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Wednesday, February 26, 2014

If Facebook kills entrepreneurship, what’s next?

The $19b that Facebook paid to buy WhatsApp is shaking up Silicon Valley, as other Internet startups try to figure out how they can get their own inflated multiple.

But for the rest of the world of tech entrepreneurship — such as life sciences — it could further starve the flow of investment capital they need to get off the ground.

Entrepreneurship guru Steve Blank tweeted Monday
steve blank ‏@sgblank Feb 24
Why Facebook is killing Silicon Valley http://steveblank.com/2012/05/21/why-facebook-is-killing-silicon-valley/ … more relevant today
The earlier article talked about his work teaching entrepreneurship for science-based startups:
The irony is that as good as some of these nascent startups are in material science, sensors, robotics, medical devices, life sciences, etc., more and more frequently VCs whose firms would have looked at these deals or invested in these sectors, are now only interested in whether it runs on a smart phone or tablet. And who can blame them.

Facebook and Social Media
Facebook has adroitly capitalized on market forces on a scale never seen in the history of commerce. For the first time, startups can today think about a Total Available Market in the billions of users (smart phones, tablets, PC’s, etc.) and aim for hundreds of millions of customers. Second, social needs previously done face-to-face, (friends, entertainment, communication, dating, gambling, etc.) are now moving to a computing device. And those customers may be using their devices/apps continuously. This intersection of a customer base of billions of people with applications that are used/needed 24/7 never existed before.

The potential revenue and profits from these users (or advertisers who want to reach them) and the speed of scale of the winning companies can be breathtaking. The Facebook IPO has reinforced the new calculus for investors. In the past, if you were a great VC, you could make $100 million on an investment in 5-7 years. Today, social media startups can return 100’s of millions or even billions in less than 3 years. …

If investors have a choice of investing in a blockbuster cancer drug that will pay them nothing for fifteen years or a social media application that can go big in a few years, which do you think they’re going to pick? If you’re a VC firm, you’re phasing out your life science division. As investors funding clean tech watch the Chinese dump cheap solar cells in the U.S. and put U.S. startups out of business, do you think they’re going to continue to fund solar? And as Clean Tech VC’s have painfully learned, trying to scale Clean Tech past demonstration plants to industrial scale takes capital and time past the resources of venture capital. A new car company? It takes at least a decade and needs at least a billion dollars. Compared to IOS/Android apps, all that other stuff is hard and the returns take forever.
Two years ago — ironically a few weeks before Blank’s blog posting — I started writing my own posting along these same lines. What I wrote (but never posted):
Did software ruin entrepreneurship?
On Friday, I sat between two entrepreneurs at an office party for my old job. One of the entrepreneurs is in clean tech (hardware) while the other is in IT (software). One is in his 30s and one is in his 50s.

The hardware guy was talking about his challenges raising funds. One VC told him (I'm paraphrasing): “I gave Instagram $5 million and got back $200 million. Why should I give you money?” [after their $1 billion acquisition by Facebook].
The remainder of my (incipient) argument was that software promises abnormally low cap short returns, and the amount of money needed to fund a software company is getting smaller by the week, as VC Mark Suster wrote back in 2011.

How will this play out? I see at least four possibilities:
  1. During the dot-bomb (dot-con) era we had too much money chasing too few good ideas, and what resulted was what economists call excess entry. Eventually the bubble burst — and it could again.
  2. Another possibility is that these other ideas don’t get funded. There are business models that made sense in the 1890s or 1950s that no longer make sense — such as ones that are labor intensive or based on craft work — and new businesses here don’t get launched.
  3. Blank points to the genius philosopher-king model — where a really rich guy (it’s almost always a guy) puts his money where is mouth is (again, almost always a big mouth). In a previous century it was Howard Hughes or Richard Branson, while today Blank points to Elon Musk.
  4. The final possibility is that politicians play kingmaker, not with their own money but with Other People’s Money, i.e. yours and mine. (They will be egged on by a incantations of “market failure” of a few economists.) While this may make sense for public goods such as public health, we saw how such large scale private intervention worked with firms like Solyndra.
Of course, these are not mutually exclusive. Musk depends on public subsidies to support the business models of Tesla and SolarCity, although — unlike Fisker and Solyndra — he’s at least offering something people want to buy. SpaceX depends on public procurement, but I believe his announced plans that this is just a bootstrap to get the business off the group (so to speak).

Is there a happy ending? Like Blank, I think the Facebook effect is going to get worse before it gets better.

Thursday, November 14, 2013

A bird in the hand...

The morning paper reported that Snapchat CEO Evan Spiegel turned down an (all cash) purchase offer from Facebook for approximately $3 billion.

My Snapchat-addicted teenager was relieved, saying "that means we're probably not going to get ads". (I had to break it to her that ads are inevitable, no matter who owns the company).

There is an interesting comparison to other pre-revenue startups
  • Snapchat, two years old, refused $3 billion offer from Facebook
  • Instagram, two years old, $1 billion purchase in 2012 by Facebook
  • YouTube, 18 months old, $1.65 billion purchase in 2006 by Google
  • Pinterest, valued at $3.8 billion in last month’s VC round
  • WhatsApp turned down $1 billion from Google in April, and one analyst Wednesday estimated its value at $11 billion (based on Twitter’s $24b market cap after last week’s IPO)
Obviously, these are exceptional exit opportunities, but still there are lessons for other firms considering the timing of their exit.

The New York Times suggests that its offer for Snapchat suggests desperation by Facebook:
Facebook’s Snapchat bid shows triple the desperation. The social network paid $1 billion for no-revenue Instagram a little over a year ago. Now, it’s said to be dangling as much as $3 billion to lure a mobile app that sends self-destructing digital images. Facebook’s apparently escalating need to buy off marauders at its moat suggests its defenses may be scalable.

Coming just months before its initial public offering, Facebook had obvious reasons to buy Instagram. Consumers were spending more time on mobile devices, instead of desktop computers. This was listed as a “risk factor” in its prospectus for its initial public offering as the social network still hadn’t figured out how to make money on mobile advertising. More important, it faced the risk that users might migrate to a rival optimized for smartphone usage.


Snapchat has similarly astounding growth. In September, its users were sending 350 million photos a day, up from 200 million in June. …

Still, there’s a disquieting element about a company spending billions for a simple application it could almost certainly have replicated for next to nothing. Facebook’s acknowledgment that teenagers are using its service less on a daily basis may signify the social network is losing its edge among the ranks of new technology adapters. That it is also now willing to shell out $3 billion to snuff out a rival in its infancy brings with it a whiff of desperation.
Writing on Sunday, Blogger Ben Evans asked where Facebook should draw the line:
Is FB going to buy Whatsapp, Snapchat, Line, Kakao and the next ten that emerge as well? Sure, some of those will disappear, but it doesn't look like FB will crush the competitors the way it did on the desktop. On mobile, FB will be just one of many.
From the standpoint of the entrepreneurs, Business Insider reports on those claiming that Instagram sold too early and too cheap:
Now, 18 months later, industry people are starting to believe that [CEO Kevin] Systrom was wrong to accept that deal. They believe that if Instagram had stayed an independent company, it could be worth between $5 billion and $15 billion today.

This morning, activist investor Eric Jackson tweeted: "Systrom has to be feeling like he totally missed this wave. Instagram likely worth $15B today minimum." Jackson told us he came up with that valuation figure by looking at Instagram's total active users, about 150 million, and Twitter's, around 236 million. Assuming that Instagram's user base is more U.S.-weighted, and therefore more valuable, he figures Instagram's market cap as an independent company would be at least half of Twitter's $30 billion.
To me, this is the question of the value of a bird in the hand. Instagram’s continuing success is not guaranteed. Like any stock, the value could go down, not up. (NB: Digg, MySpace, AOL). Since they’re pre-revenue (let alone having positive cash flow), no one has any idea what these companies will be worth.

It seems unlikely that Spiegel (or Systrom) will have another comparable exit opportunity. If (as Wikipedia says) Systrom owned 40% of Instagram, 40% of $5b-1b is $1.6b (pretax) left on the table. For the founders, it’s the difference between never having to work again, and having enough pocket cash to change the world, whether by buying/selling companies or eradicating malaria.

Mark Zuckerberg refused a Yahoo purchase offer and delayed his IPO, and now is #20 on the list of US billionaires with a worth of $19 billion, the richest American under 40 years old. Timing is everything: Zuckerberg is worth far more than the widow of Steve Jobs, who accomplished far more over a longer period (but IPO’d early and sold his Apple founder’s shares in the 1980s).

Key employees with stock options will be similarly conflicted. With another 5x rise in valuation, some may never work again. On the other hand, some have enough money to buy a house (even in Los Angeles) today, and they won’t if the company never concludes a successful exit. The more sophisticated realize they, too, may not have another opportunity: a childhood friend had stock options from seven Silicon Valley companies, and none ever produced a sizable ($100K+) return.

The existence of a Chinese VC valuing Snapchat at $4b is giving Spiegel a concrete reason to turn down the Facebook offer. Still, new capital is not liquidity. Also, as Tech Crunch notes for Pinterest, the ever-increasing valuation may make it impossible late investors to profit from acquisition — making the exit IPO or nothing.

So does turning down a $3 billion exit mean a $10 or $15 billion one? Or a $500 million one? Spiegel isn’t panicking, but instead is leaving all his chip on the roulette wheel for one more spin.

Saturday, October 26, 2013

Buy, don't start a company

In doing research for my first (journal) article on 3D printing, I found an interesting article that suggests young entrepreneurs should consider buying a small growth business rather than start one from scratch.

The story (from the October 28 dead tree edition of Forbes) is about Stanford alumnus Rob Cherun and a course he took that changed his career goals from McKinsey consultant to one-man LBO artist:
Cherun’s inspiration was a little-known but increasingly popular course at Stanford called “Strategy 543: Entrepreneurial Acquisition.” This second-year elective is a fast-paced, two-week primer on how to become a one-person version of KKR or Blackstone Group, carrying out your own tiny takeover and installing yourself as chief executive officer. …

Every year second-year Stanford students like Cherun stampede into S-543 to learn the essentials of raising money, finding an acquisition target and closing the deal. Instructors Peter Kelly and David Dodson–two longtime entrepreneurs and investors themselves–take only 40 students per session, and that doesn’t come close to satisfying demand. Months before this autumn’s class began, every slot was claimed, and another 26 students hovered on the waiting list. Frustrated aspirants will get a second shot in the spring, thanks to a new scheduling expansion.
Columnist George Anders cites a study of “search funds” that concluded that the occasional home run (100:1 return) produces a pretax IRR of 34%, even allowing for a 50% failure rate.

In Cherun’s case, money was the easy part: after four Stanford instructors ponied up, Cherun and a partner raised more than $500k for their search and a promises of equity funding for an actual deal.

The entrepreneurs bought 90% of a Canadian company that monitors construction sites for thefts. The 35-year-old founder remained as a minority partner and got to spend more time with his wife and kids without having to travel across the country. The new owners have doubled revenues to $10m (loonies?) annually.

However, these Stanford students face a sizable opportunity cost. In almost the same issue, Forbes proclaimed Stanford the “best” US business school, based on the difference between pre-MBA salary ($80k) and post-MBA ($221k) salaries that (net of tuition and lost wages) left them on average $100k richer after five years. The generous salaries for the elite graduates of the Stanford class of 2008 were aided by placements at Apple, Google and the top consulting firms (Bain, BCG, McKinsey); these were 5 of the 6 employers most preferred by MBA students (#4 on the list is Amazon).

Three other schools (Chicago, Harvard, Wharton) also had $200k post-graduation salaries. My undergrad school, MIT, ranked 12th -- just ahead of UCLA, Berkeley and Virginia; my grad school, UCI, ranked #62 (up from #69 in the last ranking).

It takes great confidence to walk away from the certain cash to run a small company. (Stanford students are nothing if not confident.) The risk is probably lower if (as in Cherun’s case) the company has a track record and (as recommended by Stanford) can be bought for 6x EBITDA.

Except for the last point, this looks like a win-win, providing a liquidity opportunity for entrepreneurs who can’t take the company to the next level. Still, having a residual equity stake (and a meaningful management role) makes it a lot more attractive for founders who might have trouble letting go of their baby.

Saturday, August 24, 2013

Cleantech entrepreneurs thinking big

Cross-posted from Cleantech Business

As an MIT alum interested in clean energy, I subscribe to the free semiannual magazine Energy Futures.

The purpose of the magazine is to tout MIT advances in energy technology, but since MIT (with the MIT Energy Initiative) is one of the world's cutting-edge energy research labs, I find that it is often a provocative look into a possible future that may or may not* come to fruition. (*The technology may not work, it may not scale, it may not be cost effective, something better may come out, etc. — such are the risks of technology entrepreneurship).

In the spring issue, one article describes the work of Prof. Vladimir Bulović, recent PhD grad Miles Barr and ex-postdoc Richard Lunt to create transparent solar cells. The cells absorb energy in the UV and near-infrared, but only about 30% of the visible light. This would allow the PV cells to become just another layer on a building’s windows, and could also use the window class to protect the (currently fragile) layers from the elements.

[Spectral response]

Right now, the efficiency is only 2%, but are hoping to get the efficiency up to 10-12%.

As with any BIPV (Building Integrated Photovoltaic), integrating the PV into windows would eliminate most of the installation cost; it would also mean that the PV is not an obstacle in use of the existing roof, interfere with drainage, need to cope with snow accumulation, etc.

The big win seems to be for large commercial buildings. The article claims that a 5% efficient PV cell could generate 25% of a building’s electricity. Absorbing near IR would reduce cooling in the summer (but increase heating in the window). With such a cost-benefit, the builder of a new commercial building would invest in such efficiencies (even ignoring the LEED bragging rights) while a consumer might worry about increasing the price of a house $20-50k (and would also tend to have more shading problems). If every new skyscraper had such BIPV, it would both generate a lot of energy and also be a big market.

To exploit the opportunity, the three men formed a company called Ubiquitous Energy, where Barr is president and CTO, and the other two are on the scientific advisory board. They have a $1m in seed funding and $375k in SBIR funding so far.

Like any tech startup, it’s a gamble — but this seems one with a big payout if they can solve all the challenges.

Saturday, June 8, 2013

Risk-taking and risk aversion

The cover of the Wall Street Journal† Monday proclaimed:
Risk-Averse Culture Infects U.S. Workers, Entrepreneurs
By Ben Casselman

Three long-running trends suggest the U.S. economy has turned soft on risk: Companies add jobs more slowly, even in good times. Investors put less money into new ventures. And, more broadly, Americans start fewer businesses and are less inclined to change jobs or move for new opportunities.
The VC story isn’t quite as compelling as promised. Some of the story is already known — that VCs keep hoping for another Internet bubble that won’t return (but spawned excess entry). At least one measure — share of VC for seed capital — the trend isn’t monotonic, but shows peaks and valleys.

The concentration of VC in Silicon Valley can be read two ways: VC only wants Silicon Valley entrepreneurs, or entrepreneurs know they should move to Silicon Valley to get funding. And as everyone knows, the companies that VCs fund are only a small fraction of the nation’s startups.

And while Casselman reported new specifics, we know that the last four years has been a jobless “recovery.” Citing the work of Maryland economist John Haltiwanger, he wrote:
In the eight recessions from the end of World War II through the end of the 1980s, it took the U.S. a little more than 20 months, on average, for employment to return to its pre recession peak. But after the relatively shallow recession of the early 1990s, it took 32 months for payrolls to rebound fully.

After the even milder recession of 2001, it took four years. Today, nearly four years after the end of the last recession, employment has yet to reach its pre crisis peak.
No, what was really troubling is what the story said about America’s entrepreneurial culture. This is what made America successful over the past 150 years, and the envy of the world. (It is also why, as some have argued, the country needs a new frontier to keep entrepreneurial processes alive).

Instead, Americans are changing cities often, changing jobs less often, and working more for big companies than for small companies. Even family businesses are not being passed down, as the children of entrepreneurs opt for the safety and comfort of corporate jobs.

As a natural consequence of this cultural shift, young companies account for a declining share of both the population of companies and national employment. This is terrible for the country, because we know (especially from Prof. Haltiwanger’s research) that young companies account for all the net job creation in this country. These little companies are finding it harder to compete against established incumbents.

I wish I had an answer. The country has become more regulated and bureaucratic, and it’s taking a toll on entrepreneurial intentions. Thirty years ago, we had an effort to reset the country’s attitude towards risk taking and free markets, but the tide has been inexorably coming in ever since.

† It’s to the Journal’s credit that they devoted so much space to the topic. Twenty years from now, we’ll hold this out as an example of why newspapers were once a good thing and tragic that they all died.

Wednesday, May 22, 2013

Research on startup teams and startup success

At the ACAC lunch today, Kathy Eisenhardt summarized her decades of research on tech startups. For an academic conference (the Atlanta Competitive Advantage Conference), Prof. Eisenhardt literally needs no introduction: as host Bill Bogner of Georgia State said, “Kathy Eisenhardt needs no introduction: if she does, you didn't pass comps.” (Academics would know her paper that has 20,000+ cites, while tech entrepreneurs might know her as co-director of Stanford Technology Ventures Program or her many STVP videos).

Eisenhardt's focus was on the importance of a startup’s management (“Top Management Team” in strategy jargon) in determining the success of a small or young firm in a highly uncertain environment. She identified three factors that explained that success
  1. Optimal management team
  2. Optimal strategic decision process
  3. Matching strategy and structure (at “the edge of chaos”)
1. Management Team

We know that successful teams need to be larger, diverse and have prior work experience together (and thus trust). However, there is an interaction effect between the team and the sort of opportunities they pursue. As scholars who study tech startups will tell you, firms tend to be veterans of an industry who start firms in that same industry that they know.

Her 1990 paper with Kaye Schoonhoven showed that the best firm growth came where a top team caught a great opportunity. A great opportunity was a market that’s at the takeoff phase of a growth market: at least $20 million of industry revenue and 20+% annual growth. In California-speak, Eisenhardt said this is a great surfer catching a great wave.

In specific domains, she cited the recent research of Anne Fuller and Frank Rothaermel on star faculty entrepreneurs as well as various papers by Sonali Shah on user entrepreneurs. As she noted, Chuck Eesley of Stanford (an MIT alum) who estimated when experience is more valuable than talent, based on a survey of entrepreneurs from among the 100,000+ MIT alumni.

2. Strategic Decision-Making

Her old studies on TMT decision making showed that for fast choices in highly uncertain environments, managers need more information and more alternatives, as well as a decision process that is midway from managerial fiat and (a hopeless search for) total consensus. She also noted later work of researchers who examined improvisation and bricolage.

Her former student, Sam Garg, has studied how CEOs manage their boards. The best CEOs constrain the interactions with the board and don’t give up their power over leading the company, using it to make decisions (not generate ideas), by using a divide and conquer strategy.

3. Strategy and Structure

Summarizing her research with Chris Bingham of UNC, she noted that young firms were most successful when they could use their experience to generate heuristics. Experience was valuable when it created “simple rules” that firms could apply over and over again: such rules were both quicker and often better in solving problems in conditions of high heterogeneity and high uncertainty.

Eisenhardt noted that firms (like parents “raising your teenager”) face a dilemma between too much and too little structure. In a simulation with Bingham and Jason Davis, they found that in a highly unpredictable or turbulent market, too little structure is more dangerous than too much. (This also sounds like raising a teenager).

Finally, in cases of high ambiguity (e.g. nascent markets), success is more determined by luck than skill. Therefore, skillful managers want to reshape the market to fit their skills — rather than leave the outcome to dumb luck.

Wednesday, May 8, 2013

The multi-dimensional 3D printing revolution

At @KeckGrad today, our graduate students are doing their year-end project presentations. In watching the presentation by mechanical engineering students gave me insight into how 3D printing is going to change entrepreneurship.

There are at least three different dimensions of how 3D printing is creating entrepreneurial opportunities. In each case, there are parallels between personal computers almost 40 years ago — and smartphones today — and how they gradually displaced mainframe computers. This is a classic Clay Christensen “disruptive innovation”.

Some of the emphasis on the impact of 3D printing has focused on the 3D printing companies. In fact, Scott Shane published a 2000 research paper on how a variety of companies licensed the original 3D printing technology from MIT. This has been the subject of news has also been on some of the larger and more successful 3D printer manufacturers, whether public companies such as Stratasys or 3D Systems or startups such as Shapeways.

A second opportunity — the one that captures the attention of the popular press — is the print-on-demand business.This nicely fits the mass customization vision of Silicon Valley marketing guru Regis McKenna and German innovation scholar Frank Piller. An example of this is Layer By Layer (@LayerByLayer3D) a company formed by Harvey Mudd students who are graduating next week, who proposed to custom-print iPhone cases.

An advantage of the 3D printing model is easier customization and lower setup costs. However, for now it’s slower and more expensive per unit, and has limitations in product reliability.

However, at the KGI presentation today, I saw a third category of opportunity. This seems like a much broader and more immediate application of 3D printing: changing the process of industrial design.

Among our Team Masters Projects, a team of KGI and Harvey Mudd students spent the academic year to create a mechanism for evenly coating seeds. As in previous projects, they used SolidWorks to design the mechanical components, and had some bent or machined metal components.

However, it became obvious to the team that the default prototype fabrication approach is the 3D printer. The students created two seed picking components that could be sized and shaped to fit whatever requirements they had. Once they had the design, they set the printer going and hard their part ready in the morning.

This reminds me of my first computer experience (pre-PC), when computing job turn-arounds took 10 minutes to several hours. To improve on batch computing, we eventually obtained timesharing — quick but expensive — and then desktop personal computing and handheld computing. Over time, as computing became quicker and cheaper, it allowed computing to permeate and enable every aspect of engineering, science, business and government.

So if 3D printing becomes cheap, ubiquitous and quick, what will that do to physical design? The marginal cost may not become as low as software products, but it will certainly close the gap and thus converge the innovation processes between physical and intangible goods.