Once again: Is it the jockey or the horse?

Early stage investors have been arguing over this for years.  Do they bet on the entrepreneur (jockey) or the business idea and plan (the horse)?   This is serious stuff.  If you are looking for money, this question will certainly come up in one form or another when you approach professional or organized angel or VC investors.

A more complex answer

My answer always varies as I examine each deal, sometimes deferring and passing on an investment because of an uneasy feeling about the entrepreneur, even if the business plan seems able to capture the market.  Speaking for others, I see VC investors jumping into deals knowing that soon they will push to replace the entrepreneur with a professional, experienced manager that the VC has vetted and trusts.

Sometimes there’s a real surprise after the fact

I have bet on the entrepreneurial jockey numerous times and been blind-sided by after-investment behavior that completely reversed my opinion about an entrepreneur’s ability to manage growth to breakeven.  Other times, the entrepreneur went on to assemble a great team and execute the plan as it inevitably changed again and again.

[Email readers, continue here…]  Although this debate will continue for ages, I tend to fall on the side of betting on the jockey, simply because it has been a rare business plan that did not change again and again seeking a successful model in the marketplace.  And great management can morph a company to adopt without destroying the culture of the company in the process.

What if you see a great idea but no team to execute?

What if you were the investor and someone walked into your office handing you a business plan executive summary that floored you with its brilliance?  And what if that person admitted immediately that he or she had no team and was not the person to take this plan to market?  Would you, as an investor, plow money into the plan and help to incubate the idea into a real enterprise?  I would not, nor would most all of those I co-invest with.  There are millions of great plans that failed over the years for want of a great management team.  And I am sure there are many, many average plans that developed into great companies with the help of a great team.

Concentrate on a world class team

So, if you are one of the entrepreneurs without experience or ability to take your great plan to market, admit this early and form a team that investors can trust to do this, personally stepping into a position that fits your core skills, be it marketing, sales, development, or other areas required by a young company.

It would be refreshing as an investor to meet an entrepreneur with a great plan and a pre-formed management team fronted by the strongest possible leader, even if the entrepreneur offers to take a back seat in order to make the vision a grand reality.

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Posted in Depending upon others, Ignition! Starting up, Surrounding yourself with talent | Leave a comment

Can you become a master negotiator?

Think you don’t use negotiation most every day of your life?

From the time we learn to manipulate our parents from the crib to today, we learn to negotiate to obtain our wants and needs.  As we grow, we negotiate constantly with our parents, then with our peers.  As we enter the business world, we negotiate with our bosses and our subordinates.  We negotiate with our suppliers, customers, investors, and even our auditors. At home, we certainly negotiate with our spouses or significant others.

Learning and practicing the art of negotiation

If we are constantly negotiating to obtain an advantage or just a win-win attempt at parity, we should try to learn and then practice the art of negotiation (although I prefer to think of it as a science then delivered in its final form as art.)

It could be as simple as reading the right book

Because I believe that negotiation is so important to our success in the business and in the social world, I re-read my favorite book on the subject again every couple of years, just to keep myself aware and sharp using the tools and techniques so important to a successful negotiation.  The book, You Can Negotiate Anything, by Herb Cohn was first published in 1980 and is available today as the best and easiest to read of all the books on the subject.  I implore you to read this book and internalize the three crucial variables, the many styles of negotiation, and the fourteen powers you can call upon or recognize when used by others in a negotiation.

Removing the emotion from a negotiation

[Email readers, continue here…] Over the years, I have been delegated by more than several entrepreneurs and boards to negotiate critical agreements, sometimes to sell the company or merge it with another.  I was selected because I did not have an emotional stake in the outcome as did the entrepreneur, or the continuing relationship with a buyer as would others in management who might remain after the sale.  With that freedom, I was able to use the tools of negotiation to achieve a result better than if I worried each moment about disrupting the deal when making each move and countermove.  There is a lesson there, one the same Herb Cohn quoted in a later book, in which he entreated his readers to negotiate with care, but “not that much care” as to lose perspective.

A story of a big win-win

I recall one such instance, when delegated to be the lead in negotiating a sale of a company on whose board I sat, I asked the entrepreneur to name his expected price in an ideal sale, which he did immediately as if he’d been thinking of this for some time.  Surprising him and the rest of the board, I asked him to go home and not to attend the negotiation session set for that evening at a local hotel, promising to call him immediately with the outcome.  I am sure he worried over losing control of his most important business negotiation ever, but he did cede the task to me (and another board member).

Doing your homework before the event

Doing my homework ahead of time, using one of Herb Cohn’s principles (please read the book), at the start of the negotiation I placed a paper in front of the negotiator representing the intended buyer, showing how our company would be accretive to their public company valuation, properly valuing our purchase at three times the ideal amount as stated by our entrepreneur-CEO.  The buyer looked over the numbers for a few minutes, recognizing the accuracy of my statement from his due diligence and knowledge of his own financials.  In a sincere response so transparent as to be an obvious truth, he stated, “Oh, but I only have authority from the Board to offer two-thirds of that” which of course was twice our entrepreneur’s the asking price.

And a successful outcome

After forty-five minutes of further negotiation, we walked from the room with an agreement to sell the company for cash at twice the asking price.  And as the entrepreneur still tells the story, we two board members walk on water for having delivered such great results.  In fact, we had done our homework, presented a logical case, and created a win-win by leaving enough value for the buyer to add to its market capitalization as well as doubling our sales price.

Since we negotiate daily for things large and small, wouldn’t it be high on your list to learn to use the tools and be aware of the elements of a great negotiation?

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Posted in Growth!, Positioning | 7 Comments

Non-competes, gray areas, and salvaging a failed purchase

Last week we introduced the subject of non-compete agreements.  Let’s dive a little deeper and present some “gray area” scenarios to consider.  Then we’ll address the success or failure of the buyer with your product…

First the obvious case in point

What if you are the seller of a previous business or shares amounting to more than an insignificant percentage of a previous business?  Certainly, the buyer’s asset purchase documents included a non-compete clause, usually valid for two years from the date of the closing.  And because there was consideration paid to you in the sale, that clause is binding upon you and is effective almost everywhere.

Now we add complexity to the issue: bankruptcy of the buyer

Well, what if the buyer is now bankrupt?  That does nothing to regain your right to its purchased information.  The estate of the bankrupt company retains and can resell those rights into the infinite future.  (Patents expire after 14 or 20 years – depending upon type – and publicly disclosed patent information is no longer subject to your original agreements after that expiration, as long as you use only the publicly disclosed information as filed within the patents themselves.)

Abandonment of your product line or your later new inventions

What if the buyer abandons your previous product?  That does not change their purchased rights to it.  What if you invent a substantial enhancement or change to the product?  As long as you did not use patented processes or trade secret material from your previous company, you should be protected, but you might be prepared for a fight.

After the non-compete expires

[Email readers, continue here…]  How about after the two-year limitation in your non-compete agreement?  Just separate confidentiality from non-compete, and obey the confidentiality clauses, which do not expire.  The non-compete agreement does expire when stated.

But watch it. Some clever buyers try to slip in an unlimited non-compete, and some courts have upheld this.  And there are gray areas for former key employees who signed a non-compete with a limited life as part of the sale but remained on with the buyer for some time thereafter. Does the non-compete start anew upon the departure of each continuing employee?  Courts tend to apply only the reasonableness standard to these gray area cases, looking to see how much the person now competing gained from the original sale.

The safest advice is to avoid using any materials from the previous company, and compete only after the expiration of any written agreements or clauses signed with the buyer.

About starting over or repurchasing your business

Many entrepreneurs have new and better ideas for a similar product and wait out the non-compete by watching the clock.  Others find opportunity in repurchasing rights to your product from the buyer who has been disillusioned by low sales from your product, or distracted by taking an alternate strategic path during those years.

If you are one of those watching the buyer’s success or failure with your baby over those first years, you will need to decide if you could revitalize the wayward business, or start over with a new, better product with non-obvious advances and without using any of the technology from your previous product.  Many have done one or the other with great success, but only after analyzing the lessons from failures by the buyer.

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Posted in Depending upon others, Protecting the business, The liquidity event and beyond | Leave a comment

What about your previous company non-compete?

Entrepreneurs tend to remain in the business niche they know best.  Usually that means one they once or recently spent time in as an employee or manager within a company where they had little or no ownership.

Are you one of those?

Some of these entrepreneurs starting a new company are alumni from companies that would be a competitor to the enterprise being created or joined.  And some are former selling shareholders of just those businesses.

Rules about non-compete agreements 

So, what are the rules about those pesky non-compete agreements signed upon your discharge, or upon the sale of your previous company?

The good news is that if you were not a significant (usually 5% or more) selling shareholder of a previous company, most states specifically exempt non-compete agreements signed between companies and their employees or minority shareholders.  In that case, you must worry only about information and trade secrets taken from the previous company which are both certainly subject to protection by almost all laws and courts.

The obvious admonition

 [Email readers, continue here…]  So, to you and to everyone: do not take customer lists, design documents or any document considered a trade secret from any previous employer or previous consulting customer.  Digital or analog!

Yes, some companies were sloppy and did not have you sign a confidentiality agreement, but that procedural slip-up does not protect you from their legal wrath.  Further, there is no expiration date on these poisoned documents. You cannot complain that the document or information in question is more than five years or two employers old.

It makes good sense not to be in a position to be accused, let alone guilty of taking gray or bright red “borrowed” digital files or documents from a previous employer.  We all have enough worries in our business lives not to be threatened by an emotional, upset previous employer.

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Posted in Protecting the business | 1 Comment

What would you do if told to “fail fast?”

Here’s a question that should strike close to home. Professional investors like to quote this mantra to anyone who will listen.  “Fail fast,” they say. But what if you believe so strongly in your budding enterprise that this seems to be the most ill-advised directive you’ve ever heard?

So here are some rules that might make it clearer for you and for those who so easily quote the mantra.

Rules to consider as tests of early success.

With the first round of funding, there should be agreed-upon milestones to be achieved.  If they are not achieved within the expected time, the reasons must be analyzed by you and by your board and acted upon to avoid loss of capital beyond plan or expectation.

If you discover and become convinced that your vision is flawed, or the product impossible to create within cost and time expectations, or the demand impossible to quantify, or revenues never close to plan, then it would certainly be time to rethink the plan and product.

Could you pivot to save the company?

Could you and your team pivot if given the time and runway to do that?  Would that restart the clock, putting even more pressure upon you to perform?  Your investors know that an excellent management team is perhaps the greatest asset for any company – because it is just this team that has historically been able to make a drastic alteration of the plan, ultimately making a failing vision into a wildly successful one.

[Email readers, continue here…]  But if neither great management nor your vision for the product shows real signs of success in the market, then it may surely be time to listen to the investors and perhaps the board. Fail fast! Reduce further expenditures of remaining capital and protect the assets purchased with the original investment.

A personal story of failing fast

My favorite story of a fast failure was of a technology incubator started in the year 2000 with optimistic money from several angel investors, including me.  Within a month after the tech crash, the founder of the incubator decided that it made no sense to incubate companies that were not likely to receive new investments soon following incubation in the winter-of-cash that followed the tech crash.  He volunteered to close the incubator and he returned 96% of our investments to all of us angel investors.  (That return proved to be the best investment return any of us saw in the several years that followed.)

Is it the end of your entrepreneurial world to fail quickly?

Half of all professionally managed venture capital or angel investments fail.  There should be no shame to the entrepreneur in admitting such a failure.  Some angel and VC investors will give special credit to those entrepreneurs who have experienced failures when investing in their next effort.  The lessons learned are difficult to teach and are great assets in the next effort.

There is little shame and quite a reputation boost in acknowledging a failing plan and “failing fast.”

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Posted in Finding your ideal niche, Ignition! Starting up, Protecting the business | 4 Comments

Investors, your board, and you: Who controls strategy?

You’re building a company from your vision and a passion, and lots of people are going to tell you that you have this or that wrong, and that it just won’t work.

Business plans rarely survive market contact

The truth is that very, very few early business plans survive in a form completely recognizable when looking back a few years.  But even with massive changes, the vision and passion usually don’t diminish in the process of morphing a business plan into a profitable business.

Are investors smarter than you?

Investors will invariably try to tell you that they know much more about the “how to” than you do, and that you should listen to them.  And because you need their money, the temptation is to listen a bit too well, and take all of the advice thrown at you during your presentations and during due diligence and finally from the vantage point of a board seat.  A good entrepreneur-turned-CEO listens, takes it all in, responds with reason, and stands up for what s/he believes for the parts that matter most.  It is good to listen.  And it is better to assimilate the best suggestions into your cake as you bake it.

How to respond to “change the course” suggestions

[Email readers, continue here…]  But there is a limit, a point where your gut is more important than your ear.  If you reach that point with suggestions from these people trying to help, think carefully about how to respond, whether with facts, instinct or support from others.  Make your case for staying the course.  Remember the same passion you demonstrated when you first attracted these well-meaning helpers.  And push back.  Some investors may drop out if you are in the pre-funding stage. But they are not the ones whose support you would later want.  Some board members may show dismay.  But most often, a good case made with passion wins the day and unites the group to move forward.

A personal story to illustrate the point

I was chairman of an excellent company where I had led the deal, attracting angel investors through several rounds as the company grew to a breakeven with over four million dollars of gross revenues.  We then sought and received a venture investment from a top tier Silicon Valley VC firm, whose partner came onto the board.  After several months on the board, he spoke up. “I don’t like the niche we’re in. It will never grow enough to make this a valuable company. Forget this niche and turn the battleship. Let’s go after the Fortune 50.”  “But that’s walking away from an industry where we are #2, growing nicely and already becoming profitable,” the CEO responded.

“Don’t worry. We’ll be there in six months when you run out of money with your new R&D focus”, the VC board member replied.  The rest of the board, including myself, went along with this because, as I’ve stated often, “The last money in has the first say.”

The shocking end to the story

Can you guess the end to the story?  Six months later, the company ran out of cash, as planned, when ceasing to focus on the original niche. And the VC firm’s partners voted not to fund the restarted venture.  A good company, in a fine industry, ended up being dismantled just to repay the bank loan. No investors received anything. And the rest of us just shook our collective heads.  No one stood up to the VC board member, even though all of us heard but ignored our respective gut responses pushing back, as we remained silent.

And the lessons learned too late by the board and founder

It is years later, and the memory of that failure to push back remains fresh for me and surely for the rest of the former board members.  As chairman, I should have pushed back.  Certainly the CEO-founder had a duty to push back.  Another VC from a smaller company should have pushed back.  In retrospect, we were intimidated by the first tier VC, and half wanted to believe that he knew something we did not.

He did not.  Now, with that lesson firmly behind, I often remind members of a board when in a situation where someone on the board pushes to change the plan that the vision of the founder ignited us to bring us together.  If we believe we have a better idea, we should convince the founder and the rest of the board that we have strong beliefs that dispute the current plan.  But we should not be so loud as to drown out those other voices – you know – the ones from the gut and that of the founder’s dream.

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Posted in Depending upon others, Finding your ideal niche, Positioning | 2 Comments

Missed Expectations and The Eighty Percent Acquisition Rule

Eighty percent of all businesses purchased by another company or by a new investor-operator fail to meet the stated expectations of the buyer after one year.

As with the fifty percent rule discussed last week (fifty percent of startups fail within two years), this rule is hard to find an author willing to be quoted as the source.  But it is within the range of experience by many of us professional investors, and with those who have acted as brokers, serial purchasers or consultants for acquisitions.

Why would anyone acquire a company?

With this rate of disappointment, why would anyone or any company purchase another?  The answer is that the most sophisticated buyers have experience in integrating an acquisition successfully into an enterprise and those successes are the most visible models for others to follow.  I worked with one two years ago that was exemplary in its ability to understand and integrate our selling business into its significant number of subsidiaries, and quickly create uniform dashboards and supply integration talent.

How about those less-experienced buyers?

[Email readers, continue here…]  As we move down the chain of experienced buyers, the problems of underestimation of capital, customers who drifted away from the acquired company, key employees who found the new enterprise a culture too different to endure and left, and other difficult-to-plan-for events overwhelm the majority of acquired companies, resulting in less revenue, less profit, and far less growth than forecast during the buyer’s due diligence.

Lessons to learn from the best

There are great lessons to learn from Cisco and other companies that have grown wonderfully by acquisition, understanding the need to maintain elements of the acquired company’s culture, while offering the employees retained new and attractive reasons to stay and build the combined enterprise.

And the lesson?

So, this insight is simple.  Study the literature about companies that have succeeded in their acquisitions, finding how and why such successes rose to the top twenty percent of all acquisitions when measured by the acquiring company CEO satisfaction ratings after a year. Emulate those actions that are appropriate.  Plan for surprises by keeping enough capital available to restart or re- align the acquired company after an initial problem period.

Over all, know the eighty percent rule and act carefully to protect both the acquirer and the entity acquired against failed expectations.

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Posted in Protecting the business, The liquidity event and beyond | 5 Comments

Risk, insanity, and the 50% startup rule

Fifty percent of all businesses formed fail within the first two years. 

There are many variations of this number since there are a number of ways to measure failure.  But the number is a startling reminder that creating a business is not easy, nor is it any assurance of success.

How to define “success” for a startup?

After speaking with many entrepreneurs over the years, each defines success in his or her

unique way.  To some, it is independence from the dictates of a boss who doesn’t appreciate that person’s talent, foresight, or abilities.  To some it is financial security, building a base of wealth created from the increased value of the enterprise at the end point of sale or at an IPO.  To others, it is simply a way to express a talent for art, cooking, consulting, management, development or more.

Vision, risk and capital, oh my!

Everyone has a vision when starting a business.  And few think of the risks that increase over time as initial capital is expended.  We all see the examples of well-known successful entrepreneurs, many in our chosen field, who achieve success by anyone’s measure, and we optimistically expect to emulate these role models with at least some level of success.

Can you take the risk?

[Email readers, continue here…]   The best advice to anyone considering this course of action is to measure one’s ability to take the risk.  That ability varies with economic status, age, responsibility to family, and more.  If there is enough freedom to make that leap, then the journey can more safely begin.  If not, there are alternatives, such as raising initial capital from friends and family, before leaving the life boat of a present job.

Some say that taking the leap, burning the bridges, the life boats – or whatever security is left behind – forces the entrepreneur to focus like never before and succeed because there is no alternative.  Although investors may respect that bold a move, it is so dangerously risky as to be a bit insane.  Then again, with the fifty percent rule, aren’t all entrepreneurs a bit insane to start?

Next week: The eighty percent acquisition rule…

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Posted in Ignition! Starting up | 2 Comments

Should I license my IP, sell a royalty stream, or just produce products?

This week we contacted royalty licensing expert, the well-respected Arthur Lipper, asking the magic question.  Why are you so strongly sold on royalty licensing as the most effective way to finance a tech-based early stage company?

I asked him five important questions, which he answered, and I’ve summarized below.  Since I am a proponent of using equity as a tool and he is so much opposed, this week it is his turn to make the case. I have the weeks to follow to make mine.  So here goes:

How would I find companies willing to license my intellectual property or to invest in a royalty stream from licenses?  Would I hire a broker? Investment banker? Lawyer? Do it myself?

Arthur’s response:   Identify the specific beneficiaries of your invention – and the companies already serving those beneficiaries. These are your candidates, because they are companies already absorbing much or all the marketing expense necessary to make sales of your invention.  They will be more willing to pay a royalty fee if your product gets them to market earlier or is protected by patent to create a barrier to their competition.

How do I appraise my intellectual property to estimate royalty rates?

[Email readers, continue here…]  Arthur:  This is a matter between the owner of your IP (you) and the would-be user of your IP. The license to use your IP can be in the form of a one-time payment or structured as a continuing fee. If a continuing fee, the license could be based upon units of the product incorporating your IP. If so, be aware of the issue of how you can and do verify the licensee’s report of usage.

Does the average agreement call for advance payment of royalties? Do I understand the royalty replaces the need for equity investors?

Arthur:  The usual royalty revenue sharing funding agreement is for an agreed period – and commences on the generation of revenues by the royalty issuer (company licensing the IP.)  The royalty investor providing capital is a third party who makes a financial transaction with you, investing in you to receive a portion of the royalties from your IP.  That party is only concerned with its royalty revenues and growth – and not profit from or valuation of its business. He’s bought the royalty, an intangible,  entitling him to a percentage of your revenues. If you and your shareholders (the royalty issuer) really believe in the business and its intellectual property, then you should welcome financing arrangements such as shared royalties, which are non-equity dilutive and avoid reducing their percentage of ownership in your business. No owner of a business which became successful ever said: “I sure wish I had sold more of the company before it became successful.”

What are the advantages of using royalties instead of raising investor funds, other than no dilution of equity?

 Arthur:  The royalty investor is not concerned with your executive compensation or the quality of cars you may have leased for your executives to use. The licensee is not concerned with your awarding of options to buy stock on advantageous terms. On the opposite side, the investor in your royalty stream (call him the “owner of royalties”) is not concerned with the amount of money spent by the licensee company on staff education, the level of sales commissions paid, and the licensee company’s entertainment policies. Your royalty investor is only concerned with the licensing company’s  revenue growth.

In you experience, what are the pitfalls of using royalties instead of equity financing and selling product?

Arthur:  Only companies having healthy profit margins and the ability to maintain them should consider selling royalties. On the other hand, low profit margin businesses must sell equity and even borrow money where and when able. Companies with both growth potential and good margins should want to retain as much ownership as possible – and be willing to suffer a reduction in profits until the funds received from the sale of a royalty are used to increase revenues and profits.

So, there you have it.  The argument for royalties from an expert and advocate.  Starting next week, we’ll examine the process and advantages of raising money using various financial tools from notes to preferred stock to other more esoteric tools.

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Posted in Raising money | 7 Comments

Can a revolutionary concept be too late to market?

Too many startup businesses, especially in the technology world, are built upon brand new concepts that have not yet been proven in the field against products from other companies that already have revenues flowing.

As a rule, creating a product that does not fit into an existing space, cannot be defined against one or more competitors, or which needs a long description to understand, will require considerably more market research,  more marketing capital, and entail much more risk than one that follows an existing trend, even if an emerging one.

Flying against the prevailing winds

I’ve often used the analogy of “flying against the prevailing winds” to prove this point.  A pilot flying with the wind behind is helped by the speed of the wind and uses less fuel and less time to make it to the destination.  One flying into the wind uses double the difference in both fuel (money) and time.

For example, a 100-knot plane flying into a 50-knot headwind and using 8 gallons of fuel per hour uses double the fuel, (16 gallons) and takes twice as long to the destination as with no wind.  If flying with the winds behind, the flight takes 66% of the fuel and gets to the destination is two thirds of the time as if with no winds.

A valuable lesson from aviation for entrepreneurs

That’s a valuable lesson.  If others have created awareness of the market, you need only compare yourself favorably to those companies.  If the market is moving quickly toward your class of product or service, you may be able to gain a piece just by being there at the right time with the right product or service.

[Email readers, continue here…]  Either way, very few startups can afford to forge new markets or create a product that does not fit into an existing class of increasing demand.

A story of a company that couldn’t see far enough ahead

I have often told the story of a company I financed and helped to found, back in the days of analog cell phones.  People could not easily or cheaply carry their analog cell phones from city to city, often having no service or having to pay a dollar a minute for roaming service.  Our company developed a unique product for hotels that allowed a guest to use a local cell phone provided by the hotel and make calls as if in the room even while traveling through the city, and to remotely receive calls made to the room phone in the hotel.

Obsolete before becoming profitable?

The problem was that our company did not see far enough ahead to know that digital cell phones and roaming plans were right around the corner.  When they arrived, our expensive phone switches and analog phones were almost immediately obsoleted, as travelers quickly bought digital cell phones with roaming plans.  The company had to take back all of its equipment at the end of each hotel’s lease and went out of business as a result.

The critical question no-one asked

The question to ask: Didn’t anyone know or have a friend who knew of the development and subsequent release of digital cell phones in the two years before they became a reality?  Certainly there were resources available to point the company toward the information.  The market was moving in the opposite direction from the company, and the company paid the ultimate price.

Fly with, not against the prevailing winds of change.  A revolutionary concept may be set to change an industry that is already primed to jump a generation, leaving your creation isolated between the past and future.  Market research is critical, even with revolutionary products or concepts.

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Posted in Finding your ideal niche, Ignition! Starting up, Positioning | 2 Comments