The lighter side of raising money

Raising venture capital is an essential prerequisite to many tech startup business plans. While some companies — usually software or services — can bootstrap off of savings or credit cards, companies with high R&D or manufacturing costs need a sizable cash hoard before they see first revenues (let alone profits).

In teaching about VC, my favorite tool has been the documentary Startup.com. Although about a New York-based startup called GovWorks.com, the presentations and negotiations with Kleiner Perkins, General Atlantic and Highland Capital illustrate the broader issues faced by tech startups raising money.

A friend, serial (i.e. chronic) tech entrepreneur Doug Klein, recommended The VC, a comic strip from the dot-com era. The strip rang true: as an entrepreneur during this period, Doug swears he lived each of these vignettes at some point during their fund-raising efforts.

The comics take the point of view that the actions of VCs are funny. Some of these are painful funny, as in the VC is going to flush us because he can’t buy a clue. Most of them are about laughing at (rather than with) the VCs in some way, shape or form.

All 52 strips from 1997-2000 are online at TheVC.com Business school professors (and public speakers) have been using Dilbert cartoons for a decade to lighten up discussions of project management, managers and (more generally) corporate bureaucracies. This site is a source of illustrations for one aspect of tech startups.

Creating firms and an industry

One of the major goals of our entrepreneurship program at San José State is to identify and re-establish ties with successful alumni entrepreneurs. We have a number of College of Business graduates who achieved success in low-tech startups, most notably Peter Ueberroth, Don Lucas, Gary Sbona and Mike Sinyard.

However, the most visible successes have come from our tech entrepreneurs. A few people know that Gordon Moore spent 2 years at SJSU (where he met his wife) before graduating from Cal, and then Caltech and going on to Shockley Labs, Fairchild and Intel. (Not to mention Moore’s Law).

In addition to semiconductors, two other SJSU alumni helped create the disk drive industry that made PCs possible.

Last April we had as a guest speaker serial entrepreneur Larry Boucher (who has an EE from Cal and both a BS and MBA from SJSU). He worked for Shugart Associates before founding Adaptec, Auspex and Alacritech. He was a technical pioneer that made both SCSI and NAS possible.

An even more compelling story is Finis Conner, who got a 1969 degree in industrial management. Conner founded three major disk drive companies: with Al Shugart, he co-founded both Shugart Associates (1973) and Seagate Technology (1979). Without Al, he created Conner Peripherals in 1986.

Very few people have created both firms and an industry the way that Shugart and Conner did. Certainly Moore and Andy Grove deserve credit for helping to create the semiconductor industry (and Intel), as the two Steves did with PCs and Apple Computer.

What is cool is when an entrepreneur can have success creating an industry, as well as technical success, business/shareholder success, and personal financial rewards. SJSU can be proud of its major successes here, even if they are far fewer than Stanford or Cal (let alone MIT).

Users becoming entrepreneurs

Last week I was at the HBS-MIT User and Open Innovation workshop. The conference is mostly (but not entirely) about user innovation in the footsteps of Eric von Hippel and his 1988 and 2005 books.

One of the major subthemes was on user innovators who become entrepreneurs. I’ve summarized the research I heard on the open innovation blog, but here wanted to comment on its applicability to facillitating engineering entrepreneurship.

One of the examples cited was Medtronic, the $14 billion/year firm founded by an electrical engineer and his brother-in-law to repair medical equipment. They were not user innovators, but to make their first pacemaker they involved doctors (i.e. pacemaker buyers, i.e. users) in the design.

This raises a question of how to best commercialize at the intersection of a highly technical user (in this case, MDs or scientists) and highly technical production processes (e.g. engineering of a human-wearable medical device). In this case, science is the customer — as with say instruments for radioastronomy — as opposed to being the input for the engineering (as with the WW II RadLab physicists enabling microwave radar).

So what if you have a product category that requires a combination of engineering competencies with deep knowledge of science, which belongs on the founding team? Are the engineers — who talk to doctors — more likely to succeed? Or does the advantage lie with a doctor-founder who hires engineers? The first is an example of a lead-user approach, while the second is user entrepreneurship.

My hunch (not immediately provable) is that the most important factor is none of the above. Instead, I suspect the driving force will be the same as with any other tech startup: how much business knowledge does the technical founder have — or, lacking such knowledge, how much is the founder willing to defer/listen to those with such knowledge?

Build or flip?

Once upon a time, tech entrepreneurs were motivated by a desire to build something of lasting value: a better mousetrap, a great company, or to change the world. In 1938, Bill Hewlett and Dave Packard sold eight oscilloscopes to Walt Disney, who was making Fantasia. Seventy years later, the successor business-to-business instrument division is at the core of Agilent.

It always helped to have good timing — either by being lucky or making your own luck. HP was there when Disney (and soon the war effort) needed electronic instruments. Fairchild bet big on silicon just as the military was shifting from tubes to transistors. Intel took the integrated circuit to the next level with its 4004 microprocessor, and bought back the rights from Busicom. Steve Jobs and Steve Wozniak went to the Homebrew Computer Club and saw how the microprocessor would enable personal computing.

In the original waves of tech startups, going public meant generating enough of a track record of revenues and profits that investors could reasonably hope that your stock would go up. Those (relatively rare) IPOs meant a few tech entrepreneurs got to be fabulously wealthy and endow vanity foundations (that today seem likely to do less good for society than their companies did). But the wealth was not the thing, at least until the hippies of Apple Computer created dozens of millionaires with their IPO, and later IPOs from companies like Sun, Oracle and SGI permanently changed the Silicon Valley mentality.

However, a much larger number of companies didn’t change the world, or create large (or even small) fortunes. Instead, they provided value to their customers, income and training to their employees, and a chance to have a vocation of meaningful work. It’s a standard power law distribution: if you buy a lottery ticket, you’re far more likely to win $5 than $50 million.

This more typical path was my own experience. We didn’t have an exit strategy because I hadn’t heard of the term when we started the company in 1987. Every penny that I made off the company came out of positive cash flow which (without the benefit of reduced capital gains taxation) is a much harder to way to throw off profits. But we produced good quality software for 17½ years before closing the doors in 2004.

The dot-com bubble seems to have changed things. Companies went public without profits and sometimes barely with revenues. There was a gold rush mentality and people who weren’t really qualified (either by talent, ethics or disposition) to build a real company were looking for a get rich quick scheme. This has continued into the current Web 2.0 era, as I was reminded when I gave a presentation at USC Thursday on Web 2.0 business modes.

So the new mantra is “flip this company.” As a 2004 Business 2.0 article proclaimed

The New Road to Riches
How To Get Ahead In The Postbubble World
Build A Company Cheap. Flip It Fast. Repeat.

Flipping a company today is about selling out to a big company ina just a few years: the Holy Grail is the $1.8 billion that Google paid for YouTube after only 18 months. However, the philosophy is similar to the dot-bomb (some say dot-con) era, companies built using this philosophy were sold to the public as a naked demonstration of the “greater fool” school of ethics.

This may be the road to riches, but it’s not a way for entrepreneurs to create value or success (more broadly defined). This philosophy was dissected by author Jim Collins in a thoughtful 2000 essay. He illustrated a point using a 1985 medical equipment startup:

The real question, the essential question is this: Is your company built to work? The answer rests on three criteria: excellence, contribution, and meaning. Again, consider Cardiometrics. The company may not have been built to last, but in all of its activities, it adhered to the highest possible standards: Instead of relying on expedient studies and marketing hype, it conducted rigorous, costly clinical trials in order to demonstrate the value of its technology. And the company clearly made a significant contribution -- to the market, to its investors, and to the lives of patients all over the world. Finally, the people of Cardiometrics found their work to be intrinsically meaningful: They worked with colleagues whom they respected and even loved, and they pursued a worthy aim to the best of their ability. Built to Flip? Built to Last? Cardiometrics embodies neither of these models: It was built to work.

Today, I believe that the opportunities for startups to IPO are greatly diminished, for a variety of reasons. IT is mature with a large number of diversified established incumbents. Biotech startups have disappointed investors with both the risk and the payoff. Both types of startups lack the complementary assets such as distribution or economies of scope to fully capitalize on their innovations.

Today startups are being acquired, and sometimes a piddly little company can create a value that they will be unable to unlock on their own, but can be realized by a Google or a Cisco. But in a free economy, every excess eventually self-corrects, so if acquiring companies don’t get value, they will buy fewer companies and pay less for those that they get — or their mistakes will put them out of business.

Either way, assuming that a bad business will be bought at a good price seems like a lousy bet.