The National Venture Capital Association has just released their latest member survey. Expectations for 2010 are as follows:
The number of venture capital firms will decrease as poorly performing firms will be unable to raise new money
Lower risk later stage investments will attract a greater percentage of available capital, as VCs look for lower risk investments
Existing portfolio companies will receive a greater percentage of capital
Early stage companies will be more difficult to fund through venture capital
In summary, the investors in venture capital funds are being more selective in these challenging economic times, which forces the VCs to lower their risk profile to attract new capital. Plan accordingly.
@philmur posted a good question in response to yesterday's post on VC mentoring. He asked:
"How specifically would you recommend entrepreneurs better experience the mentoring potential of their VC's?"
Most entrepreneurs are usually good at some of the following:
product development/tech
selling
story telling
Most entrepreneurs have little experience in:
starting a new business
business strategy
managing an organization
raising capital
cash flow management
Most VCs are good at:
evaluating business strategies
forecasting operating performance
forecasting cash flow requirements
raising follow on capital
managing an exit
The key to develop the maximum benefit from VC mentoring is to recognize where the VCs have vastly superior knowledge and show respect for that expertise. The ill will that undermines the mentoring relationship usually develops in either the area of business strategy or capital raising. If the VC disagrees with the proposed strategy, they rarely will tell you that you are wrong. However to barge ahead with your plan and not take the time to reach an agreement with the VC is almost always a mistake and can lead eventually to management changes. The same is true with capital raising. If you and the VC disagree it means that you have not convinced the VC and you need to continue the dialog. If after 2-3 board meetings you have not convinced the VC, you are probably wrong!
Like with good marriages, keep talking until you reach an agreement.
This week I heard Greg Baty from Florida Growth Fund speak. I have covered the new Florida Growth Fund several times here, including this interview with Greg. The good news is that Greg's talk was very similar to what he told me back in August.
The bad news was a shocking statistic that Greg quoted. He said that the venture capital investment in California for any 17 day period equals the venture capital invested in Florida for an entire year. Understand, I am not criticizing Greg. I am sure he got the numbers right.
As is the case with most states in the U.S. and many, many countries, in Florida we have no world class universities. California's venture community in many ways revolves around Stanford and Cal Tech. Here's my idea to partially solve the problem. Much as many U.S. universities have foreign campuses, perhaps we should invite a great university in the sciences such as Oxford, Cambridge or Singapore University to open a campus in Florida for Florida residents. The state government could donate some land, offer some construction loans and provide grant money for research in the sciences. Voila! World class university in Florida. With a little arm twisting we could open enrollment to our neighbors in the Caribbean and LATAM (who would hopefully stay in Florida after university).
Again, I have offered an idea that will get no political traction in Tallahassee, but I will keep offering my ideas. Someday we need to find the next step after the Florida Growth Fund to improve the venture capital environment in Florida.
Note: While there may not be any world class universities in Florida, we do have some world class schools within universities, such as the School of Hospitality at FIU (where I teach) to name just one.
It is well recognized by both academics and practitioners that there are three keys to early stage company success:
Pick the right market opportunity
Mentoring
Access to capital
Through a tweet today from @vcwatch I found a very interesting survey by Dow Jones Venture Source---A Study of Venture-backed Company Boards. The slides are here. The most interesting slides are 22-29, but if you are not familiar with venture capital read all the slides.
Based on the survey, venture capitalists see their value to their early stage companies (ranked by the percentage of respondents) as follows:
Network of contacts
Mentoring
Follow on financing
Exit strategy
Remember the VCs already confirmed the market opportunity (in their mind) when they made the initial investment.
Early stage entrepreneurs backed by VCs see the value of the VCs as follows:
Network of contacts
Follow on financing (tied with 1.)
Exit strategy
Mentoring
Maybe if the entrepreneurs saw more value in mentoring 7 out of 10 VC investments would not be a total write off. One could always argue if the VCs were better mentors, they would have fewer write offs. I am inclined to think that the entrepreneurs are typically at fault in the mentoring relationship given my 30+ years of dealing with entrepreneurs, my thousands of hours spent with entrepreneurship students and my clients over the last five years, but I could be wrong ;)
Chip Hazard, a partner at Flybridge Capital in Boston (VC firm), has a new blog which focuses on IT. His first post is about opportunities in cloud computing, a topic which I have discussed as recently as yesterday (and here and here.) Hazard identifies four major types of new business opportunities from cloud computing:
Enable enterprise data centers to be more cloud like (enterprise IT will operate using a cloud computing model)
Bridge the cloud
and enterprise boundary (enterprise computing will use cloud computing to handle peak loads)
Provide tools
to better manage cloud environments (self-explanatory)
Develop SaaS
applications for vertical markets (Hazard believes that horizontal SAAS (CRM, ERP, etc.) is closed but industry specific applications are wide open
Hazard's last point is perhaps the most important for entrepreneurs--create companies enabled by the cloud.
"One of the aspects of cloud computing
that excites us the most is that it is a huge enabler of innovation.
Cloud computing makes it so easy to develop and deploy applications that
it levels the playing field for start-ups versus large, well capitalized,
competitors. As an entrepreneur, I can now buy access to world-class data
center infrastructure for dollars an hour that would have previously cost me
millions to purchase and deploy. As a result, savvy start-up executives
can look to create companies that would have previously been too capital
intensive to contemplate."
Think about the perfect business model from a financial/economic perspective. It would have three characteristics:
Low initial capital requirement
Low fixed costs
Marginal cost to scale the business
Cloud computing allows the entrepreneur to meet all three requirements. As additional technology is added to cloud computing (e.g. Oracle, Calais, etc.) it will only get easier and more attractive to start new businesses.
I found Chip Hazard's blog through a tweet by @bussgang, his partner at Flybridge who writes a terrific blog.
The Pino Entrepreneurship Center at FIU has a full series of entrepreneurship workshops planned for this fall (see below). A new workshop on the Venture Capital Process by Nick Robbins should be particularly interesting. For additional information click here. All proceeds go to Pino.
I recently interviewed Greg Baty, the senior man on the ground in Florida for Hamilton Lane, the Manager of the $250 million Florida Growth Fund. Greg's background is quite diverse and includes a five year stint playing for the Miami Dolphins, where he developed his love of Florida. He has also spent time as a start up entrepreneur, advisor to early stage companies and as a venture capitalist with Guy Kawasaki's Garage Technology Ventures in San Francisco. He is a graduate of Stanford Business School where he was a Sloan Fellow. Key points from the interview follow:
Hamilton Lane's strategic direction is to expand their discretionary fund management business, which includes programs similar to Florida with the states of California (CALPERS) and New York. Consequently, Greg and his team have complete access to the full resources and support of Hamilton Lane and their relationships with over 600 funds worldwide.
The Fund will initiate its own deals but must have a co-investor fund that sets deal terms, valuation, board seats etc. This is where Hamilton Lane's vast relationships with other funds can be used to develop the lead investor.
The Fund will focus on technology growth companies in Florida but may also invest in other sectors with significant growth and return potential.
The Fund will invest approximately $125 million of its $250 million capital in direct investment in companies at all stages of development--from seed to pre-IPO.
The Fund will not focus on any particular industry or investment themes
The Fund's priority is investor return and is not specifically targeting job creation or economic stimulus
The Fund has well thought out objectives and is already seeing a "tremendous amount of deal flow". My one recommendation to Greg was to consider a Spanish speaking associate on the team in order to fully develop relationships in south Florida.
Back in June I posted on the launch of the Florida Growth Fund. The Fund launched with $250 million in capital
earmarked for venture capital investments in Florida. Funding was
provided by the State of Florida Retirement Pension Fund under special
legislation. The Fund is managed by Hamilton Lane, who manages over $100 billion in capital for private equity investments through third party funds and direct investments. Hamilton Lane's expertise includes all forms of equity investment including seed stage venture capital. Recent email correspondence with Hamilton Lane has provided the following additional information:
The Florida Growth Fund will be opening offices in Ft. Lauderdale and Orlando
The mandate of the fund is to invest in Florida-based equity funds and to co-invest in Flordia-based growth/technology companies
I am particularly pleased to see that the Fund will be co-investing in growth companies. Most out of state venture capital firms will not invest in start ups here in Florida without a local venture capital firm to co-invest and closely monitor the company. Florida Growth Fund will be able to play this local role through its two offices. This will increase the available capital in Florida not just from their fund but also the out of state venture capital firms.
I will be speaking with a representative of the Fund later this week and will hopefully have more to report on this positive development for early stage companies in Florida.
According to Silicon Alley Insider, the Florida Growth Fund has launched with $250 million in capital earmarked for venture capital investments in Florida. Funding was provided by the State of Florida Retirement Pension Fund under special legislation. This is a good decision by the State of Florida given the scarcity of venture money in Florida and something I have been advocating for the last ten years. In my plan I always thought the fund should be managed by a first class VC who would set up operations in Florida. Think Kleiner Perkins, Sequoia, etc.
The State of Florida appointed Hamilton Lane (who ?), an institutional money manager based in Pennsylvania, to run the fund. Hamilton Lane is an institutional money manager that specializes in the private equity asset class and offers discretionary and non-discretionary services. In other words, they pick private equity firms to put client money with or make the decision to co-invest client monies in PE firm deals. The good news is the State of Florida did not pick a three man firm in Boca Raton to manage the firm.
A few concerns:
How much Florida deal flow will a firm near Philadelphia have? Hope they are not relying on Florida politicians to send them deals.
If Hamilton Lane specializes in private equity then they are likely to fund late stage, near IPO venture deals; Florida does not lack for late stage funding and Hamilton Lane will just be another source of capital in a market that is already robust.
Hamilton Lane does not appear to have significant experience in seed and early stage investing, which is where Florida badly needs capital.
Let me not be too negative. I applaud the state government for organizing the fund. Let's follow developments and see what kind of deals this new fund will do. Wonder if they would be interested in a medical device company I am representing?
Note: The Florida Growth Fund website is currently just a placeholder.
Tech Vibes has a good post today on startups entitled "5 Things I learnt from Year One in My Startup". Three of the points are themes which I have discussed here at Sophisticated Finance.
The other two points made in the post I would have stated differently.
Hire those with the best attitude and a willingness to learn over those with experience.
I would have said "hire those with experience and the ability to learn". Typically in a startup learning comes from mistakes and mistakes use up capital--the scarce resource. Experience may reduce the number of mistakes. Hire experienced people who have been in successful previous startups. The startup environment is a learning environment and a person willing to return to a startup situation has both experience and usually a willingness to learn. Another indicator of a willingness to learn is someone who has worked on a lot of successful projects. Also, remember that it is the CEO's responsibility to lead the team. If your experienced team members are reluctant to follow in a new direction, it could be a reflection on your maturity as a CEO.
A "Strategy Guy" should not be hired in a Startup
I agree that a strategy guy should not be in a startup. First, that should be a role played by the CEO. Second, a strategy guy is too expensive and too low value-added for a startup budget. Just like a marketing guy. However, I find that most startups can not articulate the basic parts of a strategy, which is why they have trouble raising capital. The CEO has to have the ability to articulate a strategy and take the responsibility to communicate, implement and update it.
Read the post for a good re-statement of the three points I agree with completely.
I am a strong advocate of focusing on sales (and not m__k__g) in my workshops, entrepreneurship classes and with clients. I constantly harp on customer acquisition cost and how are you going to get the customer, close them and collect the cash as part of fully developing a business model.
Every once in awhile I see a post that I should have written. Steve Barsh, an Adjunct Professor at Wharton, has a great post entitled Chasing the Money: Stop Trying to Raise-Start Trying to Sell. A must read for any aspiring startup execs.
Wilson Sonsini, the premier venture capital law firm in Silicon Valley (and probably the world) has a free application to generate a term sheet for a venture round of capital. Fill in the blanks and it produces a term sheet that you can compare to the one the VC sent you.
Further proof that my idea of an application to prepare SEC filings may not be far off.
Venture capitalist confidence in the economy may be improving for the first time since 1st quarter 2007. As reported by Mark Cannice at the University of San Francisco:
"The quarterly Silicon Valley Venture Capitalist Confidence Index™ (Bloomberg ticker symbol: USFSVVCI) is based on an on-going survey of San Francisco Bay Area/Silicon Valley venture capitalists. The Index measures and reports the opinions of professional venture capitalists in their estimation of the high-growth venture entrepreneurial environment in the San Francisco Bay Area over the next 6 - 18 months.The Silicon Valley Venture Capitalist Confidence Index for the first quarter of 2009, based on a March 2009 survey of 30 San Francisco Bay Area venture capitalists, registered 3.03 on a 5 point scale (with 5 indicating high confidence and 1 indicating low confidence). This quarter’s reading rose from the previous quarter’s reading of 2.77 (a 5 year low).."
The historic chart is below.
Perhaps another small piece of evidence to suggest an upturn in the economy.
Note:I found this information through a tweet by @briannorgard.
In June of 2008 LinkedIn raised $53 million in venture funding from a blue chip group of VCs that included Bain, Sequoia, Greylock and Bessemer. This round brought the total venture investment to $80 million. At the time LinkedIn had 23 million users and a reported valuation of $1 billion.
Today the New York Times reported that the CEO who raised the money has been replaced, roughly six months after the deal closed. Users are reported to be 32 million.
While I have no inside information, here is what I think happened:
The $53 million round was the pre-IPO round and there is no IPO market in the near future. Now the VCs have no quick flip on their investment and have to live with the company for several years (grumpy VCs)
Remember those pitch books and promises you make to the VCs--they remember. Mr Nye, the now former CEO of LinkedIn, probably did not fulfill his plan
LinkedIn has a large, fast growing membership, but the members do not use the site very often (I have not been there in six months for any amount of time)
By the nature of its membership model and "closed community", LinkedIn missed the trend toward sharing information
Most of its new features on LinkedIn are me-too copies of things that have been on Facebook for a long time
With several failed initiatives, LinkedIn has no real, believeable go forward strategy. The recent hire of a senior Google executive to take charge of product development at LinkedIn supports this conclusion
Lessons to be learned:
It is not the number of users, subscribers or members but the number that are active and the amount of time they spend on the site
First mover advantages can be fleeting as LinkedIn failed to innovate and update their site to meet user needs
When the VCs get grumpy (no IPO) beware--your job as CEO may be in danger
Given the quality of the VCs involved, they all probably knew at the time of the funding that the CEO was going to be replaced in the near term. He gave them a reason for sure.
Mr. Nye, who I do not know, is a graduate of my alma mater Hamilton College. I commend him for his work at LinkedIn. Building a company with a valuation of $1 billion is an incredible accomplishment.
Note: I found the NYT story on Twitter posted by skap5.
HBS Working Knowledge has a very interesting post today--Performance Persistence in Entrepreneurship. Don't let the "heavy" title mislead you. The paper is well worth reading and was funded by both the Harvard Business School and the National Science Foundation. The data for the paper came from the Venture Source database for the period 1975-2003. Venture Source contains detailed company information and the various rounds of financing for every company that has publicly acknowledged venture capital funding. The paper defines a "successful" venture-backed company as achieving an IPO.
Findings from the paper include:
A venture capital-backed entrepreneur who succeeds with his first company has a 30 percent chance to succeed with his next venture; entrepreneurs who failed with their last company have a 20 percent chance of success in their second venture-backed company and first time entrepreneurs have an 18 percent chance of success.
A venture capital-backed entrepreneur who succeeds with his first company demonstrates markedly better skills at picking their market opportunity and their market entry timing for their next venture.
A venture capital-backed entrepreneur who succeeds with his first company may find it easier to achieve credibility for the next start up with suppliers and customers.
Track record is a better predictor of success than the successful entrepreneur's wealth or luck.
Serial entrepreneurs backed by a VC receive funding earlier in the company's development than other entrepreneurs seeking funding.
Unfortunately, the paper does not discuss whether successful serial entrepreneurs stay within an industry, but the point on supplier/customer relationships would suggest they do.
This paper confirms several points of "conventional wisdom" about VCs:
VCs prefer serial entrepreneurs, especially successful ones
The VC focus on the market opportunity and market entry timing are probably the two most important factors in selecting potential investments
VCs fund previously successful serial entrepreneurs earlier than first timers
I suspect that all of the findings in the paper would hold true if "success" had been defined as a 10X return for the VCs instead of an IPO.
A previous post on an academic paper that investigated venture capital decision making is here.
The complete paper is available through the following link Download 09-028
. The authors of the paper are Paul A. Gompers, Anna Kovner, Josh Lerner and David S. Scharfstein.
I recently saw an explanation of calculus which stated that it is just differentiation, integrals and 1400 pages of applications. I think that new business development is equally misunderstood, with an unwarranted complexity. The new business development process is really just four parts (as shown in the graphic below):
the customer (customer need, value proposition and target customer)
the business model (as explained in a previous post)
the financial model (cash flow)
If you think of business as the conflict between growth and survival, then the first three factors above explain how you are going to allocate resources to increase revenue and profit (growth) and the financial model focuses on cash flow (survival).
Now that we have simplified business to four ideas-customer, industry, business model and cash flow-maybe I'll move on to solving world hunger :) Seriously, the older I get, the simpler my ideas on business and management become. Much of management education and practice over complicates developing a business and misdirects the energy and resources of managers and entrepreneurs. KISS
The Angel Blog has a good post about the "gap in understanding" between investors (angels and VCs) and entrepreneurs.Setting aside the difference in background between entrepreneurs and investors, the post states that typically a conflict arises when entrepreneurs want to make a decision that they do not realize will put the company's existence at risk.The logical question to ask is: "why are the entrepreneurs not able to see the risk in their proposed plan".
The simple answer(s) may be:
the entrepreneurs are bull headed
the entrepreneurs lack experience
the entrepreneurs take every criticism of their plan personally
My experience suggests that all of these answers are correct, but there is a more fundamental point. Entrepreneurs forget that they are stewards for the investor's money. As a steward they are responsible to generate an appropriate return for the equity investors. While early stage investing takes a portfolio approach whereby some of the investments will fail, the entrepreneur is supposed to do everything not to fail and lose the invested capital. Nobody invests expecting the next Google but entrepreneurs repeatedly try to hit home runs with every decision when a single or double will suffice. This is not their charm but rather their stupidity lack of experience.
The next time an investor takes issue with a proposed decision, remember that 1-3 above undoubtedly apply to you, that you are not building the next Google (despite what you may think) and you would be well advised to reconsider whether the decision will put the company's existence at risk.
After my recent diversion to foreign affairs and politics, I am back to talking about startups, VCs and tech. I subscribe to about 200 blogs and read a minimum of 50 each day. I pick the blogs by subject--venture capital, web technology and entrepreneurship--with a few extra blogs on presentation, analysis techniques and scholarly business articles. I chose them based on the quality of the opinions, which basically means they have discussed something in detail and I agree with the analysis. I rarely read self-serving or promotional blogs.
One other characteristic of my blog reading is that I rarely drop a blog after reading it for more than a week. One exception to this rule is Seeing Both Sides, which I apparently lost somehow when I switched to NewsGator. Seeing Both Sides is written by Jeff Bussgang, a Partner in the former VC firm IDG now rebranded Flybridge. Jeff is one of the VC bloggers who I have actually met a few times pitching deals for clients. Jeff's blog is clear, analytical, to the point and always "spot on" in his conclusions. Jeff is the same way in person, even if he did pass on two deals (that others funded.)
In catching up on several months of posts by Jeff, after re-discovering the blog,I found a particularly relevant post related to my last series of posts on CEOs (here, here, and here). Jeff talks about entrepreneurs as CEOs being "in over their head". He counsels that you should have a feeling of control over 80 percent of the business and be in over your head about 20 percent of the time. Maintaining this balance is a key factor and the 20 percent of the time that produces the fun and excitement in being an entrepreneur needs to be managed.
In my courses and workshops I teach three keys to entrepreneurial success:
Pick the right opportunity
Mentoring
Access to capital
Jeff believes that mentoring is one of the best ways to maintain the proper 80-20 ratio. Jeff's specific recommendations to properly manage the 80-20 rule are quoted below:
1) Be self-aware. It's ok to feel as if you are in over
your head as an entrepreneur. In fact, it's natural. Don't be afraid to
recognize it, admit it, and talk openly about it with your board and management
team. Figure out which side of the 80/20 rule you find yourself.
2) Learn your way out...with help. Seek the advice of the
wise men and women around you to learn how to step up and grow into the
situation you find yourself in. Don't close yourself off to outside advice for
fear of appearing weak. Instead, embrace smart, diverse opinions to help shape
your own.
3) Accept life preservers. Many entrepreneurs are terrible
at accepting help. After all, the reason they're entrepreneurs is that they
enjoy being their own boss and are passionate and often stubborn about following
their vision. It's hard for them to admit they need help and, sometimes, need a
life preserver to pull them out of the situation. It may mean hiring a COO,
hiring a CEO and moving into a chairman role, or other big moves that risk
giving up control.
I see many entrepreneurs who incorrectly "thrive" in the environment of
being over their head and never realize that they have broken Jeff's
80-20 rule. They are addicted to the thrill at the expense of their companies. 80-20.
I recently posted on passion, a key ingredient for entrepreneurial success. While much is made of the importance of passion, I tried to provide a better understanding of what passion is really about. Today I would like to discuss delegation, another key ingredient for entrepreneurial success.
My experience shows that an average entrepreneur can operate with one man management until a business reaches $ 10 million in annual sales (assuming a moderate growth scenario). An exceptional entrepreneur working 100 hours a week can manage a business until revenue reaches $35 million. Given that most of us are not exceptional and like to take a day off once in awhile, we should be thinking about delegation probably when sales reach $3-5 million and earlier if we have the next billion dollar idea.
So now let's explore what delegation is all about.Delegation can be explained simply using math:
1+1=2; or
1+1=3; or
1+1=1.75
Most of us think of delegation as scenario 1. We hope and deceive ourselves into thinking we have scenario 2. The most common form of delegation is probably scenario 3. In this case two people work together and the output increases, but not to the full potential of the two people. Yes--we have achieved the benefits of delegation by increasing the work output but we have not realized the full potential of delegation.
Why do we end up in scenario 3 and rarely achieve scenario 2? People who have controlled every decision (many entrepreneurs) have a hard time becoming effective delagators. If you tell someone how to do something in detail, you immediately reduce the other person's effectiveness and completely forego the opportunity for that person to have a break through epiphany (which is how one achieves scenario 3). Telling someone how to do something also is frequently demotivating, which reduces productivity and undermines delegation. Lastly, telling someone how to do something in detail tends to undermine their sense of ownership in the project.
To improve the productivity and effectiveness of delegation, two rules may help:
There is more than one right way to do things
If it will not put you out of business, let people do it their way, make mistakes and learn
Last rule on improving the effectiveness of delegation--be respectful of staff. Nothing undermines delegation as much as screaming and yelling, late night projects and ridiculous deadlines.
Few of the entrepreneurs I see follow many, if any, of these rules. If you want to build a great company, learn to delegate well and follow these rules.
Yesterday I was on a due diligence call with a venture capitalist, their accounting expert and management. Five minutes into the call I knew the accounting expert was an experienced professional. He began his questioning by focusing on the key process in my client. Every company has a key process that drives the business and is key to generating revenue. For example:
In a telecom company understanding the network and how a call completes is the key process
In a retail company the key process is probably understanding how they source merchandise and the time it takes from an order to merchandise delivery at the store
In a billing and collections company--at what point in the collection process is the revenue earned and accounted for
In each of these examples there is a common characteristic. In each case the key process relates to the largest asset. For telecom--network, for retail--inventory, for billing--receivables. When you are trying to understand a new business, whether for an acquisition, valuation or due diligence, begin the investigation by focusing on the business process related to the largest category of asset. Such an approach is the most efficient way to quickly understand a new business. Hint: if someone can not explain their key business process, move on.
If you find a business with two large asset classes, make sure you understand the process behind each one and start with the less liquid asset class. Generally that's where the real insights are about the business.
