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Tuesday, December 8, 2009

Timing is everything

Over the weekend, Apple bought music streaming company Lala for an unspecified price. The most authoritative report comes from blogger/reporter Peter Kafka:
Apple ended up paying around $80 million for the company, according to multiple sources. That’s less than half what investors valued the company at in 2008, but it’s more than the $35 million the company raised throughout its life. Which means that some investors could get their money back and more.

But not all of Lala’s investors. Warner Music Group (WMG), for one, ended up getting back about half the $20 million it put into Lala, I’ve confirmed with people familiar the company.
This account and others make it clear that Lala is being purchased for the knowledge of its staff and its technology. One thing it never did was create a viable revenue model, despite multiple iterations and support from both VCs and record labels.

This seems to be a common problem in Web 2.0 startups. The Dot-Com II era has not been creating viable stand-alone companies, but instead technology sandboxes that have to be bailed out by a good fit to a rich incumbent. In this case, Lala’s service nicely complements the market-leading iTunes. But relying on acquisition for exit has always been a small-numbers problem, particularly when the big boys have gobbled up your competitors (leaving you without a dance partner).

As it was, it sounds like the Lala investors (or founders) got a little greedy. Kafka notes that the investors thought the company was worth $200m at its peak. It‘s not clear if there was a willing buyer that was turned away. But if the owners were holding out for more, they clearly gambled big and lost big. As Charlie Jackson used to tell me, “I’d rather be lucky than good” — an admonishment that timing is everything.

Instead, timing is against the entire categlry. A lot of people thought digital technologies would transform the music industry, and thus garnered piles of VC in hopes of realizing that vision. As Kafka notes, the track record is not great:
The last big exit for a digital music company happened way back in the spring of 2007, when CBS (CBS) paid $280 million for Last.fm. But no one has gotten anything close to that for digital music since then. Imeem is being sold for spare parts, and News Corp. also bought iLike at a steep discount. Spiralfrog filed for Chapter 11 after burning through its cash.
Still, somehow Pandora raised another $35 million. Between the economy, the capital markets, the cratering of its sector and its similar lack of a business model, the wildly popular service with innovative technology has been darn lucky to survive multiple brushes with death. If I were CEO, I’d be looking to negotiate any exit ASAP.

Update Wednesday 9am: Other estimates put Lala's purchase price at $17 million — and a net price of $3m after allowing for cash on hand. Meanwhile, MySpace bought another music service with $24m of VC for “less than $1 million” according to various accounts.

Saturday, November 7, 2009

CEO of the decade: never settle for good enough

Apple founder and twice-CEO Steve Jobs was named this week by Fortune magazine to be “CEO of the decade.” Although he’s a liberal arts dropout rather an engineer — and today CEO of a Fortune 100 company rather than a startup — I think Jobs’ career exemplifies the best of what a high-tech startup should be.

Barely removed from his hippie era, the Jobs I era (1976-1985) was clearly about changing the world rather than making a buck. (Until his 1997 return to Apple, Steve made almost all his wealth from Pixar, not Apple).

Reading the Merc summary by John Murrell, it’s clear that the Jobs II era has also succeeded due to Jobs fastidious unwillingness to settle for “good enough.” As Adam Lashinsky wrote in the main Fortune article:
In the past 10 years alone he has radically and lucratively reordered three markets -- music, movies, and mobile telephones -- and his impact on his original industry, computing, has only grown.

Remaking any one business is a career-defining achievement; four is unheard-of. Think about that for a moment. Henry Ford altered the course of the nascent auto industry. PanAm's Juan Trippe invented the global airline. Conrad Hilton internationalized American hospitality.

In all instances, and many more like them, these entrepreneurs turned captains of industry defined a single market that had previously not been dominated by anyone. The industries that Jobs has turned topsy-turvy already existed when he focused on them.
To me, this is what entrepreneurs do, whether Henry Ford and Juan Trippe or Simon Ramo and Irwin Jacobs. Great entrepreneurs — like other change agents — pursue their vision without regard to whether it’s practical.

At the risk of being cliché, this is the epitome of Schumpeter Mark II. As Richard Swedberg said in his introduction to Schumpeter’s Capitalism, Socialism and Democracy:
Schumpeter’s theory was centered around the entrepreneur: he argued that change in economic life always starts with the actions of a forceful individual and then spreads to the rest of the economy.
How did Jobs get where he is? In the Fortune sidebar, fellow IT billionaire Larry Ellison described his friend and former neighbor thus:
"The difference between me and Steve is that I'm willing to live with the best the world can provide. With Steve that's not always good enough." And if you look at how he tackles building a phone, or building a laptop, he really is in pursuit of this technical and aesthetic perfection. And he just won't compromise.
However, as Ellison notes Jobs is proud to have the highest market cap of any Silicon Valley company — ahead of Cisco, Intel, Google and Oracle. Ironically, two years ago Apple’s market cap passed IBM: the same IBM that offered to bail out Apple’s failed management team at $40/share (until they demanded $60) and of course the same IBM that created the PC that bedeviled Apple until Jobs’ return.

Friday, October 2, 2009

Two decades of nanotechnology opportunities

Visiting IBM’s Almaden Research Center Thursday, I was reminded that 20 years ago this week, an IBM ARC researcher made history by being the first person to move a single atom.

Don Eigler is perhaps better known for his November 1989 accomplishment: arranging 35 Xenon atoms to spell out “IBM.” Either way, these were major breakthroughs that enabled the subsequent growth of nanotechnology-related products and startups.

I must confess my limited knowledge of the technological and business aspects of nanotechnology. However, it was clear from my visit with ARC associate director Moidin Mohiuddin that IBM is continuing to invest in developing these technologies, part of decades of materials science basic research. Once this technology had direct application to IBM products (such as disk drive recording heads or coatings), today IBM will also out-license its technology as part of its seminal open innovation strategy.

As it turns out, two of my fellow Anteaters (UCI alumni) are not so ignorant. Jennifer Woolley and Renee Rottner published an article last year on nanotechnology startups in Entrepreneurship Theory & Practice — one of the top entrepreneurship journals.

Their article focused on the geographic distribution of nanotechnology startups. Their conclusion was that states that most aggressively supported nanotechnology research and commercialization had the most activity. (As a cynical ex-politics reporter, I might posit an alternate hypothesis — that the regions with the strongest nanotechnology base lobbied most effectively for state spending — but I haven’t seen their data).

For those trying to understand the phenomenon of nanotechnology-related entrepreneurship, this will be a seminal piece. Jennifer is continuing to do research in this area, so I recommend her work for those interested in the topic (despite her working for arch-rival Santa Clara).

Saturday, September 12, 2009

Useful revenue model ambiguity

Michael Arrington of TechCrunch remarks on Twitter’s dilemma for starting its revenue model. To reword his points:
  • Many firms are acquired pre-revenue and thus their valuation is made without proof of its revenue model.
  • Before a startup has a revenue model, its revenues are anyone’s guess.
  • Once a firm has revenues, the range of guesses will be much narrower — and often lower than the most optimistic predictions.
Of course, I’ve long been skeptical of Web 2.0 companies and their ability to create viable business models.

Cross-posted to Open IT Strategies.

Tuesday, September 1, 2009

A solution that found a problem

Several years ago, one of my students was involved in a business plan concept to use video board graphics processing units to provide extra processing power. The problem was this was a technology — or a solution — without a well-defined problem.

In this morning’s Merc, there was a story about TechniScan, a Salt Lake City company that is using GPU to enhance image processing of medical images (such as CAT scans). This is the targeted solution that my students lacked: a bounded technical problem (in terms of developing code and algorithms) with a well-defined group of customers with similar needs. If ever GPU processing is going to turn into a business, this would be it.

Ironically, the market they’re targeting is not a new one. Back in 1987, when my company was brand new, Peter Marx came down to Vista from Harbor-UCLA Medical Center to tell me how someday all medical imaging would be stored on computers. (At the time, the idea of images being stored on Sun workstations would have been considered technically challenging). He showed me all sorts of cool images that he’d processed on his Macintosh II.

Peter clearly had the right idea, but both the digital image generation and the host-based processing power were decades away.

So here we have examples of some of the factors that distinguish an incipient opportunity from a real one: a well-defined customer with a well-defined problem, and of course technical feasibility to do something about that problem.

Thursday, August 20, 2009

The inevitable need for Plan B

Many if not most tech entrepreneurs eventually face a wrenching problem: when do I give up on Plan A and go to Plan B?

In some cases Plan A and B (or A,B,C,D …) co-exist alongside each other in a successful diversified revenue model. In other cases, the company is too small to have more than one plan or the initial plan is such a loser (or another such a winner) that the answer is obvious.

However, in many cases it’s hard for managers to admit the correct decision — either because the data is ambiguous or because of emotional involvement. I suspect that most founders will have a hard time letting go of Plan A, because of the psychic investment and legacy role. Or if Plan C comes from your new CEO — and it bombs — it’s often hard to decide to ditch the plan if it might also mean ditching the CEO.

On Wednesday, I stopped by Pinger, a mobile software startup located walking distance to my SJSU office. CTO Jocelyn Cloutier — who worked for Yahoo, AOL, Bell Labs and as a Montreal C.S. college professor — happens to be married to one of my friends and co-authors.

A venture funded startup that’s not quite 4 years, Pinger spent 2 ½ years trying to get its Pinger voicemail multicast system established. Despite a few high profile wins (like the 2008 presidential campaign of John Edwards), like so many other tech startups it found itself flogging a solution in search of a problem.

Cloutier said that at some point, the management team had to admit that the original company concept wasn’t working: “I just put two years of my life into there, so let’s try something different.”

So when the iPhone App Store launched in the summer of 2008, Pinger carefully evaluated it. On the one hand, ”we didn't know at that time that app store is going to be the thing.” In retrospect, the App Store proved to be a smash success — but as in any startup, it’s tough to make a decision when the future is unknown.

Still, Pinger saw iPhone apps as a big potential opportunity, based on the prior success of the iPhone and its increasing momentum. It jumped in with both feet: in little more than a year, Pinger released four iPhone aps:
  • Dec 2008 Pinger Phone: an enhanced souped up IM client (ala Adium) with some other friend features. ad supported
  • Feb 2009. Textfree: a freemium SMS client, naturally segmented by the # of messages per day
  • July 2009: Doodle Buddy, a kid -oriented drawing program (that allows collaborative color sketching over a network)
  • Today (Aug. 20). Free2Call, a new app (approved while I was there at Pinger) that tells consumers which calls are in-network.
While the first application is no longer being sold — the cost structure didn’t work — it paved the way for all the future apps. As Cloutier said: "Pinger phone showed us there's volume there. We can put an application out there and we are going to have a lot of downloads. Now the question is how can we have an application that they're going to use every day and are going to pay for?"

For Pinger, Plan A was a hosted service and Plan B was peddling iPhone apps at $0-$5 each. (Textfree Unlimited has an annual subscription).

It turns out the technology wasn't very similar between Plan A and Plan B, but the technologists were. The founders were veterans of Handspring — and thus understood the whole device-constrained software model — which enables the team to do a good job of designing something for a 320x480 screen with no keyboard and no mouse.

Pursuing Plan B, Pinger has made it so far, but there are lots of uncertainties and no guarantees. International growth is problematic: most of their products are tied to US-specific telecom industry features (Free2Call) which would require data or localization or negotiation for each country. The iPhone/iPT is only a small part of the US market; although ISVs would like to reach other handset owners, it's not clear which app store will catch on next.

More generally, there's also the inerhent problem of package software sales — as opposed to services like If you’re Google or Verizon Wireless, which make ongoing revenue off a customer after acquiring only once.

Software products — like vidoegames, records, movies — are prone to the one hit wonder problem. Once everyone buys your hit, what do you sell them next? If you don’t sell them another product — or an upgrade like Office 2023 or EA’s annual NFL Football update — then once everyone in your segment has bought the product, the income flow stops.

This one-time nature of software product sales nearly killed my own company, as initial strong sales fizzled out as we quickly reached the limits of unexpectedly small niches.

At Palomar we went from Plan A (consumer apps) to Plan B (developer apps) to Plan C (semi-custom OEM utilities) to Plan D (retail OEM utilities). We worked through the 4 business models in the first 4 years. At year 6 dumped all but Plan C (which was cash flow positive and the long run the only one that made any money).

What’s the take home? Entrepreneurs face several tough decisions, including when to look for Plan B (or C or …), when to implement Plan B, when to abandon Plan A. This choice is obscured by the various uncertainties: not knowing what customers will want, what competitors will do, where the industry will go and how effective our execution will be.

There is also the diversification vs. focus problem. Do you hedge your bets, or does spreading your bets guarantee that neither will succeed? Do you put all your eggs in one basket — all the weight behind the arrow? If so, how can you recognize that all-or-nothing bet has become controlled flight into terrain?

Monday, August 17, 2009

Famous lie slightly more true

As is well known in the US, there are three great lies:
  1. "I'll respect you in the morning."
  2. "The check is in the mail."
  3. "I'm from the government, and I'm here to help you."
In a man-bites-dog story, Entrepreneur magazine (which is a lot more pro-free enterprise than Inc.) is praising a government website for actually helping small business owners:
There's something new at business.gov, the official online business link to the U.S. government: community. OK, starting a blog site isn't that new an idea generally. But the business.gov blog, which just got going in July, offers a unique opportunity for small business owners to learn how to do business with the feds.

With all the new federal funding floating around from the stimulus bill, this seems like a great place to maybe get a quick answer if you're stymied on how to apply to get stimulus funds, apply for an SBA loan, or about anything else governmental. …

Not enough small businesses even look at trying to snag government contracts if you ask me. Hopefully, this blog will help demystify the process.
I don’t think anyone is going to change the list of lies, but every rule has its exception. It’s good to see sensible, low-cost efforts to disseminate information about existing government programs.

Friday, August 7, 2009

Innovation is more than invention

We thought we were home run hitters, but then we learned that we were born on third base. — Attributed to an AT&T alumnus
This quote by Stanford economist Tim Bresnhan (at Tuesday‘s State of the Net West conference) nicely captures the key problem facing innovative engineers working for any company smaller than the old Ma Bell.

Bell Telephone Laboratories had a better research staff (and working conditions) than all but a handful of universities. The monopoly profits of The Phone Company fueled some of the greatest inventions and scientific discoveries of the latter 20th century — things like lasers, satellites, information theory, etc. etc.

However, as this quote suggests, there are two reasons why such inventive output doesn’t provide a good measure of success:
  • It’s easy to bring technology to market (e.g. electronic switching, microwave long distance) if your captive customers comprise 90+% of the largest economy in the world.
  • When you can’t bring your expensive new technology to market, the guaranteed rate of return means there is no penalty for waste or inefficiency.
Invention is never enough. Except at Ma Bell, big innovations require (as Hank Chesbrough demonstrated in his Xerox studies) a business model and someone entrepreneurial enough to create a market if it doesn’t exist already.

Friday, July 10, 2009

Killing a business

Friday’s paper brought news of the planned liquidation of the Smith & Hawken, the premium garden store founded in 1979 in Marin County. Although I’ve never visited one of their stores, it was nonetheless sad news, because the company provided important inspiration for my early days as a tech entrepreneur.

When we founded our company in July 1987, my partner Neil Rhodes and I were intentionally (and ultimately unsuccessfully) emulating Hewlett & Packard. Like Bill & Dave, we started in a garage, and we deliberately emulated certain elements of the HP culture (which also became our biggest customer).

However, it was Smith & Hawken that provided explicit validation for some of our ideas about what a business was and could be. A year after we launched, in 1988 we read Paul Hawken’s Growing a Business; this was decades before the two comparable HP histories, The HP Way and Biil & Dave.

In his book, Hawken talked about issues that resonated closely with us, things like how to treat employees and the meaning of business. Although it’s been 20 years since I opened the book, I recall his view as being that creating and growing a business was more than just about money, and that founders could and should shape the firm to reflect what they believed important.

Although his industry was very different, this was a view quite consonant with tech startups of the 1980s, back when people tried to build a business for the long haul and before IBM and HP layoffs changed forever the idea that somehow tech companies were different.

Perhaps Smith and Hawken weren’t different, either. Hawken used the success of the book and the company to branch out into other things, leaving the company in 1992, which was then sold in 1993 for $15 million to the parent of NordicTrack. Some of the experiments by the founders (losses on an unsuccessful clothing line) were seen as contributing to the company’s need to be acquired

Since 1993, Smith & Hawken has had three corporate parents. The last owner was Scotts Miracle-Gro, which bought the company in 2004 and has been unable to find a buyer for the firm. Some of the turnaround moves sounded plausible, but nothing worked.

The two founders showed none of the remorse one might expect of a parent outliving its child:
"Scotts couldn't have been a worse corporate owner," said Hawken, who lives in Mill Valley. "Smith & Hawken had become just a ghost of itself."

[David] Smith, who lives in Mendocino County and owns Mulligan Books in Ukiah, said he had gone so far as to ask friends not to shop there.

"When Scotts bought it and Smith & Hawken was owned by the largest pesticide seller in the U.S., I suggested people boycott it," he said. "It had completely lost its roots."

Hawken, chairman and CEO of engineering company Pax Group, used the occasion of the closing to host a party Wednesday night. "I couldn't be happier to see my name come down," he said.
What’s the moral of the story? Perhaps that nothing lives forever. Certainly that (as my mentor Charlie Jackson advised me 15+ years ago) once you sell a company, you have to let go and accept what happens. Also, people change — even visionary founders — and their passions will also change.

Most of all, I think it says that even with a unique business concept and vision, firms need to have the management depth and the dispersed leadership and the culture to continue on after their founder is gone. This is certainly a crucial issue for Apple to deal with, more than a decade after Steve Jobs undid the terrible damage done by his three CEO predecessors, and nearly five years after his initial cancer surgery.

Tuesday, July 7, 2009

Is entrepreneurship down, and why?

Scott Shane of Case Western argues that entrepreneurial activity is declining, due to competition from larger rivals with superior scale.

Meanwhile, Jonathan Adler (also of Case Western) has a contrary argument:
It seems to me that another likely contributor is the increased regulatory burden. It is well documented that regulation can increase industry concentration. Smaller firms typically bear significantly greater regulatory costs per employee than larger firms (see, e.g., this study), and regulatory costs can also increase start-up costs and serve as a barrier to entry.
What I find interesting is that entrepreneurial opportunities and activities are not equally distributed across the country: more firm formation happens per capita in Silicon Valley than in (say) Northeastern cities. And California is larger than any other state, the total numbers will be even higher than the ratios.

Today, California is going through a series of changes that are making the business climate less attractive, especially for startups:
  • a shortage of venture capital
  • increasing taxes
  • cutbacks in education and other infrastructure spending
  • a political climate that is encouraging increased regulation
California entrepreneurs may continue despite such burdens, or they may move somewhere else, or they may not start a company after all. But a decline in entrepreneurship in California would certainly reduce the total number of US startups more than in a smaller or less entrepreneurial state.

Monday, May 18, 2009

Panel on bootstrapping tech companies

Not surprisingly given the membership pool, the MIT Club of Northern California has four activities related to technical entrepreneurship. This includes separate speaker series on semiconductors and clean technology, as well the Venture Mentoring Series for alumni (more at a later date).

One that I didn’t know about is the C3 group (Convergence, Community and Commerce), which put on a panel last month called “The Art and Science of Bootstrapping.” The four bootstrapping panelists wereAlthough I didn’t make it, there is a long report in the Spring 2009 edition of the MITCNC newsletter.

Not surprisingly, the interest in bootstrapping is motivated by the increasing risk aversion of VCs, making it difficult to get seed funding. Entrepreneurs are having to bootstrap off of personal (or 3F) money to grow the business to a point where it’s interesting to VCs.

There are two paragraphs that caught my attention:
All panelists agreed that a company cannot always remain bootstrapped and there are circumstances when the founder should be open to accepting outside financing. Paul Kochar further elaborated that if a company is in a market that is poised to takeoff and there are no barriers to entry for other competitors to come in, moving fast is key to capturing market share. In such circumstances when a company can grow very quickly, it is imperative to look for the type of financing that can facilitate such growth, for example, to develop customer support and sales organizations or to invest in user experience. On the other hand, if a company is in a niche market with no competitors, then one can afford to bootstrap and slow the growth to maintain financial control.
I am guessing from the report that all of the entrepreneurs had high growth aspirations — and hence their concern about growing quickly before the window of opportunity closed. Here is the other paragraph:
Regarding how long a company can be bootstrapped, Michelle said that it is easy to bootstrap in the first two years of a company’s life, but beyond that it was less clear because the window of opportunity remains open only for so long. Sridhar said that if one does not have a big idea and no big discontinuity, it is better to be bootstrapped. Only 1% of new businesses are venture financed. Paul pointed out that some arenas, such as clean tech or semiconductors, are not generally good candidates for bootstrapping.
Actually, 1% is much too generous a number. By my own calculation, funding peaked in 1999 (during the dot com bubble) at about 0.15%, but in the early 2000s averaged about 0.037% — one company out of 2,700.

Obviously some of the other 2,699 companies are those (like my own) that are high-tech startups or have a strong technology component. Many of these are bootstrapped forever, but this normally consigns the venture to slow growth niches.

This is how I would have summarized the event if I’d attended:
Bootstrapping is a way of getting launched and proving viability to outsiders. However, if you are pursuing a rapid growth opportunity, then you will soon need sizable outside funding — either VC or corporate VC. If your competitors have it and you don’t, you will be left behind.

Wednesday, May 13, 2009

The greatest source of tech entrepreneurs

Journalists love anniversaries, particularly ones with big round numbers. Politicians (and others seeking publicity) love them two. They’re what we call a “news peg.”

On Sunday, the San Jose Mercury published a long article by Scott Duke Harris celebrating the 100h anniversary of the founding of Federal Telegraph and Telephone in Menlo Park. The article mentioned two other Stanford-related startups founded in the first half of the 20th century — HP [founded in 1937] and Varian Associates [1948] — as well as the familiar list of IT firms from the 1980s and 1990s.

Harris used this history to make a point about Stanford’s role in promoting high-tech entrepreneurial culture:
Stanford University's 100-year tradition of entrepreneurialism, which has spawned such tech giants as Hewlett-Packard, Cisco Systems and Google, has been recognized as a catalyst to Silicon Valley's emergence as the globe's pre-eminent tech hub.
Alas, to quote Will Rogers, “It isn't what we don't know that gives us trouble, it's what we know that ain't so.”

OK, I’m a little biased here. I’m an MIT grad, active in the local MIT club, and onetime entrepreneur alum. I have been researching MIT-trained entrepreneurs as part of a book tentatively named From MIT to Qualcomm. There are also key Stanford rivalries, with strong personal and family ties to the UC system, and today teaching tech entrepreneurship in the shadow of the world’s second richest university. (Full disclosure: I was accepted by Stanford the only time I applied, as a high school senior).

And by no means do I want to minimize the role that Stanford has played in sparcing alumni (and faculty) entrepreneurship in Silicon Valley, starting with Cypress Semiconductor, Electronic Arts and Sun Microsystems in 1982, and extending through Cisco, Yahoo and Google (among many others). After benign neglect by the business school, Stanford’s engineering school has played an incomparable role in promoting technology entrepreneurship among students at Stanford and elsewhere, with efforts like the Stanford Technology Ventures Program and its free iTunes U podcasts.

However, after talking to Silicon Valley historian (and Palo Alto native) Stephen B. Adams, I believe claims of Stanford’s role in the early 20th century are greatly exaggerated. As Steve wrote me in an email responding to the Merc article:
The early start-ups (pre HP) did not take because the Valley lacked critical mass of high tech talent. Therefore, local firms such as Federal and Farnsworth moved to areas (New York/New Jersey and Philadelphia respectively) that already had clusters going. The 1939 Census of Manufacturing showed the same thing that Fred Terman later said: by then the Valley had fewer than 100 scientists and engineers in industry. Not exactly critical mass!
In fact, there wasn’t much to HP until it wartime orders swelled its ranks to 200 employees, and it laid off more than half of those after the war.

At best, Stanford’s role as an entrepreneurial incubator began when Fred Terman was appointed engineering dean in 1946, or when Stanford decided in 1951 to allocate some of its land to form the pioneering Stanford Industrial Park. Even in the 1970s, Stanford’s role in creating startups was not obvious. Shockley (and then Fairchild and Intel) put the “silicon” in Silicon Valley without direct ties to Stanford.

Adams points out that Stanford was aggressively ahead of Berkeley for a very simple reason: without Berkeley’s ongoing support from Sacramento, Stanford badly needed the money. Necessity is the mother of invention.

Which brings me to the other point. As Anna-Lee Saxenian documented in her 1994 book, Regional Advantage, Silicon Valley surpassed Route 128 in the 1980s and never looked back. Saxenian says it’s because of the valley’s open culture, but others argue that it’s because Boston bet on minicomputers while the Bay Area bet on PCs.

However, in the period 1920-1970, there was no question which university was inspiring and fueling technological entrepreneurship: it was MIT.

Losing its land grant status and rejecting a proposed merger with Harvard, in the early 1920s MIT was scrambling to raise resources both for the Institute and for its faculty. (Remember, big Federal R&D spending started with WW II).

During the interwar era, MIT invented its industrial cooperative program (allowing students like Andy Viterbi to work in real jobs to pay for their schooling). It also invented the now-standard consulting rubric used by all American research universities, the “one day a week rule.” This is well recounted by Henry Etzkowitz and his fascinating book, MIT and the Rise of Entrepreneurial Science.

Through the end of the 1960s, MIT was also the world’s leading university in creating the field of electrical engineering and establishing computer science as an academic discipline. MIT has its own list of alumni- and faculty- (co)founded companies, with an impressive run of electronics-related startups from 1922-1985 in both Massachusetts and California that included Raytheon (co-founded in 1922 by Vannevar Bush), EG&G, BBN, TI, DEC, Bose, Lotus, PictureTel, 3Com, and Qualcomm. Among those launching its many Bay Area startups were the two men who put the Silicon in Silicon Valley: William Shockley and Robert Noyce.

By the way, where did Terman (son of a Stanford psychologist) learn his trade as a radio engineer? As one biographical article recounts:
Stanford’s own Electrical Engineering Department chairman told Terman that the biggest and best EE department in the country was at MIT. So in 1922 Terman joined a generation of promising EE graduate students on a pilgrimage to Cambridge.

At MIT, Fred undertook graduate study under Vannevar Bush. Fred earned his Doctorate Degree in electrical engineering in 1924, and having a fascination with all of the exciting events at MIT, Fred was to accept a teaching position there.
Due to health reasons, Terman returned to Stanford, but he spent 1941-1945 running the Harvard Radio Research Laboratory, an auxiliary to the much larger MIT Rad Lab.

Today, both MIT and Stanford have exceptionally qualified faculty, undergraduate and graduate students in engineering and the sciences. MIT’s technical role remains strong, but certainly (as the Merc argues) Stanford has taken the lead in fostering tech startups. Stanford has a much better local environment for entrepreneurs, but it’s an open question whether that’s due to West Coast vs. East Coast cultural differences, the availability of VCs, or the wealth of successful entrepreneurs (and entrepreneurial wealth).

If MIT has been eclipsed by Stanford in firm creation, there’s no guarantee that the latter will remain pre-eminent indefinitely. Stanford’s main rival will not be Cal (or even MIT), but instead Tsinghua or the various campuses of IIT.

I don’t think it will happen right away: these other schools may be able to imitate Stanford’s talent, but it will be longer before than can replicate the ecosystem that lies in its back yard. So even if the Merc has the history garbled, the contemporary story of Stanford’s entrepreneurial success is true (at least for the time being).

Monday, April 13, 2009

End of the IPO anomaly?

In 2008, there were only six IPOs nationwide, compared to 365 twenty years earlier. The end of IPOs means that founders no longer run their companies, but instead get acquired by big firms and then quit to do something else.

Sunday’s Merc, presented its annual compilation of the Silicon Valley 150. One noticeable result was a reduction in the number of public companies and also of IPOs.

Columnist Chris O’Brien remarked on the trend:
From 2001 to 2008, there have been 90 IPOs in the valley, an average of 11 annually — and the last one was more than a year ago. Compare that with 331 IPOs in the years from 1990 to 1998, an average of 41 annually. The two years in between were so insane — producing 163 IPOs — that it's no use considering them for sake of comparisons.
We’ve long known that Silicon Valley has a higher rate of IPOs than in other countries, but the evidence also suggests it has a higher rate than the rest of the US.

In my own research on communications startups in San Diego, I’ve noticed a much lower rate of IPOs. By my most recent tally, there are eight public companies in the telecom cluster (a few were either acquired or died after their IPO).

So, I’m sorry to say, the data is starting to confirm my conjecture. The 1980s and 1990s offered an unusual window of opportunity for IPOs — both in terms of the availability of financing and the ability to create a new stand-alone company.

Acquisitions do have a few advantages: they are quicker, available to a wider range of firms, and less dependent on the cyclical capital markets. My mentor Charlie Jackson planned for an IPO but sold his company to Aldus in 1990 when the IPO market closed.

I wonder when (or if) the business (or engineering) school courses in entrepreneurship will notice the change, and adjust their curriculum accordingly.

Thursday, April 9, 2009

Illegitimate startups

In grading business plans this week, I was struck by a common blind spot: my undergraduates were overly optimistic about their chances of gaining sales (or distribution) from day one.

They didn’t realize that they would be handicapped by the inherent lack of legitimacy that a brand-new firm has. This is something I lived as a software entrepreneur, but also a well-known problem to strategy researchers.

Just as innovation and entrepreneurship scholars often trace back their core theory to Schumpeter’s “gales of creative destruction,” those worried about the disadvantages faced by young firms go back to sociologist Arthur Stinchcombe and his 1965 book chapter which coined the phrase “liability of newness”.

Subsequent research (such a 1986 ASQ article by Singh et al) has shown that the liability stems in large part to the lack of external legitimacy held by the new organizations. (The test was with nonprofits, but the principle is the same).

I had trouble finding something suitable for undergraduates to read; perhaps this is a publishing opportunity. However, I but did find a closely related 2008 article in Entrepreneur entitled “Credibility is King.”

In class, I tried to tease out the difference between legitimacy and credibility, but given the impromptu nature of the discussion I have to admit I was mostly winging it. In my mind, legitimacy is whether or not you’re in the consideration set. Credibility (as in the political context) is whether or not customers believe what you say.

We brainstormed the reasons or conditions for a lack of legitimacy, and I noticed that they all boiled down to two issues. One is the lack of information (e.g. about the unmeasurable quality of your good). The other is for cases of high risk: making a bad decision on a bicycle helmet is different than doing so for buying an ice cream cone. Again, this is something I hope to elaborate in a future article.

In terms of solutions, most of our options boiled down to two. One is to borrow legitimacy, such as from suppliers (“Intel inside”), dealers, or testimonials by buyers or celebrities. The other is to reduce the risk faced by buyers, such as by providing a free trial.

Again, this is something I’d like to write up sometime, but at least I have a starting point to sensitize future students to this challenge they will face as entrepreneurs.

Tuesday, March 10, 2009

Are you a bootstrapper?

At SJSU, I’ve been working with some faculty colleagues to try to better explain how and why firms bootstrap. (Of course, there is a big question about what “bootstrap” means).

Last night, our Silicon Valley Center for Entrepreneurship had a panel discussion entitled “Bootstrapping Startups: The Pros and Cons.” It was moderated by angel investor, blogger and SJSU entrepreneurial finance professor Steve Bennet. His panel consisted of:
Steve opened by saying “Bootstrapping is a topic near and near to my heart.” As he noted, current difficulties of raising investment capital have raised the interest in bootstrapping.

Jon had an interesting definition of bootstrapping:
Can I approve with my management team a merger? … Do the team and I own 50.1% of the company. … Do we have the ability to exit when and if we should?
Jon noted — as I have argued for a while — that the IPO exit was extraordinary, and the normal exit for most firms is (and will be) acquisition. Thus, he argued, it is important for entrepreneurs to design their companies to be acquire-able.

Gus Alberelli’s Kennet Partners, surprisingly, specializes in investing in companies that have already bootstrapped to significant financial results. As their home page proclaims:
You’ve funded your growth the hard way: by selling real value to real customers.

You don’t need venture capital to validate your idea: the market has already done that. You need a different kind of capital.

The companies we invest in often do not need money to survive. They have options.

But the right investment from the right partner can help them keep ahead of their markets, expand internationally, ramp up their sales forces and lead to greater value for shareholders.
This is a very thoughtful argument for the bootstrap strategy (and their ability to profit from them). They have detailed pages on why this helps entrepreneurs, and how they choose firms. They have an entire page about bootstrapping, and a white paper entitled “Bootstrap Your Business for Success.”

During Q&A, Gus said they looked for two key things: “Do you have a repeatable sales model and is there a big enough market?” Unlike other VCs, they claim to be agnostic as to whether they will keep the founding CEO (and grow his/her skills) or bring someone else in.

I didn’t take as careful set of notes for Ilya (my former student), because he had a one hour presentation to my day class that had many more details. At that session, he listed some of the key bootstrapping challenges:
  • Lots of work
  • Difficulties in attracting a good team
  • Small volumes mean less buying power and higher COGS
  • Slower growth
  • High level of stress on personal life
Starting with limited funds, the bootstrapper’s way out is to acquire customers quickly that pay the bills. Ilya number one piece of advice:
  • Look for customers that are most likely to buy quickly
  • Don’t target big segments that will take longer and are less likely to pay off
I am hoping that the panel will end up on the web or iTunes U. If so, I’ll add a link.

Finally, I want to end where Steve started: with a humorous quiz on bootstrapping, crafted by Greg Gianforte, founder of RightNow Technologies. (Angel Tim Keane has the full quiz online). The theme of the quiz is a self-assessment of the reader’s bootstrapping abilities (or proclivities).

My favorite question:
5. Your product does not do everything a prospect wants. You should?
a. Tell them it won't do those things;
b. Get them to pay for the enhancements;
c. Take the order and tell them it will ship in four weeks;
d. Explain why those things are difficult to do and convince them to buy the current product.
This was funny because it was so real: it exactly fits my experience as the head of a software company that bootstrapped from a $12,500 staring investment to a seven-figure run rate.

Update 1:45pm: Steve Bennet has summarized his own views of the event.

Friday, January 30, 2009

VCs vs. entrepreneurs

To be successful, any sort of business deal must align conflicting interests. In thinking about venture capital, the decision of entrepreneurs to seek (and accept) VC investments assumes that both parties want the company to succeed, and the only conflict is over the terms of the investment (particularly the dilution).

However, a couple of recent blog posts highlight a second, equally important category of conflicting interests: control over the timing of exit.

On AngelBlog, Basil Peters recounts an example of a tech startup with a chance to exit via acquisition, one that would produce a 3x return for VCs, and perhaps 10x for the angels and 100x for entrepreneurs. The problem is that the VC needs a bigger return (the home run) from its winners to cover its losers. This is consistent with the story of VC investment math told by Bob Zider a decade ago in his HBR article, “How Venture Capital Works.”

Of course, such an early offer may mark a peak in the company’s valuation — in an increasingly competitive segment (as in the Peters example), the total return will only go down. Once faced with an obviously worsening situation — whether firm-specific problems or an increasingly unprofitable industry — VC are known to pull the plug prematurely, saving management attention for the likely winners rather than spending more time salvaging a “dog.” In my SD Telecom study, we had to interview one founder in the final few days before the VCs closed the door forever.

The other point is that, come hell or high water, the VCs will liquidate their investment before their investment fund matures and must return capital (and earnings) to its principals. As VCs freely admit, this means they seek a quick exit — ideally 3-5 years, with 7 years at the outside. Blogger Sigurd Rinde of Germany notes the disconnect between achieving VC objectives, and the goal of many tech entrepreneurs of creating long-term value.

I had a slow growth, bootstrap startup, which never sought (nor was suitable) for VC. This had its pluses and minuses, but it’s clear (as I used to say back then) that taking VC is like starting a time bomb: you have to come up with an answer before it goes off, or you’re dead.

Monday, January 26, 2009

Best business planning books

This semester I’m teaching a business plan course for the first time since I left UCI in 2002. (I did use a business plan assignment in a 2006 strategy class — more on that later.) The course is an elective for both our undergraduate entrepreneurship and management majors, although I have a few students from other colleges on campus. At the suggestion of a local VC, we are shifting the title and emphasis of the course from strictly business plans to “Planning the New Venture.”

Although I use textbooks for core courses to cover the recommended corpus of knowledge, where possible I try to use regular (i.e. trade paperback) books for electives. They tend to be more readable, cheaper, more likely to be kept after graduation and more representative of what students will read after they graduate. So in preparing for the class, I searched on the Internet and Amazon for books related to business plans.

In 2006, I asked students to write business plans without much information on how to do it, other than walking them through our standard template, which was derived from the U. Maryland BPC. Both versions were derived originally from the standard MBA entrepreneurship textbook by the dean of entrepreneurship scholars, the late Jeff Timmons.

This year, I wanted to give them more help on the two most difficult tasks — estimating revenues and estimating costs — while also covering the broader questions of starting a new business. After buying five books and getting a 6th from the library, I eventually settled on three books.

The first book I picked was the smaller (and cheaper) Timmons paperback, entitled Business Plans that Work. It‘s not complete, but for an undergraduate course it gives a good consistent way of looking at the problem, and (not surprisingly) matches well to our (i.e. Timmons) BP format.

The second book I chose was Bankable Business Plans by Edward Rogoff. I did not expect to like the book, and with its “action steps” (rather than chapters) it’s a bit of a scattershot. However, I found it a nice complement to the Timmons text. In some areas, it’s much more concrete than Timmons, including one of the most important blind spots from 3 years ago — setting up a sales process.

These two books would have been enough for our 15 week course, if I had built a reader with 4-6 other articles to supplement the gaps in coverage. Together, they are only $28 at Amazon — a steal for anyone involved in entrepreneurship.

However, I wanted to give students a little more of the big picture of starting a business, including a sense of why they want to be entrepreneurs in the first place. In the end, I decided to use Guy Kawasaki’s The Art of the Start, which turned out to be much more substantive than any previous Kawasaki book I’d read. Still, I see Kawasaki and this book as a motivational speaker — identifying some important tricks and traps — rather than providing a business plan checklist.

One problem I’ve found in teaching entrepreneurship — with all the work of Timmons, and also many competing academics — is too much of an emphasis on venture capital-funded IPO-oriented startups. Kawasaki nicely balances this out with an entire chapter on bootstrapping, which (as he notes) can also be used by VC-bound companies to bridge between 3F money and their first professional capital. This nicely fits my course goal, which is to help students to identify the most appropriate funding approach for their idea and industry context.

The VC-centric counterpart to Kawasaki’s book is Raising Venture Capital for the Serious Entrepreneur by Dermot Berkery, a former McKinsey consultant turned VC and MBA lecturer in Dublin. It came highly recommended on Amazon, and after reading it, I saw why. It really walks entrepreneurs through the funding process — as VCs see it — and explains what they must do (and why) to put their best foot forward.

I decided not to use it this year for two reasons. First, it’s so VC centric that it would have undercut my message about being funding agnostic, and secondly, it’s more suitable for those already in business or graduate students. I would strongly consider it if I were teaching high growth-startups in the Stanford or Berkeley engineering school, and I’ll also recommended it for our new venture finance class.

Beyond the classroom, I would also recommend both the Berkery and Kawasaki books for those already in a startup. Despite 20+ years thinking about startups (as a founder, research, teacher and consultant) I picked up valuable tidbits from both — either things I didn’t know, or different ways of thinking about familiar problems. For example, Chapter 2 of Berkery’s book emphasized the importance of identifying 3-4 alternative exit strategies, so that investors (and founders) can still succeed if the initial plan is blocked.

One book that did not fit my immediate goals was The Business Plan Is Dead by Jeffrey Wofford. I’ll write more about it some other time.

Saturday, January 24, 2009

Raising capital in difficult times

In the past six months, it’s become even more difficult for otherwise promising tech startups to new or follow-on funding. On October 7, the now-infamous Sequoia PowerPoint deck advised their (mainly high- tech) portfolio companies:
New Realities
$15M Raise @ $100M post[-money valuation] is gone
Series B/C will be smaller raises
Customer uptake will be slower
Cuts are a must
Need to become cash flow positive
While some suggested this was a bargaining tactic by Sequoia to lower valuations, startup companies now face a double-whammy of declining demand by business and consumers and less availability of investment funds.

Of even more concern to the VCs, exit strategies will be more rare, less lucrative and more time consuming:
Increased Challenges
M&A will decrease
Prices will decrease
Acquiring entities will favor profitable companies
IPOs will continue to decrease and will take longer
Since VCs won’t be able to cash in their investments for a long time, they must set aside more money to keep alive a smaller number of companies.

In Thursday’s Wall Street Journal, veteran tech industry reporter Pui-Wing Tam wrote about [also here] the dilemma faced by a small Oakland-based VC fund:
Claremont Creek Ventures recently had to decide which of its young to forsake.

Amid the financial crisis and the plunging stock market, Claremont Creek decided to focus on the fund's best investments and stop backing the less-promising start-ups. It wanted to be sure it had enough cash for the next few years for the winners. The venture firm ranked the start-ups in the fund's 16-company portfolio with an A, B or C grade.

"We're doubling down on the As and likely won't invest any more capital in the C companies," says John Steuart, a Claremont Creek managing director. "The portfolio is competing against itself and it's survival of the fittest. It's brutal."
Angel investor and fellow SJSU entrepreneurship teacher Steve Bennet is one of the few who has beat the odds. In his ProfessorVC blog, he explains how one of his portfolio companies raised $6 million in Series C funds.

For those that have already tapped 3F money and can’t raise professional money, the choices are pretty clear: sell the company, stop operations or find a way to bootstrap.

Steve will be moderating a March 9th panel on bootstrapping at the Silicon Valley Center for Entrepreneurship. More details on the program when they are available.

Tuesday, January 13, 2009

Tech startups are always an experiment

Last fall, I taught entrepreneurship for only the second time since I got to SJSU. (I’d previously taught it as an adjunct at UCI, building more on my experience as an entrepreneur than any formal preparation).

About 2/3 of the way through the semester, as part of making a point about the lack of sufifcient information in any startup situation, I wrote on the board
Business is an experiment
which will become the mantra for all my future entrepreneurship courses.

To explain my thinking further:
  • if you’re doing something new whether new to the firm or new to the world — the answer doesn’t exist;
  • in a startup, for many questions you won’t have the time (or money) to get a definitive answer; so
  • you need to make and implement a decision with the recognition that the experiment may fail — and thus both look for signs of failure and find an expedient way to mitigate against (rather than prevent) such failure.
That leads me to an an interesting quote from Carol Bartz (newly appointed Yahoo CEO). It came from her 2001 talk at Stanford about encouraging entrepreneurship in established companies: at that time she was CEO of Autodesk, the CAD software company.

As an aside, I’d disagree with her use of the term “entrepreneurship”: if you use the term to refer to any form of innovation or business initiative, then the term doesn’t have any real meaning. While “corporate entrepreneurship” is a bit of an oxymoron, at least it demarks a form of initiative distinct from starting a new company.

However, I couldn’t agree more with her on the philosophy she brought to Autodesk to deal with the turbulent dot-com era, a philosophy she called “Fast Fail Forward.” As transcribed by Scott Fulton of Beta News:
I had to do this during the dot-com time, where everybody panicked and decided that you guys [Stanford students] were going to rule the world. … [P]eople got even more cemented in and scared to take risks, because what did it mean in an established company?

So we started this thing called 'fail-fast-forward,' and the whole idea is, listen, failure is very acceptable. When it happens, make sure you identify it quickly, and hopefully it's in a forward motion. And then start going again.
In other words, nothing new happens without risk, and the only way to deal with risk is to accept it rather than try to completely prevent it.

Hat tip: to Scott M. Fulton, III of BetaNews.