’t believe the venture model is scalable in the way that private equity is. Once of the few good things about this downturn is, it will likely drive us back to old-school venture, where VCs actually spend time at their companies, and entrepreneurs chose their VCs not like a banker but through trusted relationships and expectation of real value add.
Clearly there is no monopoly on innovation, it happens everywhere; but everywhere is different. In Silicon Valley you have probably the world’s best developed ecosystem for commercializing innovation where every banker, lawyer, accountant, HR firm, patent attorney, and engineer think startup mode and form a formidable support network. There is an abandance of risk tolerant capital, and a well established exit market. Now Shanghai and Hong Kong provide excellent exit markets, but just because you understand Nasdaq, don’t assume the same of those markets; just because you understand commercialization, don’t assume it will work somewhere else where you don’t really understand the rules, the government, the taxes, the business environment ecosystem, nor have that crucial trusted network to leverage.
Partners can solve this, they can be great, or as Marriott once said, when you a take on a partner you take on trouble. In places like China and India you can't do it without partners, and believe me you can’t do that without trouble ;-)
Saturday, March 13, 2010
Tuesday, February 9, 2010
IP Problems
A few years back we started a company by licensing some technology from Stanford--actually we did a few of these types of deals and it was always fascinating to work with an enlightened academic institution. Having written a lot of my own patents (because we couldn’t afford patent attorney fees) I have a great respect for IP, but also a healthy skepticism--patents are great shields but rarely swords. Now in many places IP is seen as the crown jewels of a company and sometimes it can be but more typically it’s just a start. Unfortunately this obsession with IP leads to the fatal "technology leading the market problem."
In my short stint as a professor (now there’s a story), I thought wouldn’t it be wonderful to create a new method of collaboration with industry where academics were not so IP obsessed and focused instead on creating long term value. The problem, as I discovered, was that in the mind of the inventor, and most academic institutions, the IP itself is the work product. As such it is seen as 80% of the value of an enterprise emerging from it. In many cases there is a non technology oriented adviser involved who wants to split the IP 26 ways to create a portfolio of companies ... well actually a series of separate transactions where the same IP can be sold over and over again ...
So in this startup that I am remembering, the technology founder cut a rather aggressive IP deal with Stanford and managed to secure an exclusive license (which they rarely do), and on pre-financing equity structure, which of course tilted significantly post financing ... there were a few other non transparent items that ultimately conspired to give Stanford very little in return for this license.
Now this type of "hey I tricked you fair and square deal" is not worth doing, ever, but it seems to be rife in certain geographies--in this case Stanford was in a position to help us considerably with the implementation of the technology and to continue to invent, develop, and otherwise drive the evolution forward and we wanted an ongoing relationship with them. So once the company was funded we went back and renegotiated the deal by giving them more. You might think that our black blooded VCs would have opposed this move, but no in fact they applauded it and it increased their level of trust. Now this is not business school 101 approach--it's your job to negotiate the best deal you can for your side and the other guy beware--but it's rare to have a negotiation without an ongoing relationship, and if you value people you had better reward them otherwise they won't waste time dealing with you again.
So can you get to a stage where institutions will work with you in good faith, knowing that you will take care of them if they deliver real value?
I think so, but not easily. The converse problem is the licensing agreement where the institution gets so much royalty out of your sales that it hurts profits and you are no longer incented to pay it--in this vein we found Stanford to be extremely sympathetic to the practical realities of building a business and a simple sliding scale royalty that decreased when market forces reduced margins to ensure the company remained profitable and vibrant rather than weighed down by the weight of royalties.
Too often in IP deals, there is a focus on the lawyering of the agreements and parties lose sight of the objective, which should be the same for both--i.e. someone needs to commercialize the invention, and both need to profit from it. The vast majority of work will be done post invention and IP owners need to be realistic about this.
Exclusivity is the other issue--patents are legal monopolies for a time, so if the IP owner can pick a winner, it's better to let them run with the IP rather than try to be an arms dealer, and enable 20 competitors to slug it out in the market. As a worst case example think of the memory market and the cross licensing IP mess it is, which is largely at the heart of its distinct lack of profitability.
At the heart of the problem is that IP is a future value to be unlocked by a team of people, often not the inventor (and almost never the IP owner). For that future value to be realized, a team of people is needed--the IP creator needs to work with this team, roll over future inventions and value to that team if they are needed to ensure success, and bet on the success of that team--in the end, it's people, not patents that make startups work ;-)
In my short stint as a professor (now there’s a story), I thought wouldn’t it be wonderful to create a new method of collaboration with industry where academics were not so IP obsessed and focused instead on creating long term value. The problem, as I discovered, was that in the mind of the inventor, and most academic institutions, the IP itself is the work product. As such it is seen as 80% of the value of an enterprise emerging from it. In many cases there is a non technology oriented adviser involved who wants to split the IP 26 ways to create a portfolio of companies ... well actually a series of separate transactions where the same IP can be sold over and over again ...
So in this startup that I am remembering, the technology founder cut a rather aggressive IP deal with Stanford and managed to secure an exclusive license (which they rarely do), and on pre-financing equity structure, which of course tilted significantly post financing ... there were a few other non transparent items that ultimately conspired to give Stanford very little in return for this license.
Now this type of "hey I tricked you fair and square deal" is not worth doing, ever, but it seems to be rife in certain geographies--in this case Stanford was in a position to help us considerably with the implementation of the technology and to continue to invent, develop, and otherwise drive the evolution forward and we wanted an ongoing relationship with them. So once the company was funded we went back and renegotiated the deal by giving them more. You might think that our black blooded VCs would have opposed this move, but no in fact they applauded it and it increased their level of trust. Now this is not business school 101 approach--it's your job to negotiate the best deal you can for your side and the other guy beware--but it's rare to have a negotiation without an ongoing relationship, and if you value people you had better reward them otherwise they won't waste time dealing with you again.
So can you get to a stage where institutions will work with you in good faith, knowing that you will take care of them if they deliver real value?
I think so, but not easily. The converse problem is the licensing agreement where the institution gets so much royalty out of your sales that it hurts profits and you are no longer incented to pay it--in this vein we found Stanford to be extremely sympathetic to the practical realities of building a business and a simple sliding scale royalty that decreased when market forces reduced margins to ensure the company remained profitable and vibrant rather than weighed down by the weight of royalties.
Too often in IP deals, there is a focus on the lawyering of the agreements and parties lose sight of the objective, which should be the same for both--i.e. someone needs to commercialize the invention, and both need to profit from it. The vast majority of work will be done post invention and IP owners need to be realistic about this.
Exclusivity is the other issue--patents are legal monopolies for a time, so if the IP owner can pick a winner, it's better to let them run with the IP rather than try to be an arms dealer, and enable 20 competitors to slug it out in the market. As a worst case example think of the memory market and the cross licensing IP mess it is, which is largely at the heart of its distinct lack of profitability.
At the heart of the problem is that IP is a future value to be unlocked by a team of people, often not the inventor (and almost never the IP owner). For that future value to be realized, a team of people is needed--the IP creator needs to work with this team, roll over future inventions and value to that team if they are needed to ensure success, and bet on the success of that team--in the end, it's people, not patents that make startups work ;-)
Tuesday, January 26, 2010
The Chinese Incubator
I was at an Asian American institute meeting a while back and a prominent Chinese American web entrepreneur was explaining his revolutionary new incubator concept for entrepreneurs in China. He borrowed some parts of it from Google, and others from HP, and added a few unique twists of his own. Basically he is recognizing a wonderful trend–-in the past, successful expat entrepreneurs returned to China and brought the “American way” back with them. They were successful at raising money and often successful in business too ;-)
But Chinese people are, at their heart, some of the greatest capitalists on earth and the local team rapidly recognized the loosening rules of the government and moved to build their own home-grown wealth. The Chinese incubator concept is to combine the best idea with the best entrepreneur with the best team--and these three groups will be different people grinding out of an entrepreneur factory.
My problem with this approach is, having been an entrepreneur before the black blood of venture capital seeped into my system, I can't imagine wanting to go to some institute or incubator to be told my idea is great but they have someone better able to execute it; and in fact there is a whole separate team who will build the company around it.
I can't imagine any of those people would be particularly passionate or entrepreneurial because they will surely have their own ideas and won't need me to think for them, and certainly will be entrepreneurial enough to find a way to fund their ideas without the help of an incubator.
My fear of these approaches, one of which is being currently tried in Australia as well, is that they become jobs programs for consultants who also aren’t very entrepreneurial. Further, when the government knocks on your door because they are there to help you, many entrepreneurs (and probably all bankers) will be too rapidly heading out the back door to realize the benefit of government “help” … this wonderful entrepreneurial alchemy that enables transmutation of nothing into gold also enables entrepreneurs to conjure up the resources they need whether it be $, advice, leverage or …
In other countries, and frankly outside of Silicon Valley and Israel, culture is often the impediment--fear of failure (see previous BLOG), and societal scorn for entrepreneurial behavior are more often the place where change can really help. Most education systems are designed to create better employees, not employers; and frankly, given the nature of most people drawn to teach at university level (66% NP types if you follow personality types), it should be possible to find entrepreneurial traits but perhaps as a result of those systems the entrepreneurial professor that one finds so readily at Stanford, is hard to find elsewhere.
It's extremely hard to stimulate innovation and quite hard to “help” it – most entrepreneurs will tell you the best help they can have is $, the next best is deep domain market expertise preferably from someone who has built a similar business in the same space they are building--operative word is “built,” not someone who has read about it or studied it or consulted to a company about it, but actually done it. This is why some of the best angel investors are exactly that, a former entrepreneur/CEO … VCs can help too, really :-)
But Chinese people are, at their heart, some of the greatest capitalists on earth and the local team rapidly recognized the loosening rules of the government and moved to build their own home-grown wealth. The Chinese incubator concept is to combine the best idea with the best entrepreneur with the best team--and these three groups will be different people grinding out of an entrepreneur factory.
My problem with this approach is, having been an entrepreneur before the black blood of venture capital seeped into my system, I can't imagine wanting to go to some institute or incubator to be told my idea is great but they have someone better able to execute it; and in fact there is a whole separate team who will build the company around it.
I can't imagine any of those people would be particularly passionate or entrepreneurial because they will surely have their own ideas and won't need me to think for them, and certainly will be entrepreneurial enough to find a way to fund their ideas without the help of an incubator.
My fear of these approaches, one of which is being currently tried in Australia as well, is that they become jobs programs for consultants who also aren’t very entrepreneurial. Further, when the government knocks on your door because they are there to help you, many entrepreneurs (and probably all bankers) will be too rapidly heading out the back door to realize the benefit of government “help” … this wonderful entrepreneurial alchemy that enables transmutation of nothing into gold also enables entrepreneurs to conjure up the resources they need whether it be $, advice, leverage or …
In other countries, and frankly outside of Silicon Valley and Israel, culture is often the impediment--fear of failure (see previous BLOG), and societal scorn for entrepreneurial behavior are more often the place where change can really help. Most education systems are designed to create better employees, not employers; and frankly, given the nature of most people drawn to teach at university level (66% NP types if you follow personality types), it should be possible to find entrepreneurial traits but perhaps as a result of those systems the entrepreneurial professor that one finds so readily at Stanford, is hard to find elsewhere.
It's extremely hard to stimulate innovation and quite hard to “help” it – most entrepreneurs will tell you the best help they can have is $, the next best is deep domain market expertise preferably from someone who has built a similar business in the same space they are building--operative word is “built,” not someone who has read about it or studied it or consulted to a company about it, but actually done it. This is why some of the best angel investors are exactly that, a former entrepreneur/CEO … VCs can help too, really :-)
Tuesday, January 5, 2010
Valley of Death – Part III
Marketing is perhaps the rarest skill to find. Your customers rarely know what the market will do or what product they need. You can make all manner of calculated predictions but in the end markets are comprised of humans and competitors (some of them are human too) and they are fickle--it's why any good entrepreneur admits luck as the major factor ;-)
A big market opportunity forgives a multitude of sins because if you can identify a clear, large pain point you only have to worry about making your solution work, and work better than your competitors (who will be many if it's a big enough market).
But if it's all about big markets, where's the fun in being a VC? After all, we are supposed to be brilliant--so in deference to the classic laser markets, I would like to discuss the alternate model because it's more relevant to small markets, which are classic early adopter territory.
Let’s think about a component company (most laser businesses are exactly this). Selling a component (i.e., a laser, a laser system, anything that is not an end-user product in its own right) is fraught with challenges, not the least of which is focus--component plays always want to be all things to all people. The laser business is a mile wide but only an inch deep, so you are invariably going to have to sell into multiple vertical markets--the illusion that OEM is better because S&M cost is so much lower is obviated by the need to understand many different markets, customer bases, and evolve multiple sales approaches, which makes the classic recurring process and revenue really, really hard to achieve.
However, if a component is unique, with strong barriers to entry and compelling differentiated technology, chances are it can start to displace the incumbent technologies. There is a point at which the value proposition crystallizes for all customers, the sales process really starts to work, and revenue begins to ramp--grow the sales team and push the opportunity to sell before competition wakes up. No component can own the market for long, but this phase gives you the opportunity to move into much deeper relationships with your customers, and to start to integrate more of their product into your component so that before long you are selling a sub-system for which they are happy to pay more money because it saves them time and integration. You are designing yourself deeper and deeper into their product, making true barriers to entry beyond mere technology.
Unfortunately for most component (or non end-user) sales, its hard to ever become big (telecom bubble not withstanding, in which the whole value chain got turned on its head). At some point you have to break out to the end-user with a whole product solution, otherwise the next bright and shining technology will do to you what you did to the old technologies. This is a difficult transition, complicated by the fact you will invariably be competing with your immediate customer and thereby risking the lifeblood of your revenue.
Once of the best ways is in an adjacent market, in its early phases, where the customer actually needs your help to create the solution. Another way is when your customer pulls you up the stack, as big telco OEMs did when they wanted to get out of the transponder business and pulled their laser suppliers up to be Tx vendors. That was a bad example (telcos made no money on Tx, and neither did laser suppliers). The one you want is the customer who is making so much money elsewhere that they are happy for you to make money supplying their system--then everyone gets to eat.
My personal two favorite component plays are the disposable, and the small niche you can own for a long time. The former is obvious, but the latter often isn’t--take marine telco. SDL worked on that tiny market for years because it was so demanding and difficult, but their laser diode was the only product that could meet the final (lockout) spec, a lockout that they created, and once installed in submarine environment, nobody was going to change suppliers. Despite many, many cheaper competitive products, that SDL laser still dominated marine telco because it's simply too costly and risky to switch. If you can't find such a niche, or scale up to a system level product, then the other way is to keep selling components into as many verticals as possible until another telecom bubble comes along and components become king again--but I think that could mean a long, thirsty journey through the Valley of Death ...
A big market opportunity forgives a multitude of sins because if you can identify a clear, large pain point you only have to worry about making your solution work, and work better than your competitors (who will be many if it's a big enough market).
But if it's all about big markets, where's the fun in being a VC? After all, we are supposed to be brilliant--so in deference to the classic laser markets, I would like to discuss the alternate model because it's more relevant to small markets, which are classic early adopter territory.
Let’s think about a component company (most laser businesses are exactly this). Selling a component (i.e., a laser, a laser system, anything that is not an end-user product in its own right) is fraught with challenges, not the least of which is focus--component plays always want to be all things to all people. The laser business is a mile wide but only an inch deep, so you are invariably going to have to sell into multiple vertical markets--the illusion that OEM is better because S&M cost is so much lower is obviated by the need to understand many different markets, customer bases, and evolve multiple sales approaches, which makes the classic recurring process and revenue really, really hard to achieve.
However, if a component is unique, with strong barriers to entry and compelling differentiated technology, chances are it can start to displace the incumbent technologies. There is a point at which the value proposition crystallizes for all customers, the sales process really starts to work, and revenue begins to ramp--grow the sales team and push the opportunity to sell before competition wakes up. No component can own the market for long, but this phase gives you the opportunity to move into much deeper relationships with your customers, and to start to integrate more of their product into your component so that before long you are selling a sub-system for which they are happy to pay more money because it saves them time and integration. You are designing yourself deeper and deeper into their product, making true barriers to entry beyond mere technology.
Unfortunately for most component (or non end-user) sales, its hard to ever become big (telecom bubble not withstanding, in which the whole value chain got turned on its head). At some point you have to break out to the end-user with a whole product solution, otherwise the next bright and shining technology will do to you what you did to the old technologies. This is a difficult transition, complicated by the fact you will invariably be competing with your immediate customer and thereby risking the lifeblood of your revenue.
Once of the best ways is in an adjacent market, in its early phases, where the customer actually needs your help to create the solution. Another way is when your customer pulls you up the stack, as big telco OEMs did when they wanted to get out of the transponder business and pulled their laser suppliers up to be Tx vendors. That was a bad example (telcos made no money on Tx, and neither did laser suppliers). The one you want is the customer who is making so much money elsewhere that they are happy for you to make money supplying their system--then everyone gets to eat.
My personal two favorite component plays are the disposable, and the small niche you can own for a long time. The former is obvious, but the latter often isn’t--take marine telco. SDL worked on that tiny market for years because it was so demanding and difficult, but their laser diode was the only product that could meet the final (lockout) spec, a lockout that they created, and once installed in submarine environment, nobody was going to change suppliers. Despite many, many cheaper competitive products, that SDL laser still dominated marine telco because it's simply too costly and risky to switch. If you can't find such a niche, or scale up to a system level product, then the other way is to keep selling components into as many verticals as possible until another telecom bubble comes along and components become king again--but I think that could mean a long, thirsty journey through the Valley of Death ...
Monday, December 7, 2009
Valley of Death – Part II
So how do you cross the Valley of Death?
Well it sure helps to have some other people to guide you who have personally made the journey and worked out where the hidden wells are along the way. A key element to carry you is risk capital – but the businesses that are really great to invest in are often the ones that don’t want the money – usually they need it, but they often don’t want it because they don’t want to deal with the crap that comes with it.
Software companies are a great example of how bootstrapping can work really well, and a new idea can be tested and validated, and even sold, well before significant amounts of money are needed. There is still a valley of death for these businesses, because just selling product and having happy customers can make you complacent and fail to recognize that these early adopters are not the whole market, and you have to grow or die. The day you launch your product you start the clock on competition, if in fact they haven’t already got something similar cooking and ready to release already. First mover advantage is a two edged sword and often instead of creating and then owning a market, you simply create it for a competitor to go take it from you. The curse of software is the ease with which it can be replicated by competitors and lack of patent protection. You have to understand how to really scale your business, and differentiate from competitors, and have a clear and focused strategy around that growth to leverage your limited resources for maximum result. Money is a fulcrum--who gives it to you can be the lever, depending on the depth of their experience, personal networks, and commitment as an investor.
For many hardware businesses, it's not possible to boostrap without capital – even if there isn’t money to be had, entrepreneurs have a gift for finding it – a customer who is a real believer in your product is often a great source of needed capital whether it's NRE or advance payment
This applies primarily to deep tech, rather than Internet or execution plays. Early adopters validate your product, fine tune it and provide premium price because they value the unfair advantage you give them – if they are not willing to pay that premium then it's just about price and you shouldn’t play in that game. A good test of the compelling advantage of your technology is to try and raise money by getting a customer to fund your company in exchange for exclusivity (you can limit the term later). Too many companies delude themselves into their value only to find their customer walks them into the purchasing department who has no interest in value other than to get as much of it for as little as possible ;-)
Early adopters let you under the hood of their company engine, and with that inside knowledge you gain deep customer intimacy that begets understanding of their real pain point, which when coupled with your deep technology understanding creates a unique solution that neither of you ever would have thought of alone. The pioneering customers help you prove your value proposition, and later will help evangelize your virtues and enable sales to the broader market where price will become an issue, but armed with the proven business case of your early adopters you can win those sales.
Once you have your clear value proposition and product that supplies it, you need to iterate your sales process many, many times, until you find the right repeatable model that secures recurring revenue. It has always amazed me what happens when a career sales person is brought in to replace the peer-to-peer selling of engineers – don’t underestimate the value of peer-to-peer, it’s the secret sauce of selling to early adopters, but there is an inflection point where the domain experienced sales person can turn up the heat for broader market acceptance and really start to ramp sales. This is the other element of risk capital; its hard to judge when to increase burn in order to capture the market – if you are bootsrapping, you will often miss this point and grow organically, trading time for money. This is usually a bad trade because you can’t win back time – there are many, many bet-the-company decisions an entrepreneur is faced with, it’s a lot easier to seize the opportunity if there is a financial buffer, and ideally people who have made these decisions before for their own businesses.
So if it's so easy, why do we so rarely succeed? (see Part III next time)
Well it sure helps to have some other people to guide you who have personally made the journey and worked out where the hidden wells are along the way. A key element to carry you is risk capital – but the businesses that are really great to invest in are often the ones that don’t want the money – usually they need it, but they often don’t want it because they don’t want to deal with the crap that comes with it.
Software companies are a great example of how bootstrapping can work really well, and a new idea can be tested and validated, and even sold, well before significant amounts of money are needed. There is still a valley of death for these businesses, because just selling product and having happy customers can make you complacent and fail to recognize that these early adopters are not the whole market, and you have to grow or die. The day you launch your product you start the clock on competition, if in fact they haven’t already got something similar cooking and ready to release already. First mover advantage is a two edged sword and often instead of creating and then owning a market, you simply create it for a competitor to go take it from you. The curse of software is the ease with which it can be replicated by competitors and lack of patent protection. You have to understand how to really scale your business, and differentiate from competitors, and have a clear and focused strategy around that growth to leverage your limited resources for maximum result. Money is a fulcrum--who gives it to you can be the lever, depending on the depth of their experience, personal networks, and commitment as an investor.
For many hardware businesses, it's not possible to boostrap without capital – even if there isn’t money to be had, entrepreneurs have a gift for finding it – a customer who is a real believer in your product is often a great source of needed capital whether it's NRE or advance payment
This applies primarily to deep tech, rather than Internet or execution plays. Early adopters validate your product, fine tune it and provide premium price because they value the unfair advantage you give them – if they are not willing to pay that premium then it's just about price and you shouldn’t play in that game. A good test of the compelling advantage of your technology is to try and raise money by getting a customer to fund your company in exchange for exclusivity (you can limit the term later). Too many companies delude themselves into their value only to find their customer walks them into the purchasing department who has no interest in value other than to get as much of it for as little as possible ;-)
Early adopters let you under the hood of their company engine, and with that inside knowledge you gain deep customer intimacy that begets understanding of their real pain point, which when coupled with your deep technology understanding creates a unique solution that neither of you ever would have thought of alone. The pioneering customers help you prove your value proposition, and later will help evangelize your virtues and enable sales to the broader market where price will become an issue, but armed with the proven business case of your early adopters you can win those sales.
Once you have your clear value proposition and product that supplies it, you need to iterate your sales process many, many times, until you find the right repeatable model that secures recurring revenue. It has always amazed me what happens when a career sales person is brought in to replace the peer-to-peer selling of engineers – don’t underestimate the value of peer-to-peer, it’s the secret sauce of selling to early adopters, but there is an inflection point where the domain experienced sales person can turn up the heat for broader market acceptance and really start to ramp sales. This is the other element of risk capital; its hard to judge when to increase burn in order to capture the market – if you are bootsrapping, you will often miss this point and grow organically, trading time for money. This is usually a bad trade because you can’t win back time – there are many, many bet-the-company decisions an entrepreneur is faced with, it’s a lot easier to seize the opportunity if there is a financial buffer, and ideally people who have made these decisions before for their own businesses.
So if it's so easy, why do we so rarely succeed? (see Part III next time)
Thursday, November 12, 2009
Valley of Death
I am involved in a government thing at present, trying to help innovation in another country. There is a bunch of money available to help startups be successful and to try and solve the “commercialization problem.” I am looking at materials around how that process will work and can't help concluding it’s a jobs program for domestic consultants rather than a fix for startup success. There are lots and lost of inputs and activity, lots of boxes to check--consultants who can handle your taxes, legal, IP, and ugg Marketing--well not real marketing in the sense that an entrepreneur thinks about it, but more marcom or branding.
The problem is that good entrepreneurs self-select out of these programs. They don’t need the government to solve these problems for them. If they did they would have little hope of solving the really hard problems of the marketplace, which is of course where they really need the help. Domestic consultants in that country are ill equipped to navigate a foreign ecosystem because they are living in it currently. Like the entrepreneurs, the entrepreneurial service providers, patent attorneys, lawyers, accountants, real estate brokers, etc who all work for equity here in the Valley, don’t do so in other ecosystems and wouldn’t naturally migrate to a government program because they are entrepreneurial enough to do it themselves.
It's not lack of basic business advice that kills startups, it’s the valley of death, that gulf that separates the first early adopter customers and the mass market that propels a company to revenue growth, scaling and success. Many, many companies survive in purgatory for years, without achieving success, but government programs might label them as successful because they didn’t fail ... in other cultures there's a great fear of failing--but as with skiing, if you don’t fall down, chances are you won’t learn to ski!
The power of networking is an awesome thing to behold, and no one uses it better than a great entrepreneur.
So you have a great technology idea for a laser sheep shearing machine and you want to get it funded; you talk to a few friends, and one of them knows an angel or a VC; they set a meeting. That investor doesn’t like the deal but he knows someone else who does, he makes a call, you meet for a coffee and sketch the business model on a napkin. The second investor laughs and you go through five iterations together, and he sends you away with three more names to vet it out. Next day, you meet those three people, one is a domain market expert who has worked in the sheep shearing market for 15 years. The other is a laser expert, who vets your technology, and the third is a former entrepreneur who has never seen a sheep but built five successful laser companies.
After your business plan has been torn down and rebuilt seven more times, you have a fairly invested group, and a solid plan and you can go back to the VC. You also have the names of three other VCs who invest in laser technologies (which means you have the worldwide market for laser investors ;-) ).
One of those VCs tells the former entrepreneur, looks great idea but there are five of those deals going around the Valley now, and I’m pretty sure X funded one of them--better check it out. The sheep shearing guy knows the customers and verifies, yes in fact VC X did fund them, so we’ll cross that VC off the list--is there an angle here to partner, compete, or should we give up this idea? We still have time to put together a new plan, and it isn’t even the weekend yet …
No cash changed hands in these interactions, no commitments were made. If the company had been funded, chances are some of the people who helped would become advisors or BoD members, maybe the seasoned entrepreneur would have ultimately stepped in as CEO. The people involved will stay connected, the entrepreneur who came up with the idea, will try to find ways to help those who helped him, and pay it forward. Value gets rewarded, any good entrepreneur knows this, and knows how to reward and nurture those who help.
One way to deal with the valley of death is simply to avoid it--when pitching an idea to a VC the second best answer you can get is NO, but with sound reasons. It's awful to spend years trying to build a business, languishing in the valley of death, it's far better to avoid it all together and do something else.
If you are Evil Knievel, then you may be able to jump the valley of death. So how do you cross the valley of death?
The problem is that good entrepreneurs self-select out of these programs. They don’t need the government to solve these problems for them. If they did they would have little hope of solving the really hard problems of the marketplace, which is of course where they really need the help. Domestic consultants in that country are ill equipped to navigate a foreign ecosystem because they are living in it currently. Like the entrepreneurs, the entrepreneurial service providers, patent attorneys, lawyers, accountants, real estate brokers, etc who all work for equity here in the Valley, don’t do so in other ecosystems and wouldn’t naturally migrate to a government program because they are entrepreneurial enough to do it themselves.
It's not lack of basic business advice that kills startups, it’s the valley of death, that gulf that separates the first early adopter customers and the mass market that propels a company to revenue growth, scaling and success. Many, many companies survive in purgatory for years, without achieving success, but government programs might label them as successful because they didn’t fail ... in other cultures there's a great fear of failing--but as with skiing, if you don’t fall down, chances are you won’t learn to ski!
The power of networking is an awesome thing to behold, and no one uses it better than a great entrepreneur.
So you have a great technology idea for a laser sheep shearing machine and you want to get it funded; you talk to a few friends, and one of them knows an angel or a VC; they set a meeting. That investor doesn’t like the deal but he knows someone else who does, he makes a call, you meet for a coffee and sketch the business model on a napkin. The second investor laughs and you go through five iterations together, and he sends you away with three more names to vet it out. Next day, you meet those three people, one is a domain market expert who has worked in the sheep shearing market for 15 years. The other is a laser expert, who vets your technology, and the third is a former entrepreneur who has never seen a sheep but built five successful laser companies.
After your business plan has been torn down and rebuilt seven more times, you have a fairly invested group, and a solid plan and you can go back to the VC. You also have the names of three other VCs who invest in laser technologies (which means you have the worldwide market for laser investors ;-) ).
One of those VCs tells the former entrepreneur, looks great idea but there are five of those deals going around the Valley now, and I’m pretty sure X funded one of them--better check it out. The sheep shearing guy knows the customers and verifies, yes in fact VC X did fund them, so we’ll cross that VC off the list--is there an angle here to partner, compete, or should we give up this idea? We still have time to put together a new plan, and it isn’t even the weekend yet …
No cash changed hands in these interactions, no commitments were made. If the company had been funded, chances are some of the people who helped would become advisors or BoD members, maybe the seasoned entrepreneur would have ultimately stepped in as CEO. The people involved will stay connected, the entrepreneur who came up with the idea, will try to find ways to help those who helped him, and pay it forward. Value gets rewarded, any good entrepreneur knows this, and knows how to reward and nurture those who help.
One way to deal with the valley of death is simply to avoid it--when pitching an idea to a VC the second best answer you can get is NO, but with sound reasons. It's awful to spend years trying to build a business, languishing in the valley of death, it's far better to avoid it all together and do something else.
If you are Evil Knievel, then you may be able to jump the valley of death. So how do you cross the valley of death?
Monday, October 26, 2009
Why do you do Hardware?
I was asked this question by a young VC analyst replete with Stanford Biz school education, attitude, and three months of on-the-job experience. It struck me that perhaps the industry has passed me by and Hardware is so 80s ... so I thought it was time to soul search as follows: the rivalry between hardware and software is akin to that between physicists and chemists. Many would say that when you know what you are doing you do it in hardware and if you don’t [know what you're doing] you chose software ;-)
At Iridex I was stunned at the power of software, particularly with the advent of the touch screen. Suddenly we could change the bezel with code only, we didn’t need to retool or repaint the knobs. It was also incredibly more resilient in nasty places like the OR (well it wasn’t at first but it eventually got there). The difference from the hardware guys is that you can afford to get it wrong because it's easy to fix (compared to messing up the mould for the bezel or display, which could take months to fix). However, to hardware guys, the software is always the gating item in a project because it's always late, and never works properly--in fairness the software can’t be done until the hardware is complete so it’s a shared responsibility for being late.
The logic of doing software deals is that the recipe is fairly well defined. Because there is no manufacturing you can usually see the product or a prototype before you invest, talk with beta customers and a have a clear understanding of the value proposition--but where is the fun in that ;-) In hardware, it's rare to have the product, particularly if it’s a chip, so you have to rely on market vision, trends, and team. The capital expense is much higher in hardware and if you get it wrong it's really hard to recover. On the positive side, hardware begets a lot of IP and if managed properly you will always have a residual value to your investment even if the market fails. This IP barrier is the critical missing piece for me in software deals, unless there are legitimate ways to protect algorithms (like crypto, sequencing, expert systems, etc.). They tend to become execution plays, with tender hearted companies like Microsoft and Google looking over your shoulder ready to step in with a mediocre purchase price based on a make/buy decision. Of course if you can execute, very large companies can be built, which is why there are so many software-centric VCs.
In contrast chip investors seem to be a dying breed--partly because VCs don’t have the firepower to fund $100M deals ... well, unless it's in Cleantech ;-) Yet in medical device or biotech these $ amounts are fairly typical, so what's going on there?
In the medical space, in addition to wonderful IP barriers, you also have the FDA as a blessing and a curse. On the bad side it can take five years to get approval from scratch, but the value of that asset is immense, almost regardless of revenue metrics. To a large company like Medtronic or J&J, it's well worth paying $100M for a “failed” device company that has the platinum of FDA approval--often failed deals turn into great successes when big pharma puts its marketing muscle behind them.
Virtualization and cloud computing are strong trends and important ones--but as a hardware guy I worry about the security of these connections, and the power of software to effectively secure these open network systems.
I have seen a new breed of software guys who make software hook into the silicon itself, which turns out to be a wonderful way to get chip guys who don’t do software to appreciate it, and leverage the hardware to work in concert with the software to make a secure device. I think this is probably a theme.
I guess in the final analysis no matter how virtualized you are, at some point you have to touch the real world so software is pretty useless without the hardware that manifests it, so to me at least they are inextricably linked in a timeless symbiosis ;-)
Responses to comments:
David Wright - Larry - I have had a few successes and one deemed a failure. To me it is beyond doubt that you "can" learn a lot more from a failure than successes - how far can you push yourself, your team what are the warning signs etc but I don't think many will count the scenario you presented as a failure. Timing also is an issue. In my case - I am a better CEO because of my company failure and what I learnt to get it to the heights achieved but this was permanent - the company folded so a genuine failure. Until this happens the scoreboard is still running - will this person still consider it a failure if that company turns up again. If not they should tell Mr Murdoch how much of a failure he is :)
David--Thanks for your thoughts. We invariably learn more from our failures than successes--and how we react when things don’t go as planned really teaches ourselves and others about the quality of our character. Sounds to me like you will have continued success despite some setbacks.
At Iridex I was stunned at the power of software, particularly with the advent of the touch screen. Suddenly we could change the bezel with code only, we didn’t need to retool or repaint the knobs. It was also incredibly more resilient in nasty places like the OR (well it wasn’t at first but it eventually got there). The difference from the hardware guys is that you can afford to get it wrong because it's easy to fix (compared to messing up the mould for the bezel or display, which could take months to fix). However, to hardware guys, the software is always the gating item in a project because it's always late, and never works properly--in fairness the software can’t be done until the hardware is complete so it’s a shared responsibility for being late.
The logic of doing software deals is that the recipe is fairly well defined. Because there is no manufacturing you can usually see the product or a prototype before you invest, talk with beta customers and a have a clear understanding of the value proposition--but where is the fun in that ;-) In hardware, it's rare to have the product, particularly if it’s a chip, so you have to rely on market vision, trends, and team. The capital expense is much higher in hardware and if you get it wrong it's really hard to recover. On the positive side, hardware begets a lot of IP and if managed properly you will always have a residual value to your investment even if the market fails. This IP barrier is the critical missing piece for me in software deals, unless there are legitimate ways to protect algorithms (like crypto, sequencing, expert systems, etc.). They tend to become execution plays, with tender hearted companies like Microsoft and Google looking over your shoulder ready to step in with a mediocre purchase price based on a make/buy decision. Of course if you can execute, very large companies can be built, which is why there are so many software-centric VCs.
In contrast chip investors seem to be a dying breed--partly because VCs don’t have the firepower to fund $100M deals ... well, unless it's in Cleantech ;-) Yet in medical device or biotech these $ amounts are fairly typical, so what's going on there?
In the medical space, in addition to wonderful IP barriers, you also have the FDA as a blessing and a curse. On the bad side it can take five years to get approval from scratch, but the value of that asset is immense, almost regardless of revenue metrics. To a large company like Medtronic or J&J, it's well worth paying $100M for a “failed” device company that has the platinum of FDA approval--often failed deals turn into great successes when big pharma puts its marketing muscle behind them.
Virtualization and cloud computing are strong trends and important ones--but as a hardware guy I worry about the security of these connections, and the power of software to effectively secure these open network systems.
I have seen a new breed of software guys who make software hook into the silicon itself, which turns out to be a wonderful way to get chip guys who don’t do software to appreciate it, and leverage the hardware to work in concert with the software to make a secure device. I think this is probably a theme.
I guess in the final analysis no matter how virtualized you are, at some point you have to touch the real world so software is pretty useless without the hardware that manifests it, so to me at least they are inextricably linked in a timeless symbiosis ;-)
Responses to comments:
David Wright - Larry - I have had a few successes and one deemed a failure. To me it is beyond doubt that you "can" learn a lot more from a failure than successes - how far can you push yourself, your team what are the warning signs etc but I don't think many will count the scenario you presented as a failure. Timing also is an issue. In my case - I am a better CEO because of my company failure and what I learnt to get it to the heights achieved but this was permanent - the company folded so a genuine failure. Until this happens the scoreboard is still running - will this person still consider it a failure if that company turns up again. If not they should tell Mr Murdoch how much of a failure he is :)
David--Thanks for your thoughts. We invariably learn more from our failures than successes--and how we react when things don’t go as planned really teaches ourselves and others about the quality of our character. Sounds to me like you will have continued success despite some setbacks.
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