Startup Conversations

A 4 Year Old on Marriage

My 4-year old son T has a gal pal named E.  He is all boy and she is all girl, and as such he likes to do boy-things and she likes to do girl-things.  But they like doing their own things in the presence of each other.  Its really cute.  They'll have play-dates where they each do their own thing and don't interact all that much, but they both always want to have more play-dates together.

At their school each day a student gets to design their own "play", with a plot, story-line and characters.  Other students sign up to be actors.  Yesterday's play was Three Princesses, and the story was that each Princess had a boy who was their One True Love.  And in the story they got married.

E was a Princess and T was her One True Love.  We asked T what they did when they got married.  He said "Nothing, we just stand next to each other." But he really liked it and we talked to E's mom and she said the same thing.

Hmmm....maybe these two 4 year olds are on to something.  Wasn't it Woody Allen that said "85% of life is just showing up".  Maybe just being happy standing next to each other is 85% of marriage!

NDA Voodoo Curse

Kudos to Rikki Tahta for putting NDA's in their proper place, and more importantly reminding us to stop acting so damn self-important.

I saw this on Valleywag, and am reprinting here for those who won't follow the link.  Paul Boutin is with Valleywag and Rikki Tahta is a serial entrepreneur and VC in London.  Coincidentally, Rikki is a friend-of-a-friend and he and I spent a day together in Chicago a few years ago when I introduced him to various financial markets investors for his financial markets startup that he eventually sold to Merrill Lynch.  We hadn't particularly kept in touch, but for no reason other than we didn't have anything particularly pressing to keep in touch about.  But when I saw this, it reminded me how Rikki has a great way of cutting through the crap and getting to the heart of the matter, and doing it in an entertaining way as evidenced below:

From: Rikki Tahta
To: Paul Boutin
Date: January 26, 2007 2:16:42 AM PST

hi paul :

i explain to people the imprtance of confidentiality to us as we're still in
stealth mode, and how our NDA is powered by Voodoo not any legal
jurisdiction - and that if they reveal our plans to anyone their face will
be covered in boils plain for anyone to see that they are not trustworthy.
I ask them to think hard before accepting it and not to enter into it
lightly. Once they accept, I say: 'ok for the voodoo to work i need you
take the secret oath, put one hand on your head and rub your stomach saying
to me "i swear the secret oath" '

Frankly NDAs are not really enforceable legally, their primary value is as a
reminder - a sort of statement of seriousness - you hope people, by the act
of signing a meaningless bit of paper, will take the duty of confidentiality
more seriously. But they sign them all day long and are either trustworthy
people anyway who, when they said they will keep something confidential,
they do - or they forget or ignore it as it has no teeth. But no one
forgets the secret oath. I have had people email me saying "i think you
should meet X and i want to tell him what you're working on - but that damn
curse is hanging over me - can i get an exemption?"

There is another value (paricularly important with the VC and funding
community) - it acts as a pomposity detector - if someone isn't prepared to
see the fun of taking the voodoo oath instead of a NDA - then they are
probably too self-important and won't be fun to work with. This is
particularly useful in London where success tends to breed pomposity. I
have had a board room full of bankers cheerfully take the voodoo oath prior
to a bus dev meeting and have had potential individual investors refuse to
take it in the privacy of a private meeting room.

hope it helps

feel free to use my name

Rikki Tahta
and the project is covestor.com

cheers Rikki

Well said, Rikki!

Follow Up To Venture Business Dogma Post

As a follow up to my post on what is the most important element when evaluating high growth startups, a study performed by Steve Kaplan, Berk Sensoy and Per Stromberg, researchers at University of Chicago is very apropos.  Steve is also the Academic Dean of the Kauffman Fellows Program and is at the tippy top of the pyramid of academic researchers focused on private equity markets (and is a great guy and a friend).  Kaplan et. al. performed academic research on whether its best for VCs to bet on the Horse (product / market axis in my post) or on the Jockey (the management team).  It was a pretty rigorous piece of academic research and they had access to 50 business plans of companies that went public after having received venture backing.  To mitigate sample selection issues they also then analyzed the evolution of every company that performed an IPO in 2004.  The findings strongly indicated that the Horse is more important than the Jockey.

To organize the data, they took company information at three measurement points:

• BP, or Business Plan, which is the point in time where they received venture financing

• IPO, where they took information out of the IPO prospectus

• AR, or the third Annual Report after the IPO, which would occur between 2 and 3 years after IPO (e.g. for an IPO in July 1999, the AR point was the 2001 annual report)

A few money shots came out of this research, organized into 4 different areas

• Core Business

• Of the 50 venture backed IPOs, only 1 changed its core business.  Or to put it another way only one management team successfully re-tooled the business and still made it to IPO.
• Of the 106 relevant IPOs in 2004 (relevance is defined in the paper, but in general  they eliminated REITs, holding companies, spin-offs, JVs and the like), not one of them changed their core business in the 5 years prior to IPO, and only 8 changed their core business at any point in their corporate life.
• Conclusion: Backing an "A" team with a "B" plan does not lead to IPO exits. You have to start with "A" plan.
  

• Differentiation from competitors (determined by self-reported questionnaires completed by management)
  • Unique product or technology (which would be the Horse)
    • At BP, 100% of companies ranked this as a key differentiator
    • At IPO, it was 98%
    • At AR, it was till 92%
  • Management expertise (which would be the Jockey)
    • At BP, only 45% of companies ranked this as a key differentiator
    • At IPO, it had plummeted to 14%.
    • At AR, it was at 13%
  • Conclusion: At all points in the company lifecycle, the Jockey's themselves believe that the Horse is significantly more important than the Jockey

• Management Stability
  • Starting at BP and running through AR, only 50% of the CEO’s remained the same and only 25% of the top 5 executives remained the same.
  • Conclusion: For companies that make it to IPO and beyond, the team will change, but the business plan will not.  So if you have an "A" plan, you could start with a "B" team because the team will get rebuilt over time anyway.
    

• Ownership
  • In a sample limited only to the VC-backed companies in the study, average CEO ownership immediately prior to the IPO was 10%.  There had been a similar CEO-ownership study conducted on VC-backed companies going public between 1978 and 1987, or roughly 20 years earlier, and the average CEO ownership immediately prior to IPO in that study was found to be 19%.
  • Conclusion: The relative contribution by the Jockey, as reflected in the amount of economic value the Jockey owns, has been nearly cut in half over the last twenty years. I would postulate this phenomenon as being driven by supply and demand; the scarce resource is no longer the Jockeys so Jockeys command less economic value.  That’s not to say that Jockeys per se have decreased in importance, its just that they have increased in supply relative to the supply of Horses so the relative price of Jockeys to Horses goes down. Referencing my previous post, some of the factors driving this are the Flat World phenomenon and the incredible influx of capital into the venture asset class.

Having ruminated on this for a while I have to clarify that I believe this data would only be relevant to companies in the classic venture capital mode, i.e. companies attempting for high organic growth.  In the Private Equity business and/or platform roll-ups the quality of the Jockey is much more important because the Horses have all been vetted over many years of operating results so there is less variance in different investors analyses about what is a good Horse and what isn’t.  So in the PE / LBO business value accrues to those investors who can analyze Jockeys and/or have the best relationships with the best Jockeys.  And 20+ years ago venture capital was probably more similar to that model.  But my anecdotal experiences, and this academic research shows that venture capital no longer operates on that model.

By no means am I disregarding the value of great management teams...especially because I'm now back on the operating side of the business myself! But as an operating executive I'm really trying to objectively analyze what is most important and prioritize allocation of resources most appropriately.

This is a fascinating piece of research for anyone with a stake in high-organic growth companies.  I've made lots of generalizations here in the interest of brevity and clarity of point.  For those interested in learning more, I encourage you to download the research paper and powerpoint presentation that summarizes the paper and read it yourselves and blog it at your sites or come back to comment here if the spirit moves you.

Your Chance to Change the World

I recently had lunch with a friend of mine, Kevin Malover, who just took the job as CTO for Barack Obama's election team.  Kevin was the founding CIO or Orbitz so he has great experience building a world-class IT operation in super-fast startup mode.  HQ for Obama's election team is in Chicago.

Kevin needs to build a world-class IT team in very short order and he has a lot of open spots.  He doesn't have all of his open job specs ready yet, but he needs people in all areas of IT, including desktop and network support,  database admin, application development, social media tools, desktop and Internet application support and network and site security.  The HQ staff is in Chicago but he will have remote offices around the country that all need IT support.  There are paid and volunteer slots available.

It is one of those few jobs where you can say, "actually, I AM busy changing the world!"  Kevin is taking resumes at busychangingtheworld-at-gmail-dot-com.

Venture Business Dogma

Venture Business Dogma: People, People, People...er, maybe not.

I know this may be heretical and maybe blackball me in the venture industry…but I gotta be me. And I use the word “heretical” by design because this topic can devolve into a religious argument. Many investors swear by the venture capital maxim that the three most important things in making an investment decision are people, people and people. I’m not sure that’s the case anymore.

My primary thesis is that the scarce resource in the current generation of the company startup ecosystem is finding a product or service that satisfies a significant and growing economic demand materially better than the alternatives (both direct and indirect alternatives), and creates incumbent competitive advantages, i.e. the nature of the product or service is that the strong get stronger, intrinsically.  When that scarce resource is found, all the other resources, including the right people to build the business will flow to it. In other words, optimize the equation around the product-market axis and then solve for the other variables around it over time.

A related maxim that maybe explains it more plainly is that these investors would rather back an “A” management team with a “B” business plan, rather than “B” team with an “A” plan. I think that’s outdated. There are too many entrepreneurs and too many investors around the world all introducing innovations to satisfy various demand pools all the time. Twenty years ago (or maybe even 10 years ago) the “A” team had time to retool their product or service and find the unmet demand and satisfy it. But now everything happens so fast, in part due to the Flat World, in part due to incredible influx of capital into the venture asset class, that the “A” team doesn’t have time to retool, or the more likely outcome is that if they do re-tool then the capital that backed them on their earlier iteration of the product/market plan is rendered worthless in a "re-cap" financing (I'll leave it to Brad Feld at Ask The VC to explain a "re-cap").

I don’t know if this is an apocryphal statement or not, but Don Valentine, legendary VC at legendary firm Sequoia, supposedly once famously said: “I want to invest in companies addressing markets that are so big that even the management team can’t get in its way.” I am an apostle of that church. I describe it as I look for opportunities where there is potential for the demand to just SUCK up the product or service like a wet-vac, mess and all.  When you find that situation, all the other issues become second-order; still important, but second-order.

As an investor, the biggest hit I ever had was one of these. I pursued an investment in a company that was out of favor among the “smart VC set”.  They had met with virtually everyone in the industry and no brand name firm was stepping up to lead it, and the partners at my firm initially were down on it. We killed it once, because of a combination of management team, nascent market, regulatory, deal structure, geography and syndicate issues. I brought it back up a few months later and everyone eventually got comfortable enough with it and supported me to do the investment. It turns out everyone was right. There were a lot of very messy issues, including having 4 different CEO’s in the first 5 years after we invested. But the demand for what they were delivering proved out to be HUGE, and they had the technology and infrastructure to deliver it better than anyone else. It was those two things that I focused on in my due diligence and compelled me to stick with it even though many other elements of the opportunity were sub-par.

When we invested that company had done about $1 million in revenue in the trailing twelve months. Five and half years later it did $200 million in revenue in the trailing twelve months and $70 million in EBIT and had a market cap of $2 billion.

That company was kind of like a sausage factory: it wasn’t pretty to see it being made but what came out the other end was damn good. To me that was a great experience of optimize your equation around the product / market axis and then solve for everything else over time.  It certainly doesn't always work, and I absolutely don't want to minimize the importance of great management teams (especially since I'm currently on the operating side of the business), but that's the way I'm seeing the startup world right now.  It definitely influenced me in my choice to pursue the operating company opportunity I'm doing now -- I think we have one of those opportunities where the demand is ready to suck up our offering like a wet-vac.  I'll be blogging more about that in the near future.

Medical Marvel

In my day-job I spend time keeping up on the latest health care news.  This article was just too bizarre to not post it.  A man in India had been living with his stillborn twin brother in his belly for 36 years.  In his mother's womb, his body had subsumed his twin's body, and he had been born and lived a mostly normal life (except for looking pregnant) for 36 years.  The medical term is "fetus in fetu" and there has only been about 90 recorded cases of its existence.  There is a video clip in the article.

What was the movie with Arnold Schwartznegger where he was on a Mars colony and the leader of the "resistance" movement was a guy who lived inside of another guy?  Life imitates art!

p.s. I tried inserting the video clip directly into this blog post but was unsuccessful.  Any HTML jock out there care to show me how to do that? I was able to get the URL of the clip and followed the Typepad instructions but I still couldn't get it to work properly.