Sometimes the VCs are right

Regular readers of this blog know that I’m of two minds about VCs. There are some business opportunities (such as the biotech companies KGI alumni work for) that require venture investing. However, VCs often work contrary to the entrepreneurs’ interests — sometimes comically so.

At an algae (and biofuels) conference in San Diego last week, David Tze of the boutique private equity firm Oceanis talked about what he looks for in an investment. Some of it was specific to his fund’s focus (aquaculture, i.e. feeding farmed fish), but some of it was more generic.

In particular, he lifted (with full attribution) Sequoia Capital’s advice for entrepreneurs seeking funding for their business plans. The checklist for business plans matches what any entrepreneur might learn from a business plan class, but the “elements of sustainable companies” was a little more provocative:

Start-ups with these characteristics have the best chance of becoming enduring companies. We like to partner with start-ups that have:

Clarity of Purpose
Summarize the company's business on the back of a business card.

Large Markets
Address existing markets poised for rapid growth or change. A market on the path to a $1B potential allows for error and time for real margins to develop.

Rich Customers
Target customers who will move fast and pay a premium for a unique offering.

Focus
Customers will only buy a simple product with a singular value proposition.

Pain Killers
Pick the one thing that is of burning importance to the customer then delight them with a compelling solution.

Think Differently
Constantly challenge conventional wisdom. Take the contrarian route. Create novel solutions. Outwit the competition.

Team DNA
A company’s DNA is set in the first 90 days. All team members are the smartest or most clever in their domain. "A" level founders attract an "A" level team.

Agility
Stealth and speed will usually help beat-out large companies.

Frugality
Focus spending on what's critical. Spend only on the priorities and maximize profitability.

Inferno
Start with only a little money. It forces discipline and focus. A huge market with customers yearning for a product developed by great engineers requires very little firepower.

Of these, some are motherhood and apple (or Apple®) pie. The “frugality” and “inferno” seem ironic given the role of Sequoia (and other Sand Hill Road) VCs in fueling various bubbles over the years.

However, I think two points bear repeating — and I will repeat both in teaching my entrepreneurship class and advising would-be entrepreneurs. One is the “pain point” idea, now a part of the guidelines give for many opportunity pitch competitions.

Perhaps more interestingly — at least for tech entrepreneurs — is the idea of price-insensitive customers to buy the early expensive products until the firm learns how to make the products faster and cheaper. This is how computers, cellphones, Internet service got started, and my own research into telecom engineers shows the same effect. Since joining a biotech-oriented institute, I’ve also learned how life science companies have targeted expensive pain points, as when Genentech targeted the human insulin with its first product, Humulin.

So overall, I believe the experience of VCs can help nascent entrepreneurs prioritize their efforts — as long as they watch their wallet when it comes time for actual investments.

Selling out without "selling out"

In June, I heard Panos Desyllas present a conference talk (which I then blogged) on how UK biotech startups got killed after they were acquired. Today, his co-author Marcela Miozzo of Manchester Business School presented the paper here at KGI to a student audience.

To recap, the authors concluded that the acquired firm could be complementary or competing on two dimensions: technology and capabilities. If the firm is complementary on both dimensions, the odds are good it will survive; if they are competing on both dimensions, the odds are the company’s assets will be stripped and everyone “made redundant” (as they say in England).

One question I asked today was: did the entrepreneurs see this coming? Marcela made it sound like they didn’t explicitly look for this, but it sounded like they tended to be surprised.

In particular, she said the scientists were shocked or disappointed to find that their research wouldn’t be continued, and their prospective cure for a particular condition (e.g. Hepatitis) would die with the company. I think this is an area where human health research is different from other technical entrepreneurship — both the central role of scientists, but more particularly the idea of saving lives (or not, if corporate imperatives intervene).

It might be nice to say that the entrepreneurs should know better — that selling their company to certain firms would cause it to be killed — and thus when they exit, they should avoid "selling out." However, as Marcela noted, the entrepreneurs "knew that there were only 4 or 5 companies in the world that could acquire them.”

So in this constrained optimization of exit strategy — in many cases, for startup firms that have to be sold soon before they run out of money — such buy-and-kill outcome may be unavoidable. Perhaps the only bright spot is if the entrepreneurial climate is fertile enough that (in a Schumpeterian sense) the remnants of the former company can be recombined to make a new startup.

Tech startups: cross-functional people or cross-functional teams?

Today was the culmination of the business plan class (ALS 458) here at KGI, with the final presentations by 6 teams — some of whom will be going on to formal business plan competitions elsewhere. So it was the day of the year that the students, and invited guests most celebrate (and ponder) the nature of tech startups.

Our students are unusual in having both science and business training: they come with a science (or engineering) degree, they take science classes, and they take business classes. So in effect, they are cross-functional individuals, with a little bit of knowledge about a lot of things in their heads. Similarly, a company like HP used to pick their marketing staff from among engineers who later got an MBA.

This is also how schools like Stanford and Berkeley set up a mini-business school (or “engineering management” program) within their engineering school. And it’s also why MIT recently set up its Engineering Leadership Program for undergraduates.

On the other hand, a number of schools run business plan classes and programs by assuming individual specialization and deliberately mixing the various specialists. The NSF-funded Georgia Tech Tiger program is perhaps the best known such program among those of us who teach tech entrepreneurship. To some degree, this reflects the supply limitations — you can’t get enough cross-functional people so you merge silo’d programs (with silo’d students) onto a temporary cross-functional team.

Obviously any good tech idea needs to be brought to market through a combination of technology, marketing, finance and manufacturing (or other operations) skills. How do you build such a team in a real startup? And who should be in charge?

I’m an engineer who went into B2B sales and marketing, so it’s easy to guess where my sympathies lie. And at a recent MIT club event on the “Gordon-MIT Engineering Leadership Program,” I heard veteran tech CEOs talk about how it takes a technical person to lead a tech startup.

Still, there are many counter-examples. For every Larry Page, there’s at least one (maybe more) Jerry Yangs.

Steve Jobs offers another model. Sure he was a great marketer — one of the best of the 20th century — and a great CEO. However, if you look at the recent Jobs biography, it was clear that his mechanic father and his childhood electronics experiments gave him an intuition about engineering design that many practicing engineers lack. (Alas, as the original Mac 128 death march demonstrated, he also had completely unrealistic expectations about how long things should take.)

So how do you form a cross-functional team to make the next great tech startup? And how do you allocate decision rights and authority among them? How does this change over the life of the firm, the industry and the technology? And what do you do with your hybrid business-engineers (or business-scientists)? They’re not going to be CTOs or CSOs (are they?), but do you put them as VP of R&D, or division managers, or CEO?

These are all interesting questions. Perhaps someone will research these answers.

Kauffman asks: Will it be you?

The best ad of Super Bowl 2012 didn‘t run during the Super Bowl, but before it. And it wasn’t selling a product, but a vision — or rather, an economic philosophy.

I was not the only one who loved the Kauffman Foundation’s ad “Will it be you?” The vision of the ad is: America’s economic growth comes from entrepreneurs who take a good idea into a new business and new jobs.

Latest in the “Kauffman Sketchbook” series, the ad was visually catchy , professional, and used every one of its 30 seconds to make these key points.

Unfortunately, the traffic crashed their new website, Willitbeyou.com. Let’s hope the viewers followed up when the website came back up.

The other missed opportunity was doing more to get this message in front of young people. The ideal partner for this effort is Junior Achievement, which has a network of some 400,000 volunteers teaching capitalism to America’s children in schools all over the country

Kauffman has partnered with JA in the past. However, the visibility of this message today among parents — and some teens and pre-teens — should be followed up with a special push to make this message more real (and salient) for our next generation of potential entrepreneurs.

How not to start a startup

Xconomy San Diego offers a provocative post by Joe Chung about how not to start a startup. Below are his five bullet points and my interpretation of each:

1. Don’t start a company in an ebbing tide. (Find an unmet need rather than one that's being met)
2. Don’t do something you know 20 other startups are already doing. (Most of these 20 will be losers.)
3. Don’t think too small. (You’re more likely than not to fail, so if you’re taking a big risk, shoot for a big reward.)
4. Don’t think too big. (Focus on something close enough in that you can see the path from here to there.)
5. Don’t build a product without a distribution plan. (When you pick from among multiple ideas, try to target something that has a ready-made channel.)

Of course, read the original posting for the full arguments.

As Chung notes, rules are made to be broken, but these rules will keep you away from common sources of startup failure.

Entrepreneurship means not having to own everything

We had our first entrepreneur of the academic year speak today at KGI in Claremont. Eric McAfee is a chronic serial tech entrepreneur, having started two biofuels company, a solar company and a software company (among others).

I’ve met a lot of tech entrepreneurs and heard a few Silicon Valley entrepreneurs speak. Even so, I felt he made an important point about leverage and open innovation for startup companies.

For McAfee, the distinction between an entrepreneur and a manager is that an entrepreneur is someone “who allocates resources that they do not currently control,” while the manager allocates resources they control.

To me, this is the flip side of the oft-quoted Teece 1986 formulation. Teece focused on what entrepreneurs should do if they can’t control resources. McAfee’s point is that entrepreneurs often shouldn’t even try — that it’s usually better to buy or license the missing piece of the puzzle.

He explained two examples from his current biofuels company, Cupertino-based Aemetis. First, to get key bioprocessing technology he bought another company — U. Maryland spinoff Zymetis — rather than develop the technology in-house.

His reasons were completely in consonance with the open innovation paradigm. From a technology standpoint, “most companies are stuck with the not-invented syndrome,” McAfee said. “We’ve got to be the best technology company which sometimes means we have to buy other companies or license technology.”

The other approach is that they’re taking that technology and using it to improve the cost-effectiveness of existing ethanol plants — which are often stuck in a commodity business. So instead of buying and owning those plants, Aemetis partners with the existing owners and shares in the proceeds.

So if in Teece’s world of 25 years ago, the goal was to control as many resources as possible and make do when you cannot, in McAfee’s world, the goal is to control the resources that are important and partner for the rest. I think there are clearly cases when the latter approach is superior — particularly in a fast-moving industry where capital is scarce and the window of opportunity may close.

IPOs dying again

I got an email from one of my former students this week who works with startup companies trying to IPO:

It's a brutal market out there! … Many companies were looking to go public in late Q3/early Q4, however, the continued demise of the stock market has many folks running from the idea of an IPO.

Her remarks brought home a nasty side-effect of this month’s stock collapse. And sure enough, MarketWatch and USA Today later reported that at least 8 announced IPOs have been deferred due to “current market conditions.”

PWC (as reported by Business Insider) notes that 2011 was shaping up to be a much better year for IPOs than 2010. Now that trend is in doubt.

As I’ve been saying for years, I think entrepreneurs should look at it the other way: the normal exit will be by acquisition, because only during certain rare (and frothy or bubble-y) periods will an IPO be available. Perhaps the IPO window will open again, but (as has been true since the dot-com crash) the opening will only be temporary.