Where did Summer Go?

It's been a while since my last blog post...It happens every year, but the speed at which summer travels relative to the rest of the year catches me by surprise. I enjoy the 90 day respite from teaching that runs from late May through late August. It still feels early in the summer, but I realized that my first class of the semester is only a few weeks away and my department deadline for the syllabus is tomorrow. Time to get to work. Guess it's not only the students who procrastinate...

I actually enjoy the process of pulling together a selection of materials to create a complete course on Entrepreneurial Finance. Last year, I tried out a custom textbook through one of the major publishers, which seemed like a great way to go. I assembled textbook chapters, Harvard Business Review articles, cases, and notes to pull together my own textbook. It was kind of fun to add each case and see the price of the book adjust on the fly. I was able to come in around $100 and assumed with the bookstore mark-up, it would still be under $125, not outrageous for a text. However, the cost to the students ended up at over $140.

After apologizing at the first class of each semester, putting materials on reserve at the library and finding a more economical way to get just the cases, I vowed to find another solution for next time. This year, I'm giving University Readers a try. So far, the service seems great and the price is a lot better, in large part by cutting out the bookstore. This wasn't an option with the publisher I used last year (more about that later). Students order directly from University Readers and get access to the first 20% of materials online while waiting for the book to arrive at their door.

This whole process got me thinking about the textbook business model. A 2005 report by the Government Accountability Office indicates that textbook prices have outpaced inflation by more than 2-1 over the past two decades and account for 26% of tuition and fees at four-year public universities and nearly three-quarters of costs at community colleges. The producers of the content (professors) get very little of the price, new editions are constantly coming out with added bells and whistles that most faculty and students don't want. These new texts reduce the value of used books, while publishers and the bookstores reap the rewards, 64.3% and 22.4% of the sale price, respectively, according to the National Association of College Stores. Competition in the retail chain is limited as off campus bookstores have a difficult time accessing the required texts and don't typically have a complete selection for the students.

A bill pending in Congress would require publishers to sell "unbundled" versions of the books and disclose book prices to faculty in their marketing materials. Both good steps, but competition, more choices (including online, subscription, rental and other new models) will do more than regulation.

Of course, students could certainly take this in their own hands. Randy Stross, a colleague of mine at San Jose State, wrote an interesting piece on the textbook business in his Sunday New York Times column, "First it Was Song Downloads. Now It's Organic Chemistry." He describes college students as the "angriest group of captive customers to be found anywhere" and that "students who create and give away digital copies are motivated not by financial self-interest but by something more powerful: the sweet satisfaction of revenge".

One of the shrewdest groups in the music business and way ahead of their time was the Grateful Dead. Similar to the textbook business, the music business BN (before Napster) was controlled by the labels. The artists received very little of album sales, but kept concert and merchandise revenue. The Dead developed an avid fan base (aka Deadheads) who attended mutliple shows on each tour and traded bootleg tapes of their favorite shows. While the Dead did nothing to discourage the pirated music, they actively protected their trademarks to prevent unlicensed merchandise.

Let's hope that students, after graduation, saddled with debt from the high cost of tuition and textbooks aren't on the street reciting lyrics from the Dead's Touch of Grey

"I know the rent is in arrears, the dog has not been fed in years
It's even worse than it appears, but it's alright"

Is it the Horse or Jockey?

It seems appropriate to have this discussion as Kent Desormeaux grabs Big Brown's reins and goes after the Triple Crown tomorrow at Belmont...There is an age old debate in the venture business on whether it is better to bet on the horse (business/market) or the jockey (management team/founders). Hans Hvide at the University of Aberdeen Business School just published a paper, "The Horse or the Jockey? Evidence from Nascent Firms where a Founder Dies" in an attempt to quantitatively answer this question.

Hvide analyzed 6,800 companies that started between 1996 and 2003 in Norway. Out of the 12,500 founders of these firms, 181 (1.7%) die at some point between starting up the firm and the end of 2005 (Hvide 6). This leaves a relatively small sample. And there were certainly many other founders that were figuratively "shot" by their board rather than literally kicking the bucket or left on their own to pursue other opportunities.

As you might guess, the results were inconclusive. The 6-year firm survival rate was 60% for dead founders and 61% for live founders, while the average Operating Return on Assets was 6% for dead founders vs. 8% for live founders, but neither are statistically significant (Hvilde 15). Some conclusions were that the founders role is more important in the very early stage in the creation of the horse and as the visionary and as the company moves beyond this stage, becomes replaceable. This obviously depends on the "horsepower" of the founder, but speaks to the differing skill sets required in starting vs. growing the company. Of course, this would be obvious to anyone who has been in the start-up ecosystem for any length of time

This led me to think through some anecdotal examples of the companies that I have invested in or been on the management team that have had successful outcomes. In most of these cases, the founder relinquished the CEO role within the first 18 months following institutional funding, but remained in a critical technical or visionary role, often as the company's external evangelist. In the cases where the founder has remained as CEO, this has not been their first start-up.

I typically advise the founders of my companies to be open to being replaced as CEO and to remember that a company can have a number of CEO's over it's lifespan, but not founders and that is the best title to have on your business card. Of course, that doesn't mean being sent off to Siberia. Upon taking the CEO role at a venture backed start-up, one of my friends got this word of advice from the VC investor, "Your CEO now. Do whatever you want with the founders". Basically, I invested in them, but they are your problem now.

Back to the Triple Crown and wishing Big Brown and Kent Desormeaux success tomorrow. I'm not a big horse racing fan, but do remember the glory days of the 1970's when we had 3 triple crown winners in 5 years, including Secretariat who was the first horse to claim the triple crown since Citation 25 years earlier. Who would have known we would have to wait at least 30 years for another. I'm still a little sad at having to turn down an invitation to see Secretariat run at the Preakness, but it happened to fall on the same day as my brother's Bar Mitzvah.

What does it take to be an Angel Investor?

This is often a tough question to answer. To the SEC, it means that you are an accredited investor and To the man (or woman) on the street, a minimum qualification would seem to be an interest and ability to invest in early stage ventures. However, that is not always the case as there is no qualification to set out your shingle as an angel investor or form an angel group. I often wonder if saying you are an angel investor is the 21st century version of being a consultant in the early 1990's after the corporate layoffs, a euphemism for someone without a real job.

I attended the ACA Summit in San Diego earlier this month. I ran into a friend who was wearing a nametag from another angel group and I inquired as to why she had never shown an interest in joining Sand Hill Angels. Her response was that we required our members to make investments and the other group didn't....Silly us, with that kind of a requirement. I think this sentiment has given angel groups a bad name. An entrepreneur will pitch their business plan to what they think is a group of angel investors and will get a number of follow-up calls afterwards, but they are pitches for services not investment interest.

The ACA is an interesting organization and is providing support in a number of ways to its member angel groups, from public policy, networking, sydnication, and best practices. The National Venture Capital Association (NVCA) was also represented at the conference and is forging closer links with the ACA. In fact, there are some members of both groups, as a number of angel groups have raised funds (that is an entire discussion that I'll leave for a future post).

Academically challenged

My colleague, Joel West, wrote a blog post yesterday responding to an article in the Financial Times on the looming shortage of b-school faculty. In the post, he raises the age old question of whether business students are better served by traditional academics or those with current, practical business experience. Obviously, you can't just have one or the other...At many b-schools, the faculty with the highest student ratings are rarely the ones with the best record of publishing.

In the post, he mentioned that while he feels I am a lynch pin (Thanks, Joel!) of the entrepreneurship program, I depress the academically qualified ratio. Not immediately grasping the meaning, I assumed that if I'm considered academically unqualified, I must be academically challenged. This sounds like a politically correct term for "stupid". However, when I checked into it, it just means for accreditation purposes, I am "PQ" (professional qualified), not "AQ" (academically qualified).

Thinking back to my b-school experiences at Wharton and UCLA, the best profs I had were a mix of AQ and PQ. However, the academics that were in the group of the best spent a reasonable amount of time in industry and consulting. The lecturers tended to be consistently excellent in the classroom, because they were teaching because they enjoyed it rather than a requirement as tenured or tenure track faculty. The money clearly isn't the driving force!

I have been teaching on a part-time basis for over ten years and enjoy the interaction with students and faculty. However, as an adjunct, I don't have to get involved in any of the politics (and very little of the bureaucracy) of academia. This reminds of a comment from the VP Engineering at one of my start-ups, who is a Brit with a dry sense of humor - "I used to teach at university, but then I realized I didn't like the students". Luckily, that isn't the case for me....

Baby's All Grown Up

It's been a while since my last post and it appears I missed the entire month of March. Not to worry, I was busy working on closing the Series B financing for iControl Networks. We ended up raising $15.5M, led by John Doerr of Kleiner Perkins.

This got me thinking about my role in helping companies grow up. I started working with the founders of iControl at the concept stage, prior to the first $100K of angel financing. For a while, it seemed like we were constantly walking along the edge of a cliff and had several near death experiences. In fact, for a good laugh, I just went back and checked our accounting system, and at the end of one quarter in 2005, we were down to $143 cash on the balance sheet. The CEO and I ended up funding the company ourselves until we were able to scrape together a larger angel round.

Now, the company is poised to change the home security industry, one that is in dire need of change. However, my role changes and I am moving from CFO and member of the executive team to cheerleader and advisor. It is not unlike watching your children grow up. With two teenage daughters, I am becoming quite familiar with the changes as your babies become toddlers, pre-schoolers, enter kindergarten, middle and high school. My oldest won't be off to college for a few years, but will probably happen in a blink of an eye.

At times, I do miss being part of a team that takes a company from infancy all the way to IPO and beyond. I have been tempted at various times to join one of my companies as full time CFO, but have decided that is not in the best interest of either party (me or the company). As the company grows, it is more important to have a CFO that is both strategic and skilled in process, rather than a "seat of the pants" entrepreneurial CFO. I personally enjoy the earliest stages and building a portfolio of start-ups and entrepreneurial teams.

The cheerleader role isn't all bad. Anonymizer, a company where I was an early investor, advisor and board member, just got acquired by Abraxas Corporation for a very nice multiple. Rather than home security, these guys are helping with our nation's security. Anonymizer raised a small amount of equity and was able to build a business that became very profitable. It took almost a decade from the initial investment, but in the end, worked out well for all involved. Come to think of it, this will help pay for those college tuition bills that will be coming....

4 Lessons of Entrepreneurship

For golfer's, Ben Hogan's Five Lessons is a classic. While the golf courses and equipment have certainly changed over the five decades since this was published, this tutorial is still relied upon by professionals and amateurs worldwide.

As I mentioned in the previous post, Jeff Fluhr (founder of StubHub) recently stopped by my Entrepreneurial Finance class to share his 4 Lessons of Entrepreneurship with the students. I was glad to see he didn't try and upstage Mr. Hogan by adding another one.

1. Do you have the right make-up to be an entrepreneur? You need to be true to yourself and many people aren't cut out to take the personal and professional risk associated with being an entrepreneur. There are going to be a lot of tough times and perseverance is essential.
   
2. Challenge the Status Quo - StubHub entered an industry dominated by a couple of large players who had a vested interest to block the legality of their business of providing a marketplace for the sale of tickets in the secondary market. In the early days, Jeff spent a lot of time with state legislators to get beyond the stigma of "ticket scalping" and change regulations. He definitely had a lot of people tell him that it couldn't be done.
3. Go with Your Gut - This certainly goes hand in hand with challenging the status quo. Jeff founded StubHub during the dotcom bust and funding for consumer Internet companies was disappearing rapidly. His gut told him the opportunity might not be there in a year and he dropped out of business school to launch the venture. He raised less financing than originally planned but was able to launch the site and was running a business by the time his classmates graduated 9 months later.
4. It's Ok to Exit a Little Early -StubHub was experiencing great growth and hitting it's metrics when Ebay acquired the company in early 2007 It is quite possible that Jeff could have gotten a higher price for the company by waiting, but felt there were a number of benefits to exiting when they did. Besides the natural fit with eBay, he wanted the buyer to feel good following the acquisition and certainly the investors in StubHub were happy. All of this only helps for the next venture.

Here's another bonus lesson. Be passionate about whatever it is you are doing. Any start-up is going to be all consuming and will require a lot of personal sacrifices, so make sure you believe in what you are doing. Dan Gordon, founder of Gordon Biersch, came by my class this week. Prior to founding the brewery, Dan spent five years studying beer in Germany and not the way most college students partake in this particular study. He was the first American in 30 years to graduate from the 5-year brewing program at the Technical University of Munich, the highest technical degree in brewing engineering. Upon graduation, he knew he wanted to open a German brewery restaurant in California and the passion and determination drove a lot of the early success. Brewing a great beer certainly doesn't hurt, which the students got to taste at the brewery after the class.

Buyer's Remorse

Wikipedia (where else would you look....) defines Buyer's Remorse as "an emotional condition whereby a person feels remorse or regret after a purchase" and "a natural human reaction, rising out of a sense of caution". I certainly remember the feeling after buying my first house. The feeling is fleeting and then you go about making the house into your home.

I have noticed this same feeling when making a venture capital or angel investment. While spending time with the entrepreneurs and championing the deal through the group, you tend to become emotionally attached. Of course, rigorous diligence is performed, the team is challenged, and assumptions are tested. Once the point is reached where you want to move ahead, we put the sales hat on and convince our partners about the incredible opportunity that we are lucky enough to be able to invest on the ground floor. However, once the deal is completed and the wire hits the start-ups bank account, all the warts seem to jump out. In most cases, the entrepreneur hasn't hidden anything, it is just buyer's remorse kicking in and the realization that the hard work is beginning. As early stage investors, our goal is to eliminate as much risk as possible with the least amount of cash spent.

Of course, the opposite of buyer's remorse is exercising too much caution and not making an investment where your gut was saying yes. I've found that the opportunities we let pass often stick around longer than many that we do. I started thinking about this yesterday when Jeff Fluhr, founder of Stub Hub spoke at my San Jose State class. I first met Jeff about 8 years ago when he was finishing his first year at the Stanford GSB and was beginning to raise money for a business plan he developed for a secondary market ticket exchange. This was the beginning of the dot com bust and getting a consumer deal through the partners at my venture firm was next to impossible. I liked the founders and considered making a personal investment, but ended up passing.

However, I was glad to see they were able to raise financing and launch the service. I used it as a buyer and seller on a number of occasions and rooted from the sidelines for their success against the Ticketmaster, state regulators and others trying to knock them down. Jeff was able to build a profitable company and a successful exit when Ebay acquired Stub Hub for $300 million early last year. Jeff shared some entrepreneurial lessons with the class and I may include in a subsequent blog post.

Of course, I'm not the only one to feel this way. I was listening to a podcast recently on Venture Voice with legendary VC Tom Perkins. When asked the question about the worst investment he ever made, he turned it around to mention the one that got away, Apple. Kleiner Perkins had looked at a few other computer start-ups and weren't interested, so didn't even take a meeting with the Steves. Bessemer Venture Partners lists an anti-portfolio of investments they passed on that includes Apple, Ebay, Intel, and Google.

Now, back to that house in Mountain View, California. Hard to believe you could buy a nice house like that in the Bay Area for only $300,000....