CFO's - More Guardian, Less Angel?

Just received this month's issue of CFO Magazine (yes, I know, it should be a very exciting weekend) and found an article I was interviewed for a couple of months ago. The article, "More Guardian, Less Angel" discusses how CFO's add value to angel groups by helping to kill deals. I spent most of the time with the reporter talking about Sand Hill Angels and how we add value to the start-ups and entrepreneurs that we partner with, which is why I just have a small mention in the article.

It is certainly true that we can pick apart the financial projections or pour through contracts, legal and financial diligence, but none of those areas tend to be the most important areas in deciding whether to make an early stage investment. No company's future ever matches their projections and it is the assumptions and how the entrepreneur understands the market and sees the opportunity evolving that we care about.

As I am quoted in the article, it is easy to pick holes in a business plan. It is certainly good to take an analytical approach to any investment opportunity and many venture capital firms and angel groups do an excellent job of diligence. However, at the end of the day, your gut can tell you a lot more about whether to make an investment or not. How passionate are the entrepreneurs about their business? Can they recruit and get others excited? Do I believe they can succeed? Does the business model pass the smell test?

While no real data exists on returns in angel groups vs. individual angels, I often wonder which is the better way to invest. I enjoy my colleagues at Sand Hill Angels and like investing as a group as it enables us to lead investments, take board seats and have more influence. The downside is the groupthink mentality, which can work in both directions, killing deals and also creating a bandwagon effect. In a lot of our deals, there is often a tipping point where the deal will either move forward or die.

Even though I am an active member of an angel group, I often advise entrepreneurs that they may be better off raising money from individual angels rather than groups. A lot is based on how much money they are raising, terms being sought, entrepreneur's experience, stage and total funding required for the business. I'm going to do some more thinking on this topic and write another post sometime in the near future.

Brickbreaker - Mindless Amusement or Viscious Addiction

I am not sure how this relates to venture finance or entrepreneurship, but I'm sure I'll find some connection along the way. Perhaps, it's that old joke:

Q: What two industries call their customers "users"?
A: Technology companies and Drug dealers

While the fall semester is in full swing, summer doesn't officially end for another few days. Still a good time to revisit what I did over my summer vacation. One thing I spent too much time doing was playing Brickbreaker, the only game that is part of the standard blackberry deck. Brickbreaker is an incredibly mindless game that can be played in spare moments on line, at airports, during boring conference calls, etc. For those of you fond of 1970's nostalgia, the game is similar to the Atari game, Breakout, that was a sequel to Pong. I recall playing this on one of the early Atari systems when I was a teenager.

The object is to knock down rows of bricks by hitting a ball with a paddle that can be moved by the wheel on the device. You start the game with three "lives" but can accumulate many more as you play and advance through the levels. After 34 levels, you start again at level 1 and continue. The game can be stopped and started at any time. In those spare moments, I manged to keep the same game going for several months over the summer and reached a score of 509,090 when I decided it was time to quit and let my remaining lives (somewhere north of 100) die.

The other interesting feature of the game is that you can submit your high score through the device and see where you rank on the list. My score was #471. It did not show how many scores were on the list, but given the number of blackberrys in the market, it has to be a big number. But that begs the question, Who are these other 470 people? Do they have jobs? How much abuse can the wheel on a blackberry take?

I didn't find the answer to any of these questions, but did run across a blog, Brickbreaker Conquest, that shed some light on the question. Here are a couple of those folks:

I’ve been playing my current game for about a month now. My current score is 1,376,500 with 378 lives remaining. My goal is to get in the top ten and then kill myself off. I’m spending way too much time on this thing and frankly has been an addiction worse than crack! Somebody help me! Seriously, I am having a blast knowing that I am going to be in the top ten in the world pretty soon!

For all you that can’t believe the scores out there, it is possible. I recently broke through the 2×34 level barrier. It took a few months of practice. Once you get past the second round, there are no more bragging rights. Actually the more points you boast, the more you should be scorned for frittering away your life. The game isn’t challenging and becomes boring, a way to pass time only. So if you’ve made it past the second round, pat yourself on the back and forget the game. You’ll be better for it. ps my score is currently 303,070 with 59 lives (no cheats used). Sigh….. This %$#^%$ addiciton!

Back to my point at the beginning of the post. I'm still not actually sure what this says about new venture opportunities, but there are a few points that came to mind:

• Stabilitly of mobile platform - Can you imagine using your PC and not having it crash once in several months? Maybe if you have a MAC, but I've never gotten that kind of stability out of my PC.
• Perhaps there is an opportunity in games for the non-serious gamer. I do have one investment in a company that has developed a platform for in game mobile advertising - Greystripe. They also run a site, Game Jump, that offers free games for mobile devices, many of which are similar style games, such as Tetris, Lego Bricks and Solitaire.
• Finally, in Brickbreaker, the game becomes increasingly more difficult as you work through the first two series of levels, but once you pass in to the third series, it becomes very easy. Maybe this is trying to say that once you reach a certain level in an organization, work becomes easy and boring and it's time to leave and scratch that entrepreneurial itch...

Ok, I admit it. After a couple of weeks off, I have now started another game. See you at the twelve step program.

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....