The Most Important Venture Capital Statistic

A couple of headlines caught my eye in this morning's VentureWire:

• Deals Slow As VC Feels Economic Chill
• Web Video Platform Fliqz Gains $6M In Series C Funding

The funding news and general condition of the economy has been no secret and certainly wasn't a surprise that venture funding in the fourth quarter was the lowest level in four years and most expect the decline to continue at least through the end of 2009. The latest statistics from VentureSource show 554 financings in Q4, down from 620 in Q3 and 718 in Q4 2007. Total amount raised fell from $7.5 billion to $5.5 billion quarter over quarter. First round median investment size fell to $3.8 million and $4.2 million for the year, which is the first time it has been below $5 million since 2001, a sign that capital efficiency will be even more important than it has.

Of course, the most important funding statistic to an entrepreneur relates to one specific company, and whether there is sufficient capital available to build and scale his business. On that front, I take pride in the second headline with news that Fliqz, where I am CFO, just closed on $6 million in Series C financing. From first hand experience, we certainly felt the market conditions and the funding process was much more difficult than anticipated.

I'll share a few points about how we were successful, but most of the credit goes to Benjamin Wayne, founder and CEO of Fliqz, a passionate, strategic and tactical executive. The funding search began the day after Labor Day and continued throughout the fall as the environment continued to worsen, and resulted in a term sheet the day before Thanksgiving.

Here are a few takeaways from the process:

• Extend Runway - As we planned out our investment process last spring, we realized that there were still a number of areas we needed more proof points and the optimal time to raise capital might not be for another 2-3 quarters. We decided to raise some venture debt as an insurance policy and extend our cash runway. We drew $1.5 million from Lighthouse Capital Partners, which ultimately became critical to our balance sheet and they turned out to be a great partner as we worked through the equity financing process.
  

• Evaluate Business and Financing Needs - We initially went out seeking $10 million in financing, but listened to the prospective investors and watched the market. Mid-way through the process, we took another cut at our business plan and built a model where $5 million would be sufficient to get us beyond breakeven. This brought in a new set of prospective investors and required a lower investment from the lead investor as our existing investors were committed and on board.
  

• Don't miss Plan - This may seem obvious, but I've seen a number of CEO's shot for missing the first quarter's numbers after going public, which is a great way to shrink your market cap well before the lock-up period is up. Same principle here. Prospective investors have a free look to see how you execute under the gun. At Fliqz, we met or exceeded the sales plan every month during the due diligence process.
  

• Look beyond the usual suspects - With Mohr Davidow Ventures, one of the premier Sand Hill Road firms already in the company, it would have been easy to focus on a short list of other top tier firms with long track records in the valley. However, as we soon discovered, many of these firms were forced to hoard capital for existing portfolio companies and focus most of their time and energy on deciding which ones deserved these reserves. Some were also dealing with issues of limited partners struggles with capital calls and asset allocations. With that in mind, new funds are a great place to focus. Without all of the legacy issues, they have the capital and time to seek, evaluate and actively work on new opportunities. Our lead investor, Triangle Peak Partners closed on a $170 million first fund in late 2008.

Of course, timing and luck are still a big part of a successful capital campaign, particularly with these market conditions. Many companies that have raised capital are going to need to spend it wisely to win and others will be forced to bootstrap.

Speaking of bootstrapping, this is always a subject near and dear to my heart and I'll be moderating a panel on the topic on March 9th as part of our eminent speaker series at the Silicon Valley Center for Entrepreneurship. More on that in a future post.

Why didn't I think of that??

Great ideas can come from many places. Some result from years of work and/or education while others are a result of trying to identify a unique solution to a consumer or business problem. Of course, there are those that are completely ridiculous (think Pet Rock). We recently had our Neat Ideas Fair, which is my favorite annual event of our Silicon Valley Center for Entrepreneurship at SJSU.

The NIF (in it's 5th year), is essentially a science fair for entrepreneurs. A science fair conjures images of excited middle school kids standing in front of their poster boards explaining which type of paper decomposes the fastest or in my daughter's case, the longevity of chewing gum flavor. Not sure whether she was truly interested in the answer or just thought it was a great way to get her parents to buy her a big stack of gum.

Many entrepreneurial programs feature a business plan competition, which is a great exercise. At SJSU, we also have a business plan competition in the spring, which ideally allows the students to build a viable business model around their NIF projects. However, the NIF forces the students to focus on their idea and ability to communicate it's need, kind of like the Demo conference is all about the product.

The NIF brings together students from all parts of the university (business, computer science, mechanical engineering, design, life science, etc.) to share their passions and projects. Some have developed working prototypes, while others are still at the concept stage and only on posterboard. I really enjoy the collaboration among students in different parts of the university and the excitement of talking about their ideas and thinking through the business potential, particularly for the non-business students.

One of my favorite projects from 2007 was a solar power wetsuit. This was a collaboration between students in industrial design, electrical engineering and business. This team had a working prototype of the first solar powered wetsuit using nano-solar technology. They had done a lot of research talking with surfers and divers, as well as working with O'Neill, one of the leading wetsuit design and maufacturers.

Some of the most popular projects from this year's NIF were:

• I.C.E. - Solar thermal collector that functions as an ince generator to provide cooling through a building
• Tenebra - device with cryptological communication protocol that revolves around a cheap hardware random number generator to enable consumers and businesses to communication with military-grade protection
• Snack Caddy - Reusable tray for carrying snacks and drinks at the movies or other events
  

You can see a description of these and other projects at the NIF site.

Here are a few of the budding entrepreneurs that I chatted with at the event:



Jeff Gibboney, a graduate mechanical engineering student, developed a battery operated skateboard for cruising to school or work. This new mode of transportation included a go-kart wheel, a motor and battery pack from an electric scooter, and sensors from a Nintendo Wii.



Manija Ansari is an undergraduate business student (currently in my Entrepreneurial Finance course), working on a social entreprenurial venture. She has developed a new twist on the micro-lending concept. Unforgettable treasures will provide micro-loans to third world crafts artists to enable them to build their business and will also market their wares through the Internet. She is planning on starting the business upon graduation.





There were a number of green projects at the NIF, including environmental studies major Alan Hackler's Zero Waste Solutions. Alan's concept is a foot pedal operated sink (to save water) that automatically separates compostable and other waste. While many people would have a hard time doing without a garbage disposal some municipalities have banned the use due to the impact to the water treatment systems.

Man Camp

Just returned from a golf trip to Bandon Dunes, Oregon. We played a Ryder Cup style tournament with 16 guys (the motley crew to your left) over 3 days and 72 holes, with a few drinks mixed in. Waking up Monday morning with a golf hangover, I remembered I hadn't had time to prepare for my class that afternoon. This got me thinking about the business model that Mike Keiser has built at the resort and a lecture began to form in my head.

One of the guys on the trip referred to Bandon as Man Camp. If you haven't been, it is difficult to describe the allure. The location is remote (a 3-hour drive from Eugene and over 4 from Portland, with not much in between). Mike Keiser (the founder of Recycled Paper Greetings) had a vision to create a true links experience in the US.

As described by Stepen Goodwin on the book jacket to Dream Golf, The Making of Bandon Dunes, "Bandon Dunes would be a 'pure' golf experience, pitting the golfer against the elements, allowing the land to dictate the course, banning the use of carts, making the golfer feel as one with both nature and the game. To achieve that goal would take a great amount of planning and hard work, the struggle of man against nature in shaping the land into three courses that would become the Bandon Dunes complex. Convention wisdom said it was impossible. And even if he built it, would anyone come to this remote Oregon outpost?" Well, built it he did and they have come. Less than 10 years from the opening of the first course, the $150 million investment has been recovered. And the courses are all ranked in the Top 25 courses open to the public by Golf Digest, with Pacific Dunes (#2), Bandon Dunes (#7) and Bandon Trails (#21).

So what is about the business model that is so successful:

• Focus on your core target market - The original marketing plan for Bandon Dunes is as simple as they come - "Great golf + great food + great people = marketing plan". They have done a great job of serving the market. Although I've seen a few brave women, the resort is full of middle to upper income middle aged guys who love serious golf. The offering is all about golf and camraderie - get there, stay on site, traditional golf, multiple courses, excellent pub food, and of course, the Bunker Bar (complete with poker, pool, stogies, and a bartender that will stay as long as necessary). No spa..yet, but I hear one may be in the plans. A gift shop with nice jewelry is adjacent to the front desk so you don't forget that important purchase prior to checking out, to help with the permission for the next visit. This is not surprising from a greeting card guy, who realized that $5 is expensive for a Valentine's Day card, but incredibly cheap compared to the price if not purchased...

• Manage seasonal demand through pricing - Weather on the Oregon coast can range from gorgeous to downright nasty and can change from one of the other in a matter of minutes. While pricing never approaches Pebble Beach, it can be very expensive during peak season and more difficult to justify to the spouse at home. Both trips I've made have been in early November when prices are reduced by 50%. For the true golf fanatics, the second round of the day is half-price all year and the third is free. Also, if the weather gets really bad, they offer a full refund voucher good for your next trip - all about customer retention.

• Grow organically - It took ten years of planning to get the first course open and nobody had any idea how many golfers would come. Once the first course opened, ground was broken on the second (Pacific Dunes). Several years later, Bandon Trails opened in 1995 and the fourth course (Old Macdonald) is scheduled to open by summer 2010. Certainly there must be a temptation given the success to grow faster or target other segments, but Keiser is committed to staying true to the vision, and making sure everyone can get in 36 holes in a day.I can't wait to go back, which is clearly goal #1 in the list of critical success factors if anyone is still following the business model tangent.
  

I'll leave you with the 11th hole at Pacific Dunes and a link to Dream Golf if you are interested in more of the Bandon Dunes story:

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.