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Sunday, September 6, 2015

Corporate Entrepreneurship: Oxymoron

From Dilbert, August 30, 2015:

I’ve always thought “corporate entrepreneurship” is an oxymoron, and this nicely captures some of the reasons why.

The OED defines an entrepreneur as
c. Polit. Econ. One who undertakes an enterprise; one who owns and manages a business; a person who takes the risk of profit or loss.
with entrepreneurship defined as what the entrepreneur does.

Some scholars want to define the term as only a subset of this (those that produce high-growth startups). Others want it to be a superset — anyone who innovates and creates new value — including corporate “entrepreneurs” — even though they don’t “own” or “take the risk of … loss.”

The closest that large company employees come to being entrepreneurs — with all the risks and rewards — are when they form spinoff (or spinout) companies. Some of these spinoff companies — like the Xerox spinoffs studied by Henry Chesbrough — start with technology, people, some investment but no products or customers; the founders of these companies are truly entrepreneurs, just ones with an inside track for funding. Other spinoff companies — like Agilent from HP or Avago from Agilent — began life with thousands of customers and millions (if not billions of revenues) — and are larger and more bureaucratic than many decade-old companies; it would be a travesty to call “entrepreneur” someone handed such a business portfolio.

A third example often labelled “corporate entrepreneurship” are those that explore possibilities for new business units that will remain in the company. These examples seem to be best described by the portmanteau of “intrapreneurship” — we want our employees to be entrepreneurial,  but they will remain inside the company and contribute its growth and success.

I have participated in various corporate new venture/new value/new line of business activities, both in industry and academia. I’m also head of my second startup, and I can tell you that the risk, the effort, the lack of support (including bureaucracy) and (hopefully) the potential reward make it completely different than an internal new venture.

So “entrepreneur” is not a synonym for “innovator” or “business model innovator” or the equivalent. That’s why my business card — and that of a few other faculty — says “Professor of Innovation and Entrepreneurship.”

Monday, June 15, 2015

Incubating, accelerating and funding life science startups

On Thursday I visited the SF Indie Bio Demo Day. The San Francisco life science accelerator was graduating its first class of 12 early-stage startups.

Indie Bio was launched and funded by SOSVentures, a $200m seed fund based in Cork, Ireland. Its launch was seen as a reaction to the decision of Y Combinator to take on 5 biotech firms last summer, although Indie Bio founders insisted that their plans predated Y Combinator’s interests.

Y Combinator
The Mountain View-based Y Combinator is widely considered to have invented the accelerator format — or at least to have perfected it with its 2005 launch in Silicon Valley. Its model includes:
  • Cohort admission process (two cohorts per year)
  • Incubator-style office space combined with seed-stage equity funding
  • Mentoring services to help firms refine their product and strategy
  • Mandatory on-site participation of the CEO during the intensive 3-month process
  • At the end of the incubation period, a hype-filled “Demo Day” graduation ceremony that both brands and publicizes companies being kicked out of the nest
Most of its 800+ alumni have been software or software-enabled companies that fit its original focus. Its best known graduates are online services companies such as Dropbox, Airbnb, Reddit and Weebly.

While Y Combinator has been a great success — in terms of publicity, investments and picking (and perhaps helping†) winners, there have been questions about whether the model could be used for companies with longer development cycles. There are also obvious economies of scale and scope if each cohort has overlapping technology orientations.

Y Combinator had some successes in hardware — and now a handful of recent life science graduates — but IMHO the generalizability remains an open question.

† There is a longstanding debate in higher ed whether schools such as Stanford and the Ivies mold their students into successes, or merely pick students who are bound to succeed no matter what. There are obvious parallels to angels, VCs and incubators

Indie Bio
As a former software entrepreneur who has spent the past four years teaching business at a biotech graduate school, I was eager to see how the Silicon Valley formula would be adapted for starting life science companies. On average, life science startups are different — with greater technical uncertainty, capital costs, development costs and time to market.

SF Indie Bio has adapted the accelerator format of Y Combinator: in some cases, the language and terms are almost identical. However, a crucial difference is the need for wet labs; healthcare IT companies can be incubated at a software incubator, but therapeutics, device and most diagnostic companies cannot. Designing and staffing a wet lab isn't cheap, and every life science incubator faces the challenges of which equipment is needed and how to cover it.

Another advantage for Indie Bio is an (acclaimed) life science-specific incubator team. Ryan Bethencourt and Ron Shigeta earlier started the Berkeley Biolabs, while Arvind Gupta is a venture partner with the parent venture fund. At this week’s Demo Day, there were clearly synergies between the companies in the first cohort, particularly for the tools companies that had ready-made customers while those customers saved capital as free beta sites.
Ron Shigeta, Ryan Bethencourt and Arvind Gupta at Thursday’s rollout
As with other Bay Area incubators and accelerators, the Indie Bio location means that tenant companies are close to a wide range of potential investors.

The companies in the first round received $100K of cash and in kind funding in exchange for an 8% equity stake. The next round of firms will get this, and also the option of a $150K of cash in exchange for a convertible note.

Seizing a Place in the Value Chain
After visiting Indie Bio — and talking to its founders and entrepreneurs — I got a better sense of where an accelerator would fit in the entrepreneurial value chain of a life science company. (Other life science incubator/accelerators seem to have been launched in Berlin, Houston, Israel, and Winnipeg.)

As the name suggests, an accelerator can make a big difference in accelerated a firm's growth. However, it covers only one brief phase of a longer process of development.

Indie Bio focuses on the steps of the lean startup process where entrepreneurs develop the minimum viable product and decide whether to proceed or pivot. However, before firms are ready to join an accelerate they will need to develop their science. This could be at a university, at a biohacker space (such as BioCurious), or a local life science incubator such as QB3 or J&J's JLabs — or the Berkeley BioLabs cofounded by Bethencourt and Shigeta.

At the same time, once they leave the accelerator they will need a home. If the company is small (< 5 employees), it might still fit in an incubator. If they hire multiple employees, they're too big for either an incubator or accelerator and will need an actual office. Either way — as earlier in their development cycle — they will need a shared wet lab rather than just (as with a software or healthcare IT company) access to cloud servers.

Bethencourt and Shigeta are aware of this imperative. They’re working to identify an affiliate or partner facility that the Indie Bio companies can graduate into.

Wednesday, June 3, 2015

Replaying the "Greater Fool" theory 15 years later

From the “Heard on the Street” section of this morning’s Wall Street Journal:
Testing Silicon Valley’s Greater-Fool Strategy Lofty valuations for venture-backed companies like Uber and Snapchat depend on the stock-market off-ramp staying open

There are 65 venture-capital backed companies in the U.S. valued at $1 billion or more, by The Wall Street Journal and Dow Jones VentureSource’s latest count. That is more than half again as many of these so-called unicorns as a year ago.

Even by the standards of rapidly growing companies aiming to go public, they are hardly cheap. Uber tops the list with a valuation of $41.2 billion, and that looks like it is heading higher. … In second, at $16 billion, is Snapchat, which has only recently begun generating revenue. …

Overall, private valuations are about as high now as during the dot-com bubble, according to research firm Sand Hill Econometrics. One reason valuations are so lofty: In an era when generating outsize returns has been extremely difficult, big investors who previously would have tended to take a position in a company on its IPO are instead jumping into late private-funding rounds.

[T]he list of tech companies with deep pockets and a desire for acquisitions is pretty short, and the fit needs to be right. So for most big venture-backed companies an IPO is a likelier exit. But the public market’s ability to absorb those companies may be limited.

Sand Hill estimates the total value of U.S. venture-backed companies came to about $750 billion at the end of 2014. That is equal to 2.5% of the total market capitalization of U.S. public companies, according to Federal Reserve data. The only other time venture-backed companies were valued that highly relative to the stock market was in the second quarter of 2000, when the dot-com bubble began to rapidly deflate.

Indeed, one pin in that bubble was the flow of shares of speculative companies into the market. Until late 1999, the availability of dot-com shares was limited, with many held off the market by insiders subject to lockup agreements.

From November 1999 to April 2000, though, the amount of unlocked shares rose to $270 billion from $70 billion, as economists Eli Ofek and Matthew Richardson documented [in their 2003 Journal of Finance article]. This increased the float in dot-com companies to the point there weren’t enough investors willing to pay up for them.
This is interesting on two levels. First, the Web 2.0 stock bubble is now shaping up to burst like the one 15 years later. A crash in valuations will be bad for entrepreneurs seeking funding in the next 3-5 years. As my business plan students (at both KGI and UCI) could explain, potential exit valuations influence (if not determine) the valuation for even the earliest seed stage or Series A round.

However, this time the question is whether the bubble will burst before or after the companies go public. The VCs and investment bankers — as well as the founder and employees of these overvalued companies — would clearly prefer to IPO in hopes of finding a “greater fool.” The buyers of these frothy shares would be betting that they’re not the fool, but instead they can sell to one.

The “greater fool” theory is not new. While Wikipedia (that fount of all truth and wisdom) is not much help, Investopedia helpfully provides a definition for that term:
Greater Fool Theory

A theory that states it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger or greater fool) who is willing to pay the higher price.

When acting in accordance with the greater fool theory, an investor buys questionable securities without any regard to their quality, but with the hope of quickly selling them off to another investor (the greater fool), who might also be hoping to flip them quickly. Unfortunately, speculative bubbles always burst eventually, leading to a rapid depreciation in share price due to the selloff.
As an entrepreneur, I always had trouble with this approach by other entrepreneurs — and even more so, by the financial professionals who prepare these stock offerings. I realize the stakes are high for the founders and investors holding this illiquid shares — particularly at the tail end of a surge in valuations — but doesn’t excuse succumbing to the corrupting influence of this pressure. Caveat emptor doesn’t isn’t enough to excuse offering shares with no financial basis for their valuation other than market mania.

Tuesday, February 3, 2015

The incentives for entrepreneurial risk

Cross-posted from the Bio Business blog

I have been teaching innovation management for more than 15 years at three different schools. In most cases, I kick off the course with a discussion of the incentives for innovation, a topic of particular interest to Berkeley economists such as David Teece and the late Suzanne Scotchmer.

Innovation and IncentivesThe fundamental idea is that innovation is risky in many ways: the innovator doesn't know if the technology will work (technological uncertainty), whether the market will value it (market uncertainty) or whether the innovator will be able to hold off imitators and other competitors long enough to make a profit (appropriability and ompetitive uncertainty).

As with any other gamble — whether investing early-stage companies or lottery tickets — the innovation winners have to pay above-normal returns to cover the partial or total losses from the losers. Business is an experiment, and if you don’t compensate for the risk, then entrepreneurs, managers and investors will avoid risk. (We can debate the magnitude or the approach to providing incentives — as Scotchmer and others have done—without denying the inexorable need for such incentives).

Of course, outsiders only see the winners of the lottery or the IPO jackpots. They don’t see the dry wells, the failed companies or the other investments that fail to pan out. So the big success of blockbuster drugs attracts attention (and populist attacks) from those who don’t factor in the cost of failures. In many cases, this is due to economic ignorance — innovation costs or economics more generally — and in some cases this ignorance is willful.

Forbes columnist (and former Pfizer R&D head) John LaMattina attacks such ignorance in his February 3 column “New York Times Op-Eds Misleading Regarding The Biopharmaceutical Industry.” The column is balanced and thoughtful, allowing for the basis of most of the criticisms while decrying the economic ignorance (willful or otherwise) beyond the criticism.

In the category of willful ignorance has to be that of economics Nobel Laureate Joseph Stiglitz, a “frequent” critic of the pharma industry (and, IMHO, capitalism more broadly). Let me briefly except LaMattina’s comments on the Stiglitz op-ed:
1) “In generics friendly India, for example, Gilead Sciences, which makes an effective hepatitis C drug, recently announced that it would sell the drug for a little more than 1% of the $84,000 it charges here.” – Actually, “generics friendly India” really means that India has its own rules when it comes to intellectual property (IP) and often refuses to recognize legitimate IP positions.

2) “Overly restrictive intellectual property rights actually slow new discoveries by making it more difficult for scientists to build on the research of others and by choking off the exchange of ideas that is critical to innovation.” – This is a stunning misrepresentation of the R&D process in the biopharmaceutical industry. For any investment to be made in R&D, be it the 3 person start-up company or a Big Pharma, the promise of a financial return must exist. An absolute requirement for these investments is having sufficient IP to justify that a project, if successful, will provide such a financial return.

3) “As it is, most of the important innovations come out of our universities and research centers, like the NIH, funded by governments and foundations”. – As I have said in the past, these contributions are very important in the search for new medicines. But Stiglitz, like many other critics, is either ignorant of the amount of R&D carried out by the biopharmaceutical industry or chooses to minimize that the industry’s applied research is what converts nascent ideas and discoveries to the breakthrough medicines that are continually generated by the industry.
I would be naturally sympathetic to LaMattina’s criticisms due to my free market bias, which stems both from my first experience as an entrepreneur, what I’ve learned studying technological innovation for the past 20 years, and of course what I’ve also learned teaching students how to run innovation-related businesses.

However, his three criticisms have particular salience now that I’ve co-founded a new (pharmaceutical) startup that is a spinoff of my current employer. It is (as he says) a 3-person startup, bootstrap funded for now, trying to bring a breakthrough therapy to market.

My two co-founders and I are working nights and weekends — alongside our regular jobs — to raise funds, validate the science, and try to get something approved by the FDA. We wouldn’t be working so hard (#2) unless there was some possibility of a big return at the end: hypothetically, if we’re each putting $10,000 worth of effort into it each year, then if we have a 10% chance of success then we’d each want a $100k+/p.a. return (actually more given due known entrepreneurial optimism biases).

Of course, we wouldn’t have started down this path without IP. We have to talk to the government, CROs, CMOs, potential investors, industry execs and others to make our idea feasible. We are a tiny company with no full-time employees and minuscule resources: almost anyone we talk to is better equipped to bring this to market than we do. All we have is an idea, a vision and the (patent pending) IP that we hope will allow us an exclusive to bring this to market (if we can overcome all the uncertainties).

Finally, we have thought long and hard about commercialization. Even if every NIH or other government grant goes our way, we’ll have certain regulatory, manufacturing, distribution and (yes) IP costs that won’t be covered by government grants. These costs are far beyond what we can bear personally, so unless the potential returns are attractive enough, we won’t get the equity investment necessary to bring this therapy to market.

The Stiglitz ignorance (or misrepresentation) is depressing but utterly commonplace, particularly among economic populists. But sometimes these populists can see the light.

In the 1970s, there was no more outspoken populist among national political figures than George McGovern (1922-2012), the South Dakota senator and 1972 Democratic presidential nominee. After retiring from the senate, he opened a hotel in Connecticut and found out firsthand how little politicians know about business risks.

As McGovern wrote in a June 1, 1992 Wall Street Journal op-ed (quoted in a 2011 Forbes article):
In retrospect, I wish I had known more about the hazards and difficulties of such a business, especially during a recession of the kind that hit New England just as I was acquiring the inn’s 43-year leasehold. I also wish that during the years I was in public office, I had had this firsthand experience about the difficulties business people face every day. That knowledge would have made me a better U.S. senator and a more understanding presidential contender.

We intuitively know that to create job opportunities we need entrepreneurs who will risk their capital against an expected payoff. Too often, however, public policy does not consider whether we are choking off those opportunities.
So there is hope for intelligent people who get out of the Ivory Tower (or the Beltway) to try to make a living in the real world. McGovern was a man of modest means — a modern-day Harry Truman — trying to put away money for retirement. Millionaire politicians and academics are unlikely to leave their comfort zones, but there’s still a chance for skeptics to experience this epiphany.