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

Can a “good-hearted” entrepreneur succeed in business?

People argue over whether an entrepreneur with a sense of fairness, a desire for collegiality, a want to share the profits can succeed in the long run within a business world full of lions and tigers that eat timid entrepreneurs for lunch.

Does a “good heart” diminish the chances of success?

First, let’s separate the “good heart” from the issue of whether an entrepreneur is driven to succeed.  A sense of values that allows for sharing and fairness is not at odds with a ‘type A’ entrepreneur driven for success.

What is important is that stakeholders (people working for and with the entrepreneur) accept the entrepreneur for his or her good intentions, sense of fairness and willingness to listen.

Stories of the selfish entrepreneur

I have had numerous experiences during my business career where business people I dealt with took advantage of the moment selfishly because they could, not because they should.  I recall an executive who kept a large deposit but canceled a contract, refusing to negotiate, because the next payment due was a few days late.  Or another who sued over a gray area issue, refusing to listen or negotiate.  (He lost the suit and paid both sides’ fees.)

My unscientific conclusion

And I have come to conclude that “good guys” (men and women) do finish first.  There is no scientific proof, no metric to measure the full meaning of “good.” and no special acknowledgement from any “good-watching” organization.  Even without these, I am sure of this.

[Email readers, continue here…]  Surely the ruthless more often win in the short run.  But early successes, built upon the broken backs of adversaries, are rarely followed by long- term wins for the tyrant or for the tyrant’s company.

Be of good heart.  You will enjoy your entrepreneurial or managerial ride much more, and your stakeholders will follow you through the flames as well as cheer your successes.

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Posted in Ignition! Starting up, Surrounding yourself with talent | 6 Comments

Are you wasting money filing patents?

I’ve been working with early stage companies and their intellectual property protection plans for years. But only recently did I read a clear document on the risks and rewards of patent strategy.  Thanks to Russ Krajec, a patent attorney, for the quick improvement in my education, here are some important points to consider when thinking of your patent strategy.

What is the true cost of patenting an idea?

First, know that the $16,000 average cost of research and filing a patent is only the start, even if your patent application is not opposed or even if the examiner is reasonably receptive to your brilliant idea.  The true average cost of a single patent over the twenty years of its legal life is $56,000, when you consider all costs beyond the initial application process.  That’s a lot of money for a startup, and it multiplies quickly when your patent is published for comment or opposition or the examiner continues to deny claims.

Do you let the world know your innermost secrets?

And what do you get for this?  You reveal to the world the essence of your brilliant idea for all to find work-around methods of accomplishing the same ends.  Sometime, simply keeping the trade secret through non-disclosure and confidentiality agreements would be a better service to your idea than a patent. And that’s just about free. And private.  So, a patent could be damaging to the startup, not a barrier to entry.

We investors often ask: “What’s the patent protection?” as if that would be a guarantee of value, especially for companies in the technology field.  Well, there is more to it than that.  Shame on us investors for not knowing all the pitfalls involved.

The two requirements of a patent

[Email readers, continue here…]  It is important to note that patents are useful only if they satisfy two requirements:  that they protect the brilliant invention you create, and that they are commercially viable in the marketplace.  A great idea often never succeeds in the marketplace.  Yet, we investors often ask about patent protection before the product or idea is even tested in the market.

How soon must we file a patent to be protected?

The United States Patent Office allows a full year after first introduction into the market for the patent to be filed.  Most of us believed that the patent filing is required before introducing the idea to the marketplace.  That is still true in Europe, but not here.  Surprise.

How about provisional patents?

And then, many of us investors suggest provisional patent filings as the answer. After all, they give you an additional year of protection at a minimal cost.  But did you know that no-one reads the provisional patent at the Patent Office?  With the grace year, it would be better to spend the money and time filing the real thing after initial reactions from the marketplace, no matter how limited.

The core of any patent?

Then there are the claims that are the core of any patent.  Most inventors want to explain the patent fully in its description, paying less attention to the claims.  Here’s another blockbusting piece of news. The description is not a legal part of the protection and could even be used to glean more information from you by a competitor than you ever intended.  It is the individual claims that form the entire legal basis for protection.  And claims must be written with precision, backed by significant research as to other patents which may come close but do not infringe upon each claim.  As I have learned form one of my companies and its decade-long fight to enforce a single patent, one word can make the difference between ultimate acceptance by the examiner and then winning a patent infringement suit when that time comes.  Whew.

But there is a good part of the story

Patents have made people and companies rich. They have protected their right to their inventions.  Patents have allowed companies to spend up to five percent of their gross revenue on research and development.  Patents have provided a long, rich royalty stream for inventors.  Patents protect inventions in many countries.  Without patent protection spending on research would be lower, the possibility of theft of ideas even greater, and many would be poorer than without the patent system.  Properly used, patents are an excellent defense for inventors.

More to learn (of course)

There is so much more to learn about patents than this.  For us investors and for all entrepreneurs with novel and non-obvious ideas to protect, this is one valuable place to spend a little time becoming educated.  After all, early stage companies have limited resources, and often the most valuable resource is the core idea that forms the company itself.  Protecting that core is an important, but not necessarily an expensive task.  So, it is fair to ask, “Are you wasting money filing patents?”

 

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Posted in Growth!, Ignition! Starting up, Protecting the business | 6 Comments

Do you want to control your business destiny?

There is nothing quite as thrilling in business as igniting a startup and watching it blossom.  Especially when starting a company with personal savings or money from relatives and friends, early signs of success are intoxicating.  Each new customer, each mention in the press or online adds to the feeling of early accomplishment. And it is more satisfying because it is yours, from idea to execution.

The intoxication of a new beginning

But the excitement begins much earlier.  With newfound freedom to make independent decisions about finding a company name, where to locate the company, whether to lease an office or start from home, how to engage talent, even whether to provide free coffee to employees,  the newly minted entrepreneur can only think of positive thoughts and great outcomes.

Do you ignore the warnings of experts?

This moment is not to be spoiled by such mundane warnings from advisors or consultants to plan carefully, research the market and competition, and execute the plan with tenacity and enthusiasm.  This moment is to be enjoyed for what it is: the ignition point in which the dream becomes a reality and anything is possible.

[Email readers, continue here…]  This moment is to celebrate every action, including shopping for supplies, furniture and technology to support the newly minted enterprise.  There is never again going to be such a pristine, simple, problem-free time in the life of this business.  Relish the experience of creation.  Celebrate each important “first,” including the first customer order, the first day in a new office, the first new employee hired, the first earned dollar actually deposited into the bank account.

Write your own Hollywood script

Because it is yours to write alone, there is no Hollywood script more thrilling than the one you create during those first days when everything is so very new.

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Posted in Finding your ideal niche, Ignition! Starting up | Leave a comment

The most satisfying life journey is never about the money.

Allow me to reminisce. This is the final post of this cycle.  Next week we return to the start of the journey, focusing upon the “what and how” to ignite a successful enterprise from start-up to exit. But, for this short moment…

Looking back over an entrepreneur’s journey

As I look back over more than fifty years as an entrepreneur, I can think of the financial focus of my three entrepreneurial businesses as a prime driver in my life during the early stage of each.  And yet, as I recall the greatest thrills, the memorable events, the best of memories, almost none are about the money.

The stories of people rising to the occasion, victories in the form of great sale successes, great continuing relationships, occasional awards from valued industry or academic institutions, being able to give back to those who appreciate the gift of time or money – all seem to rise well above the feeling recalled about the check or wire transfer that represented a completed sale of a company.

The rewards of angel investing

[Email readers, continue here…]  I found one of my joys in angel investing, putting money to work by investing time and money into promising young entrepreneurs much like I once was, coaching them, putting them together with others who have needed skills, helping to build someone else’s dream.  If you are in such a good place in your life, find a local angel investing group by navigating to www.angelcapitalassociation.org and clicking on “Find Angels.”  You will find such a group near enough to drive to their periodic meetings.  You’ll quickly be drawn into the governance of the organization and introduced into the process of discovery, coaching, leading deals, herding investors, serving on boards and helping entrepreneurs toward liquidity events.

Non-profit boards and volunteering

I found another joy in community organizations, joining a total of four non-profit boards, learning at first much more than I could teach, but rising over the years to leadership positions with large psychic rewards along each step of the way.

Enough family times?

And then there is family.  Be honest with yourself. Have you ever spent enough time with your family?  Can you ever spend enough?  Isn’t it time to try?

It may take you some time to come to this conclusion. But your most satisfying life journey will never be about the money.

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Posted in The liquidity event and beyond | 1 Comment

Money is not the only measure of success.

I am sure you heard of Maslow’s Hierarchy of Needs that motivate our behavior, in which Abraham Maslow laid out a human’s needs – from the physiological, to safety, then love and belonging, on to esteem and finally self-actualization.  A little too esoteric for you? Let’s make it more personal.

So, where are you in that hierarchy? Let’s assume for a minute that you have just sold your business, or come into money beyond your current needs…

If you have now passed through the mind-numbing process of a successful sale of your company and the money is in the bank, enough to satisfy your needs, if not much more, then you have arrived at the point where you can think about love, belonging, esteem and self-actualization.

But wait, there’s more.  More to look forward to.  And that is the subject of this short insight.

The cycle of life in business

During our business formation years, we pay much more attention to our growing enterprise than we know we should, surely at the expense of family and community. There are few exceptions – few among us who have built businesses and kept that work-life balance in check in the process.

[Email readers, continue here…] So, if that day does come when you have sold the business or come into a financial windfall, I propose that there are few times in life when the opportunity opens to look outward, to participate in charity events, extended family vacations, community boards, and even coaching other entrepreneurs.

Work-life balance: a new perspective

If you ever have that opportunity to experience the simple power of having few personal worries, you will have known the freedom of choice that allows you to reinvent yourself, dividing your attention between people and organizations outside of your previous circles.

How empowering.  And how many organizations need management skills and relationships such as those you could bring, along perhaps with a new focus upon philanthropy.

Back to Maslow, stretching his concept to include financial comfort…  Beyond some point, whatever that is for you, money is not the only measure of success.

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Posted in The liquidity event and beyond | 1 Comment